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EC 120 2nd Midterm Study Notes

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Wilfrid Laurier University
Rizwan Tahir

Chapter 7: Consumers, Producers, and the Efficiency of Markets Willingness to pay - Maximum amount a buyer is willing to pay for a good - Demand curve displays WTP for an additional unit of a good - Welfare economics: the study of how the allocation of resources affects economic well being - Consumer surplus: difference between what a buyer is willing to pay and what a buyer actually plays - Graphically demonstrated as above the price line, below demand curve - Farther down on the demand curve, lower the WTP - As price increases, consumer surplus falls o Fall in happiness from those who stop buying, and those who continue to buy o From P1 to P2, and Q1 to Q2 there is a loss of consumer surplus from people who continue to buy the good; and the small triangle is a loss from those who stop buying.  Questions asking to calculate “decrease/increase in consumer surplus”, find area of the rectangle and triangle CS = WTP – Price Paid Willingness to sell - Represents the price at which producers are willing to sell their goods - Since a producer will never sell below cost, we use cost to measure WTS - At each quantity, the supply curve is used to measure the marginal cost (cost to produce one more unit) - Producer surplus: difference between what a consumer is willing to sell their goods for, and what they actually sell the goods for - Graphically demonstrated as below the price line, below supply curve - As price decreases, producer surplus decreases o Due to the decrease in happiness to the suppliers who leave the market and the remaining suppliers who receive a lower unit price o Farther down the supply curve, the lower the WTS o To graph a change in price, move price down. The rectangle between the equilibrium and new price represents loss of happiness with remaining sellers and the triangle represents loss in happiness of producers who left. PS= Price Received – WTS Total Surplus: - Consumer surplus + Producer Surplus - “Value to buyers – Cost to sellers.” - Think: Beyoncé, draw an X and to the left - Allocative efficiency occurs when total surplus is maximized o Buyers who value the good the highest (highest WTP) receive the good, and sellers with the lowest cost (lowest WTS) sell the good - Any type of government distortion of the market is said to have a negative effect on overall surplus o Laissez-faire approach states that the government should not intervene with market interactions ( as they will reduce TS) o Assumptions: all markets are perfectly competitive, market failures are caused by externalities and market power imbalances - Market failures: unregulated markets fail to allocate resources efficiently - Market power: a single buyer or seller can influence market power - Externalities: side effects of transactions (pollution) Chapter 8: The Costs of Taxation Tax Effects: - Include tax revenue in total surplus; leads to good things (roads, etc.) - Decrease in consumer spending, decrease in producer spending (buyers pay more/sellers receive less) o Increase in tax - Loss of total surplus is the deadweight loss (DWL) Minimizing surplus: - The more elastic  larger DWL - The more inelastic  smaller DWL Government Size and Labour Market: - Bigger government = more services = more taxes = greater DWL - Marginal tax rate is almost 50% - If labour supply is inelastic, DWL is small Changes in Tax Size: - Low taxes  increasing/decreasing them has a big effect on DWL o Higher taxes = higher DWL o Lower taxes = lower DWL Laffer curve (upside down parabola): - Shows relationship between size of the tax revenue - When increasing taxes they may lend to an increase in total revenue - At some point total revenue starts decreasing o y-axis: government revenue o x-axis: tax rate Chapter 9: International Trade World Price: - price that prevails in world markets o if PfPw:  that country does not have comparative advantage  country imports  consumers will not pay more than world price  producers will not accept less than world price Import: - if world price is less than domestic price - the difference between quantity demanded/supplied - if it increases consumer surplus by more than it lower producer surplus Export: - if world price is greater than domestic price - the difference between quantity demanded and supplied - if it increases producer surplus by more than it lowers consumer surplus Ex. PfPw Direction Export Import CS Fall Rise PS Rise Fall TS rises Rises Generalities: - trade increases TS; either CS or PS and decreases other by the lesser amount - benefits: increased variety, economies of scale, increased comp/integration - minimal wins for many while huge losses for few Tariff: - a tax on a good that is produced abroad and sold domestically (imports) - creates DWL Quotas: - a quantitative limit on imports of a good - results in reduced imports - raises domestic price of a good - no tariff revenue - reduces imports, domestic consumption and CS - increases domestic production and PS - greater DWL for importing countries - placed parallel to x-axis Arguments against trade: - Jobs o Domestic jobs are lost in competition - National security o Can be compromised if we are reliant on others in production of weapons - Infant industries o Need protection so they can develop - Unfair competition o Foreign producers receiving more government support - Bargaining chip o Restr
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