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ECON101 Midterm 2 notes

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ECON 101
Shannon Hartling

ECON101- CHAPTER NOTES (MIDTERM 2) CHAPTER 5: Efficiency & Equity • Social interest: 2 dimensions  efficiency & equity (fairness) ResourcesAllocation Methods • Market Price: people willing and able to pay that price get the resource  too poor, or choose not to pay market price won’t get the resource • Command: system allocates by order/command of someone in authority  method works poorly for large range of activities that need to be monitored  used widely in firms & government • Majority Rule: majority of voters choose  affect large # of ppl, must put away self-interest • Contest: winner(s)  used when efforts are hard to monitor, so rewards creates motivation and more effort automatically • First-come, First-served: first in line gets resource  used when resource can only serve one user at a time • Lottery: pick winning number/draw lucky cards/gaming system winner gets resource  used when there’s no effective way to distinguish potential users • Personal Characteristics: basis of personal characteristics (“right” characteristics will get resource)  can be used in unacceptable ways (discrimination) • Force: used for good and ill o Ill: wars, theft o Good: transferring wealth from rich to poor, force of state upholds principles of laws to protect properties Demand & Marginal Benefit • Resources allocated efficiently when: marginal benefit = marginal cost   to determine competitive market’s efficiency, must look at equilibrium • Demand, willingness to pay, value: value = what we get, price = what we pay  demand curve is marginal benefit curve o Marginal benefit: value of one more unit of food/service • Individual Demand: relationship bt price and quantity demanded of good by one person • Market Demand: relationship bt price and quantity demanded by all buyers o ** market demand curve = horizontal sum of individual demand curves of each price ** o Think of: price = dollars’worth of other goods willingly forgone to obtain one good • Consumer Surplus: value/marginal benefit of good minus price paid for it, summed over quantity bought  area below consumer’s demand curve, but above market price o All goods have decreasing marginal benefit 1 Supply and Marginal Cost • Market supply reflects marginal cost  firms = businesses trying to profit • Supply, cost, minimum Supply-Price: cost = what producers give up, price = what prod receive • Marginal Cost: cost of producing one more unit of good • Supply curve = marginal cost curve • Individual Supply: price of good & qty supplied by one producer • Market Supply: price of good & qty supplied by all producers  same thing, horizontal sum of indiv supply curves forms qty supplied in market supply curve • Producer Surplus: price received for good minus its minimum supply-price  triangle area above supply curve, below market price •  Consumer surplus & producer surplus can measure market’s efficiency Is the Competitive Market Efficient? • Marginal social benefit (MSB): demand curve for good where it’s only beneficial for those who buy it • Marginal social cost (MSC): supply curve for good where it’s only beneficial for those who produce it for entire society • Efficiency depends on where MSB (demand) & MSC (supply) intersect (aka its equilibrium)  if qty exceeds, marginal costs more to prod than the value consumers place on it  if qty less, the marginal value if higher than cost for it to be produced • Efficient qty produced = total surplus (consumer + producer) is maximized,  promoting social interest 2 Underproduction & Overproduction • Underproduction: producing too little, so total surplus is smaller than maximum  inefficient, and deadweight loss (↓ in total surplus from inefficient lvl of production) • Overproduction: producing too much, causes wasted resources  reduces total surplus to less than maximum with deadweight loss (social loss) • Obstacles of Efficiency: bring over/under production o Price & Qty Regulations: cap put on the limit/permit a minimum or maximum amt of goods o Taxes: & Subsidies: taxes ↑ price for buyers, ↓ prices for sellers = underproduction  subsidies (payments from gov’t to producer) ↓ price for buyers, ↑ price for sellers = overproduction o Externalities: cost/benefit that affects someone other than seller/buyer  ext2costs (CO emitted by electric utility = overprod) & ext benefits (smoke detector ↓ fire risk = underprod) o Public Good & Common Resources: public good = good consumed simultaneously even without paying (eg. National defense), underprod  common resource = used by everyone, overprod o Monopoly: firm is sole provider of good  underprod o High Transactions Costs: opportunity costs of making trades in market are too high  too costly to operate  underprod • Alternatives to the Market: inefficient markets can use other alternative methods to ↑ efficiency  sometimes possible o Ex. Majority rule attempts to improve allocation, but inefficiency hits when majority pursues their self-interest o Ex. Managers command/avoid transactions costs o Ex. First come, first serve ensures honoured trades atATM Is the Competitive Market Fair? • Natural disaster hits  prices of essential items jump bc demand & willingness to pay has ↑, but supply hasn’t changed • Fairness: (1) not fair if result isn’t fair, (2) not fair if rules aren’t fair • 1. Unfair if Result isn’t fair: people’s incomes are too u▯eWRONG idea = efficiency req equality of incomes o Utilitarianism: greater happiness for the greatest #  the gain is more than the loss o Big Tradeoff: tradeoff bt efficiency & fairness  achieve transfer by taxing higher income ppl more, will overall shrink economic pie (↓ labour & capital)  More redistribution via income taxes, ↑ inefficiency, ↓ economic pie  Adollar from rich person, doesn’t always end up in hands of poor person  Definitely says fairness doesn’t req equality of incomes 3 o Make Poorest as Well-Off as possible: soln to Big Tradeoff  goal to make the piece of economic pie of poor person as big as possible (bigger share of smaller pie can be less than smaller share of bigger pie) • 2. Unfair if Rules aren’t fair: symmetry principle = req ppl in similar situations be treated similarly (aka. Equality of opportunity)  2 rules: (1) state must enforce laws to protect private property, (2) private property can be xferred bt ppl voluntarily o Ex. Majority rule system = strong ppl have enough resources to influence opinion achieve this o If 2 rules are enforced for symmetry principle, then there would be no obstacles of efficiency CHAPTER 6: Government Actions in Markets AHousing Market with Rent Ceiling • Price Ceiling/Price Cap: gov’t regulation making it illegal to charge price higher than specific lvl  if cap above equilibrium = no affect, if cap below equilibrium = force of law & market forces conflict • Rent Ceiling: price ceiling applied on rent  if below equilibrium can cause: o Housing Shortage: demand of housing exceed qty supplied, ∴ shortage of housing o Increased SearchActivity: time spent looking to do business  opportunity cost = price + value of search time spent finding good, ∴ more time spent searching = ↑ cost o Black Market: illegal market with exceeding equilibrium to price ceiling  rent = maximum price a renter willing to pay • Inefficiency of Rent Ceiling: causes underproduction if cap is below equilibrium  MSB>MSC causing deadweight loss to shrink total surplus • Are Rent Ceilings Fair? o Fair rules? No, blocks voluntary exchange o Fair results? Yes, outcome benefits ppl that are less well-off o ∴, fairest = allocate housing to poorest ppl  alternative mechanisms: lottery, first come first serve, discrimination Labour Market with Minimum Wage • Labour Market: influences jobs we get & wages we earn • Price Floor: gov’t-imposed regulation making it illegal to charge price lower than specified lvl  if below equilibrium = no affect, if above equilibrium = force of law & market conflicts • Minimum Wage: price floor applied to labour market  above equil causes unemployment o Qty of labour supplied exceeds qty of labour demanded, ∴ surplus = unemployment • Inefficiency of Minimum Wage: ↑ unemployment, ↑ job search  full loss = deadweight loss + ↑ cost of job search • If Minimum Wage Fair? o Fair rules? No, blocks voluntary exchange o Fair results? No, only ppl w jobs/keep their jobs benefit  unemployed = worse 4 Taxes • Tax Incidence: division of burden of tax bt buyers & sellers • Taxed items can: o Raise price buyers pay, ∴ burden only on buyers o Raise price buyers pay but less than total tax, ∴ burden shared by buyer & seller o Not change price buyers pay, ∴ burden only on seller • Tax on Sellers: causes new Supply + tax curve  shift up/left of original curve bc ↑ cost will ↓ supply o Causes: ↑ buyer’s price, ↓ seller’s price received • Tax on Buyers: lowers amt willing to pay sellers, ↓ demand  shift new Demand – tax curve leftward o To figure out shift: same qty, just ↓ down by $ imposed of tax • Burden can’t be shared equally  will have same affect on either buyer or seller • Tax Incidence & Elasticity of Demand: division of burden depends on elasticity of demand o Perfectly Inelastic: VERTICAL demand curve  ∴, buyers pay all tax o Perfectly Elastic: HORIZONTAL demand curve  ∴, sellers pay all tax • Tax Incidence & Elasti
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