Microeconomics Exam Review #3
1. There are four types of goods in an economy.
a. PRIVATE GOODS are both excludable and rival in consumption, meaning that it is possible to prevent someone from using it, and if one person enjoys it, someone else cannot.
i. Ex: ice cream cones, clothing, congested toll roads
b. PUBLIC GOODS are neither excludable nor rivals in consumption, meaning that you cannot prevent someone from using the good, and one person’s use of the good does not detract from someone else’s use of the good.
i. Ex: tornado siren, national defense, uncongested nontoll road
c. COMMON RESOURCES are a rival in consumption but are not excludable, meaning that one person’s use of a good prevents someone else from using it, but no one can be prevented from using a good.
i. Ex: fish in the ocean, the environment, congested nontoll road
d. CLUB GOODS are excludable but are not rivals in consumption meaning that you can prevent someone from using the good, but one person’s use of the good does not prevent someone else from using it.
i. Ex: cable television, uncongested toll road
2. A FREE RIDER is a person who receives the benefit of a good but does not pay for it. (Because public goods are not excludable, the freerider is a problem to the economy because it prevents the private market from supplying the goods.) If you want to learn more check out What are the ways to reduce dissonance?
3. Common resources are also not excludable, but because they are rivals in consumption, this gives way to THE TRAGEDY OF THE COMMONS. When something is available for unlimited access, people tend to overuse the good negative externality. If the government steps in and makes this a private good, the problem will most likely (hopefully) disappear.
4. The U.S. TAX BURDEN WHEN COMPARED TO OTHER DEVELOPED COUNTRIES is actually relatively low at only 25%. Countries such as Denmark, Sweden and France have burdens as high as 48%, 45% and 44%, respectively.
5. The federal government EARNS the most on individual income tax, social insurance tax, and corporate income tax, totaling ~$8,000/person. They SPEND the most on income security, health programs and national defense, totaling ~$12,000/person.
6. The state government EARNS the most on sales tax, property taxes and individual income taxes, totaling ~$6,600/person. They SPEND the most on education, health programs and public order and safety, totaling ~$6,900/person.
7. The federal government is clearly operating at a BUDGET DEFICIT, an excess of government spending over government receipts. There would be a BUDGET SURPLUS if there was an excess of government receipts over government spending. We also discuss several other topics like What is the example of carbon nucleophiles for addition reactions?
a. After operating at a deficit for so long, the NATIONAL DEBT has grown to trillions of dollars. Even if there is a surplus one year, it does not mean that the national debt has gone away.
8. The AVERAGE TAX RATE is the total taxes paid divided by total income. For example, if you paid $15,000 to taxes and you made $60,000 dollars, $15,000/$60,000 is a 25% tax rate.
a. The MARGINAL TAX RATE is the extra taxes paid for every additional dollar of income. For example if you made $50,000 and are taxed 20% for the first $50,000 and 50% for anything above that amount, if you made $50,001, your marginal tax rate would be 50%. It is the last tax bracket you pay in.
9. LUMPSUM TAXES are the most efficient type of tax because everyone pays the same amount of tax. There is no distortion in incentives and minimal administrative burden, but there is also no equity.
10. The BENEFITS PRINCIPLE states that people who use a good should be taxed for using that good and benefiting form the government’s service. For example, if you use gas and pollute the environment, then you should pay a tax. We also discuss several other topics like What are the fund-raising methods?
11. The abilitytopay principle states that taxes should be levied on a person according to ability to handle the burden.
a. VERTICAL EQUITY is the belief that taxpayers with a greater ability to pay taxes should pay larger amounts, i.e. richer taxpayer should pay more than poorer taxpayers.
i. PROPORTIONAL TAX: no matter your income, you pay the same percentage of your income (ex: 25% tax) Don't forget about the age old question of What are the judicial standards of review in civil rights cases?
ii. REGRESSIVE TAX: highincome tax payers pay a smaller fraction of their income than do lowerincome tax payers, (ex: 20% and 30%
respectively) aims to decrease the differences in tax amounts
iii. PROGRESSIVE TAX: highincome taxpayers pay a larger fraction of their income than do low income taxpayerscreates greatest discrepancies (USA)
b. HORIZONTAL EQUITY is the belief that taxpayers with similar abilities to pay taxes should pay the same amount, i.e. if you and I make the same amount of money and both have two children, we should both pay the same amount in taxes. We also discuss several other topics like How does a planet gain an atmosphere?
12. Tax incidence is who bears the burden of taxes. In the case of the CORPORATE INCOME TAX BURDEN, a corporation is more like a tax collector and the burden of
the tax actually falls on the people: the corporation is taxed as a whole, and then the workers are also taxed.
13. An OPPORTUNITY COST is what you must give up to get an item that you want. a. An EXPLICIT COST is what we would normally think of when it comes to costs; it is any input cost that requires an outlay of money by the firm.
b. An IMPLICIT COST is the input costs that do not require an outlay of money by firms (it is more so an opportunity cost because it reflects the time or money you are forgoing to do one thing as opposed to another). If you want to learn more check out What are the genetic factors for alcoholism?
c. Total cost (TC) can be measured as implicit cost + explicit cost.
14. ECONOMIC PROFIT is measured as total revenue minus total cost (both implicit and explicit) and ACCOUNTING PROFIT is measured as total revenue minus just explicit costs.
a. Accounting profit will usually be large and positive.
b. If economic profit is negative, you did not cover you opportunity costs, but if it is positive, you should stay in business.
15. The PRODUCITON FUNCTION is the relationship between the quantity of inputs to make a good and the quantity of output of that good.
16. MARINAL PRODUCT is the increase in output that arises from an additional unit of input (ex: the number of cookies more that you make with one more employee). a. The DIMINSHING MARGINAL PRODUCT is when the marginal product of an input declines as the quantity of the input increase (the more cookie workers you have, the less each person can produce, even though costs are still accumulating). This property is reflected by the total cost curve.
17. A FIXED COST is one that does not vary with the quantity of output produced while a VARIABLE COST is one that does vary with the quantity of output produced. a. Total cost also equals fixed + variable costs. (TC=FC+VC)
b. AVERAGE FIXED COST is the total fixed cost divided by the quantity output (AFC=TFC/Q)
c. AVERAGE VARIABLE COST is the total variable cost divided by the quantity of output (AVC=TVC/Q)
d. AVERAGE TOTAL COST is the total cost divided evenly out over all the units produced (ATC=TC/Q). It is also the summation of AFC and AVC
e. MARGINAL COST is the increase in total cost arising from an extra unit of production (MC= ΔTC/ΔQ)
g. The ATC curve is Ushaped because AFC always declines as output increases, and AVC always increases as output increases. At the bottom of the curve is
where the quantity produced will minimize ATC. This is known as the
i. When MC<ATC, ATC decreases
ii. When MC>ATC, ATC increases
18. The ECONOMIES OF SCALE principle states that the longrun ATC will fall as the quantity of output increases because there is increasing specialization among workers. a. DISECONOMIES OF SCALE occur when the longrun ATC rises as the quantity of output increases, due to coordination problems (company has gotten too big).
19. In a COMPETITIVE MARKET, there are many buyers and sellers, all products are identical, there is free entry and exit of firms, and each person is a price taker (no one person can influence the price of a good).
20. In a perfectly competitive market, the price line is horizontal and PRICE=AVERAGE REVENUE=MARGINAL REVENUE.
a. In order to MAXIMIZE PROFIT, a firm should strive to let marginal revenue (MR) equal marginal cost (MC) MR=MC is profit maximizing level of output i. If MR>MC, the firm should increase output
ii. If MR< MC, the firm should decrease output
b. The marginal cost curve determines the quantity of the good the firm is willing to supply at any price it is the supply curve.
21. In the short run, a firm can shutdown and decide not to produce anything, but will still have to pay fixed costs. This is known as a SUNK COST.
a. A firm should shutdown in the short run if TR< VC (Profit<AVC) because it needs to make at least enough money to cover its variable costs.
22. In the longrun, a firm can decide to EXIT the market and then it will not pay any costs at all.
a. A firm should exit the market if its TR<TC (P<ATC) because it is not covering all of its costs adequately.
b. A firm should enter the market if its TR>TC (P>ATC) because it can afford to cover all of its costs.
c. In the SHORT RUN, the SUPPLY CURVE is located on the marginalcost curve above the average variable cost. (If the price falls below the AVC, the firm should shut down.)
i. There are a fixed number of firms in the short run and each firm supplies a quantity where P=MC and when P>AVC, the supply curve is the MC
d. In the LONG RUN, the SUPPLY CURVE the supply curve is on the marginal cost curve and above the ATC. (IF the price falls below the ATC, the firm should exit the market.)
i. In the long run, firms can enter and exit the market.
ii. If P>ATC, firms make positive profit and new firms will enter the market. iii. If P<ATC, firms make negative profit and firms will exit the market. iv. The process of entry and exit ends when firms still in the market make zero economic profit (P=ATC).
v. The long run supply curve is perfectly elastic.
g. In the short run, an increase in demand leads to an increase in price, leading to short run profits, leading to an increase in supply, leading to a decrease in price, and a restoration of long run equilibrium (no profit).
23. The PROFIT CALCULATION for a firm can be calculated as TRTC, but on the graph, it can be calculated as profit= (PATC) Q.
24. A MONOPOLY a market system in which there is only one seller of a product and the product does not have any close substitutes.
a. Arises due to barriers to entry:
i. A monopoly owns the sole resources to producing a good.
ii. The government’s regulations have established a monopoly (patent, copyright).
iii. The monopoly has the best and most efficient production process.
b. Price maker and thus has a downward sloping demand curve.
a. Where MR=MC, MC being the supply curve, is the profitmaximizing level for a monopoly, and then you trace your line up to the demand curve to determine what the price of the good should be. From there, profit it determined the same way as in a competitive market, profit = (PATC) Q.
b. Despite this calculation, monopolies choose to produce at a level where MR=MC, which is less than what is socially efficient. This creates a DEADWEIGHT LOSS, which is measured by the triangle between the demand curve and the MC curve.
26. PRICE DISCRIMINATION is the practice of selling the same good at different prices to different customers as rational strategy to increase profit.
a. Eliminates deadweight loss because each buyer pays what they are willing to pay and the monopoly gets the entire surplus.
b. Require the ability to determine each buyer’s willingness to pay. c. Examples: movie tickets, airline prices, discount coupons, financial aid