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NYU / Engineering / ECON 101 / What is a stock variable?

What is a stock variable?

What is a stock variable?

Description

School: New York University
Department: Engineering
Course: Introduction to Microeconomics
Professor: Professor bhiladwalla
Term: Fall 2016
Tags: micro, Microeocnomics, and Economics
Cost: 50
Name: Microeconomics Fall 2016 Study Guide
Description: Hello All! This study guide summarizes all the chapters we have reviewed and learned about this semester...terms and concepts are underlined and highlighted and a list of formulas are included. I have also included detailed notes from Week 10 (chapters 14 and 15) into this study guide. Hope this helps! Good Luck!
Uploaded: 12/14/2016
25 Pages 9 Views 18 Unlocks
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December 4th, 2016  


What is a stock variable?



Microeconomics Fall 2016 Study Guide  

Final: December 15th, 2016  

NOTE:  

words in red indicate important TERMS that one should definitely familiarize oneself with   the underlined terms are CONCEPTS one should familiarize oneself with  

SUMMARYS  

Chapter 1: What is Economics?  

 —economics: the study of choice under scarcity  

 —opportunity cost

 -what we must give up when we make a choice  

 -the second best alternative  

 —the four types of resources 

 -land, labor, capital, entrepreneurship  

 -in order to produce and enjoy more of one thing, society must shift resources  away from producing something else  We also discuss several other topics like What is th difference between occupation and role?

 —microeconomics  

 -studies the behavior of individual households, firms and governments as they  interact in certain markets  

 —positive vs normative statements  

a An increase in the personal income tax will slow the growth rate of the economy.  positive 


What are the two types of data?



 b The goal of any country’s economic policy should be to increase the well-being of its  poorest, most vulnerable citizens. normative  

 c The best way to reduce the national poverty rate is to increase the federal minimum  wage. normative  

 d The 1990s were a disastrous decade for the U.S. economy. Income inequality increased  to its highest level since before World War II. positive  Don't forget about the age old question of What are the 4 major factor that contribute to implants?

Chapter 2: Scarcity, Choice and Economic Systems  

 —postitive possiblites  

frontier (PPF) 


What are the characteristics of a perfectly competitive market?



 

 —the law of increasing opportunity cost  

 -the more of something we produce, the greater the opportunity cost of  producing still more  

 -even when we’re operating inside the PPF (below fully utilized level), it’s not  easy/costless to move to the PPF curve itself and avoid opportunity cost (OC)   —specialization  If you want to learn more check out Replication and pairing of homologous chromosomes with two rounds of division creating four daughter cells.

 -each person and firm concentrates on one activity in order to maximize  productivity  

 -this enables people/consumers to enjoy higher living standards   -we increase living standards this way because of comparative advantage   —allocation of resources 

 -traditional economy  

 -command economy  

 -**market economy**: the one we have; resources are allocated primarily  through individual choice  

 —capitalism  

 -private ownership of resources; it helps direct resources in ways that create  benefits for others  

Chapter 3: Supply and Demand  

 —perfectly competitive markets 

 -many buyers and sellers  

 -each buyer and seller regards the market price as given   -not much influence on price  

 —supply and demand 

 -explains how prices are determine in perfectly  If you want to learn more check out What are the Symptoms of Depression?

competitive markets  

 -quantity demanded (QD): total amount buyers  

would choose to buy given the constraints that they face  We also discuss several other topics like what are the common destructive patterns in relationships?

 -law of demand: QD is negatively related to price and  so slopes downward  

 -quantity supplied (QS): the total amount of a good  

or service that sellers choose to produce at a given price  

 -law of supply: GS is upward slope  

 —shifts in demand curve are due to…  

 -income, wealth, tastes, price of substitutes and complementary goods and  expectations

 —shifts in supply are due to…(AKA new supply curve)  

 -change in prices of input, prices of alternate goods or alternate markets, the # f  firms, expectations and changes in weather  If you want to learn more check out What did Gregor Mendel do?

 —**when it’s a change in price we move along the demand curve**   —equilibrium P and Q: when S and D intersect  

Chapter 4: Working with Supply and Demand  

 —governments intervene in markets through…  

 -price ceilings  

 -price floors  

*they are designed to prevent the market from reaching an equilibrium*   -taxes  

 -subsidies  

*this is to change the market equilibrium directly*  

 —the housing market  

 -a highly leveraged financial investment  

 -its supply curve tells us the quantity (number of homes) that exist   -its demand curve tells us the number of homes that the population (people) would like  to own; slopes downward because housing has ongoing costs like interest   -the lower the price of a home, the lower the monthly ownership cost and the most  attractive owning would be to renting  

 -while prices are usually stable, restrictions on a new building or an unexpected increase  in demand would cause housing prices to increase  

 —stock variable: exists at a particular point in time  

 —flow variable: over a period of time  

Chapter 5: Elasticity  

 —elasticity: a measure of the sensitivity of one economic variable to another   —price elasticity of demand 

 -the percentage change in QD divided by the % change that caused it WITHOUT the  negative sign  

 -it varies along the demand curve  

 -more elastic up and leftward on the curve  

—price elasticity of supply  

 -the % change in QS divided by the % change in price  

 -usually greater in the long run than in the short run

 —income elasticity of demand  

 -the percent change in QD divided by the percent change in income that causes  it  

 —cross price elasticity of demand  

 -the percent change in the QD of one good divided by the percent change in  the price of some other good  

 -can be either positive or negative  

Example:  

 

 —price elasticity of supply  

 -the percent change in quantity supplied divided but the percent change in  price  

Chapter 6: Consumer Choice  

 —the budget constraint  

 -tells us the combination of goods a consumer can afford given his/her constraints (like  income and prices charged for each good)  

 -an increase in income shifts the budget line  

 -a change in price causes the budget line to rotate  

 —a consumer’s goal is to achieve the highest level of satisfaction or utility affordable   —preferences are rational  

 —“more is better”  

 —marginal utility approach  

 -the consumer chooses the combination of goods/services along his/her budget line   —indifference curve  

 —substitution effect  

 -when a rise in price causes a consumer to buy more of a relatively lower-priced good  and less of a higher-priced one 

 -always negative for the seller 

 —income effect

 -a change in demand of a good or service brought on my a change in the consumer’s  income  

 -this comes into play when either a person’s aggregate level of income increases or the  relative P of goods decreases  

*the substitution effects dominates the income effect*  

Chapter 7: Production and Cost  

 —business firms combine inputs to produce output  

 —in the short run (SR)..  

 -at least one of the firm’s inputs is fixed  

 —in the long run (LR)  

 -all inputs can be varied  

 —cost of production  

 -the OC of its owner  

 -everything the owners must give up in order to produce output   —the least cost rule  

 -firms use different combinations of input  

 -produce any output using the combination of inputs that costs the least   -in the SR, a firm has at least one fixed input (usage cannot be changed)   -variable inputs (usage can be changed) give rise to variable costs  NOTE: for the LR, there are no fixed costs  

 —marginal cost (MC)  

 -the change total cost from producing ONE MORE unit of output   -U-shaped  

 -the marginal cost curve must cross each of the average curves at their minimums    

—the average variable cost curve  

 -U-shaped  

 —average total cost curve  

 -U-shaped  

 —LR average total cost curve (LRATC)  

 -indicates the cost of producing each quantity of output with the least cost input mix   -slopes downward when there are economies of sale and continues until the firm  reaches its minimum efficient scale  

 -slopes upward when there are diseconomies of sale

—types of inputs 

 -lumpy inputs: Q cannot be changed gradually as output increases but only in large  jumps (can be in SR or LR)  

 -fixed inputs 

 -variable inputs 

Chapter 8: How Firms Make Decisions-Profit Maximization  

 —economic profit 

 -equation: revenue-expenses (costs)  

 -these costs include production, implicit and explicit costs  

 —firms face two constraints  

 -1st: there is a maximum price that a firm can charge at whatever output and that is  indicated on the demand curve  

 -2nd: more output means greater costs  

*this is why firms must consider both revenues and costs*  

 —marginal revenue (MR) 

 -the change in total revenue from producing one more unit of output   -when MR >MC then you should increase output  

 -when MR<MC, then you should lower the output  

NOTE: the maximizing output level is the one CLOSEST to where MR=MC   -if profit is negative but MR>MC the firm should continue producing in the SR;  otherwise shut down and suffer a loss that is equal to fixed cost  

 -in the LR, if a firm is at a negative profit (MC>MR), then it should exit the market  —Accounting Profit vs Economic Profit 

 -accounting profit: total revenue-explicit costs (like wages, salaries, rental payments,  etc…)  

 -economic profit: total revenue-total costs (both explicit AND implicit)  

Chapter 9: Perfect Competition  

 —characteristics of a perfectly competitive market 

 -a large number of buyers and sellers  

 -standardized product  

 -sellers can easily enter or exit from the market  

 -buyers and sellers are well informed

*in the real world economy, it is rare that the market will meat ALL of this criteria*   —horizontal demand curve  

 -it can sell as much as it wishes at the market price  

 —firms increase their output until the marginal cost is equal to the market price   —in the SR…  

 -the market price is determined where the market supply curve crosses the market  demand curve  

 -when at an equilibrium, existing firms can earn a profit (at this point there will be new  firms entering because they also want to make a profit) or suffer a loss (existing firms will  exit the market because they aren't making a profit either)  

 -entry/exit continues until each firm is earning zero economic profit   —when the demand curve shifts, prices change more to react to that shift in the SR than in  the LR  

 -the exaggerated prices act as market signals; this ensures that output is either  expanding or contracting in order to match these demand patterns  

 —in the LR… 

 -in an increasing cost industry: the increase in demand results in higher market prices   -in a decreasing cost industry: the increase in demand results in lower market prices   -in a constant cost industry: the increase in demand results in an unchanged market  price (the supply curve would be horizontal in this type of industry)  

 —a technological advance causes the equilibrium P to fall and the equilibrium Q to rise   -firms MUST use updated technology in order to survive, but consumers reap the  benefit by paying the lower price  

 —a perfectly competitive firm faces a perfectly elastic demand curve at the market price   —if a firm produces positive output…  

 -that means it produces the Q at which the market P is = to the MC  

Chapter 10: Monopoly  

 —monopoly firm 

 -the only seller of a good or service in a market  

 -this happens because of some sort of barrier to entry (this could include economies of  sale, legal barriers, network externalities)  

 -the monopoly must decide what prices to set in order to maximize profit   —single-price monopolist  

 -produces the Q that will equate to MR=MC and set the price that will enable it to sell  that Q  

 —monopoly profit can exist in the long run because of barriers to entry   -HOWEVER, monopoly profit can be reduced with government regulation and costs of  rent seeking activity  

 —monopolies produce less output and charge higher prices than perfectly competitive  markets  

 —if D for a monopoly’s product increases, the monopoly will charge a higher P and increase  production

 —price discrimination  

 -both firms and monopolies sometimes practice this  

 -charging different prices to different consumers: they must first identify the customers  who're willing to pay more and to prevent low price customers from selling to high price  customers  

ex: the use of coupons in grocery stores-it takes time to clip them and keep track of them. as a  result, coupons are used by only a small number of shoppers, those who value their  time a little less  

 —perfect price discrimination  

 -every consumer is charged the highest price they are willing to pay   —economies of sale 

 -the declining average total costs  

 -due to high fixed costs to entry  

 -it is not profitable for a second firm to enter the market because the cost to enter is not  worth the value  

 (and this is a big reason why there are monopolies in our economy)  

Chapter 11: Monopolistic Competition and Oligopoly  

 —oligopoly 

 -a few sellers in the market  

 -a market structure dominated by a small number of strategically interacting firms   -when there is a high degree of market concentration, strategic interaction becomes  more likely  

 -new entry is deterred due to economies of sale, repetitional barriers, strategic barriers  and legal barriers  

 -it can be hard to predict because each firm in whatever industry has to anticipate its  rivals’ reactions  

 —market concentration can be measured by  

 -concentration ratio  

 -Herfindahl-Hirschman Index  

 —game theory  

 -to help combat the issue of anticipating rivals’ decisions in order to make its own  decisions  

 -a payoff matrix indicates the payoff to each firm for each combination of strategies   -dominant strategy is most efficient  

 -if there is no cooperation amongst firms (every man for himself), any firm that has that  dominant strategy will play it and this helps predict the outcome of “the game”   —some firms in oligopolies can/do cooperate to increase profits  

 -explicit collusion: an actual agreement  

 -price-fixing agreement: the most extreme form is a cartel (but this is legal in the US and  many other countries so they engage in tacit collusion, etc)

Chapter 12: Labor Markets  

 —factor markets  

 -resources are traded  

 -firms are demanders and households are the suppliers  

 —perfectly competitive labor market  

 -there are many buyers and sellers of standardized labor  

 -easy entry and exit of workers  

 -well-informed workers and firms  

 —derived demand 

 -the demand for labor by a firm that derives from the demand for the product that the  firm is producing/selling  

 —each firm faces a market-determined wage rate  

 —the labor demand curve 

 -slopes downward  

 -output effect (one reason why is slopes downward): @ higher wage rates, the firm  produces less output)  

 -input-substitution effect (the other reason why the curve slopes downward): @ high  wage rates the firm substitutes other inputs for that type of labor  

 -a new or cheaper input will shift the demand curve rightward if the input is  complementary with that labor and leftward if the input is substitutable with that labor   —labor supply curve  

 -slopes upward  

 -more people will want to work in a labor market at higher wage rates   -shifts rightward when more people become qualified, alternative labor markets  become less attractive or when tastes change in favor of that labor market

 —the labor demand curve and labor supply curve intersect to determine the market wage  rate and employment in each labor market  

 —wage differences 

 -arise from differences in ability, human capital costs, characteristics of a job, etc…   -small differences in ability can create extremely large wage differentials   -created by unions, discrimination and occupation licensing AKA barriers to entry   —in order to reduce the income inequality, a frequent proposal is to raise the minimum wage  

Chapter 13: Capital and Financial Markets  

 —a firm that rents its capital equipment  

 -can use the marginal approach to profit to decide how much to rent   -the firm will increase its use of capital as long as the additional net revenue per period  exceeds the rental cost of the capital  

 —a firm that purchases it capital equipment  

 -its is more complex  

 -requires a comparison of future receipts with the current purchase price   -calculation help make these comparisons  

 —principle of asset valuation  

 -when there is complete certainty about future receipts, the value of any asset is the  total present value of all the future income the asset will generate  

 -with no risk the firm should buy any unit of capital that has a total present value of all  the future years’ net revenue and is greater than the purchase price  

 -present value is smaller when interest rates are higher  

 —higher interest rates discourage investment in physical capital  

 —bonds 

 -a financial asset  

 -the P of a bond will equal the total present value of its future payment (ignoring the risk  involved with bonds)  

 -there is an inverse relationship between the P of a bond and its rate of return because  when there is a risk, the P of a bond will be less than its present value  

 —stock 

 -another financial asset  

 -this is when you won a share of a company  

 -the value of a share of corporate stock would equal the total present value of the future  after-tax profits of the firm divided by the number of shares outstanding(ignoring  uncertainty)  

 -when we take uncertainty into account, the value of a share will be less than the  presented value  

 -we come up with the P for a share by locating the intersection of the vertical S curve  and downward-sloping D curve  

 —efficient markets theory  

 -the price of an asset quickly gathers up and incorporates all available information that  would help enable someone to predict its future price

Chapter 14: Economics Efficiency and Competitive Ideal  

 —pareto improvement  

 -an action that makes at least one person better off and does not harm anyone   —when a market is economically efficient… 

 -all of the Pareto improvements have been applied  

 -it requires more than just productive efficiency  

 -can be viewed as the outcome that maximizes total benefits in the market (the sum of  consumer and producer surplus)  

 —when the market economy deviates from the efficient quantity this result in dead weight  loss  

 -the value of potential benefits not achieved due to inefficiency  

 -when theres a change in equilibrium quantity due to a price ceiling or price floor, there  is a decrease in total benefits and therefore creates a deadweight loss  

 -it also occurs when a competitive market is monopolized  

—side payments  

 -if one side of the market makes a special kind of payment to the other   ex. the owner of an empty lot wants to build a movie theatre and although  many people do gain from the theatre, nearby residents might be harmed because the  theatre will ring noise and traffic  

 if total benefits are $100,000 and total harmed is value at $70,000   building the theatre alone would not be considered a Pareto  improvement because others would be hurt even though this benefits some   but we can change this by conducting a side payment   if side payment is $80,000, those who benefit are left with $20,000(still a  again) and those who lose end up gaining $10,000  

*ANY payment between $70,000 and $100,000 would make building the theatre an  improvement*  

 —the appropriate side payment is not always easy to arrange  

Chapter 15: Government’s Role in Economic Efficiency  

 —the government contributes to economics efficiency in two ways  

 -1st: it establishes the legal and regulatory systems that enables the market system to  function  

 -2nd: it steps in to correct certain/specific market failures (meaning that without the  government intervening it would be inefficient)  

 —market power  

 -a type of market failure  

 -also derives from patents and copyrights  

 -possessed by a monopoly

 -the government tries to eliminate market power through anti trust laws   -a common solution isa regulated price that includes a fair rate of return for owners   —externalities*  

 -unpriced by -products of economic transactions that affect others (in other words, kind  of like the unexpected cost of doing something that affects others unintentionally)    

small example every morning there’s a nosy truck that take a short cut off a highway and past  a private resident’s house waking him up (negative externality)  

 —the driver benefits: saves time  

 —the resident doesn’t: loses sleep  

*as long as the rights to the road are clearly defines, the efficient outcome WILL result without  direct government intervention  

if harm($10) >benefit($4)  

 —resident will tell trucker to not use the road  

 —net benefit 6  

if benefit($10)>harm($4)  

 —the trucker with make a side payment to access the road (between 4 to 10)   =net benefit>0  

what if the trucker has the right to the road?  

 “well i have the right to the road and i will use it”; $4 of harm is created , benefit is 10  and so net benefit is 6, which is greater than 0  

THEREFORE, we just showed the outcome will be efficient no matter what party has the right  to the road as long as the property right is define  

NOTE: we are assuming that side payments do NOT have transaction costs  

—Coase Theorem  

 -under certain conditions, the market can solve the externality problem with private  action  

—pure public goods  

 -nonrival and non excludable  

 -a form of market failure  

 -private firms will not provide them and the efficient price is zero   -provided by government at no charge  

—asymmetric information  

 -when it leads to adverse selection, moral hazard or the principal-agent problem, it  can create market failures  

—solutions to market failures are often imperfect and can introduce their own inefficiencies  —Public Goods (type of market failure)

 -governments generally rely on taxation to generate enough revenue to fund the  public good  

 -pure public goods suffer from the free rider program  

—Information Summary (type of market failure)  

-excludable good: those who are unable to pay for a good are prevented from  consuming it  

 -rival good: consumption of a unit of a goof means that no one else can consume that  good  

 -pure private good: when a good is both excludable and rival  

—Additional Notes 

 -a natural monopolist chooses its quantity of production by setting MR=MC   -a natural monopolist will the charge the maximum price that it can charge at a Q   -a firm will exit the industry is if suffers economic losses  

 -moral hazard: the tendency of an agent who cannot be perfectly monitored to  engage in behavior that is undesirable to the principal  

Chapter 16: Comparative Advantage and the Gains from International Trade   —when a country has comparative advantage of a good, it means it can produce this good  at a lower opportunity cost than another country  

 —when countries specialize in the production of said goods, world production rises   -both countries end up benefiting  

 —terms of trade 

 -the distribution of the benefits between countries  

 -the rate at which imported good are traded for exported goods   —the downside 

 -those who supply goods have to compete with cheaper imports are negatively affected   -those who are affected encourage the government to block or reduce trade through  the use of tariffs (taxes on imported goods) and quotas (limits on volume/number of  goods)  

 —both tariffs and quotas decrease the gains from trade  

 —strategic trade policy 

 -the idea that governments should help certain industries and that it can be justified in  certain situations  

 -this is applied to markets dominated by a few large firms (oligopoly) and infant  industries  

Formulas to Remember  

Average Fixed Cost (AFC)  

 —the quantity supplied to market by producers  

total fixed cost (TFC)/quantity supplied (QS)  

ATC-AVC  

Average Variable Cost

TVC/QSATC-AFC  

Average Total Cost  

AVC+AFC  

Average Product  

TP/units of labor  

Marginal Cost  

TFC+TVC  

Marginal Product  

the change in total price (TP)/the change in labor  Total Cost  

TFC+TVC  

Total Revenue  

P x QS  

Total Product  

TR-TC  

Average Revenue  

TR/QS  

Marginal Revenue  

the change in total revenue/change in QS  

Cross-Price Elasticity  

the % change in QD of Good 1/the % change in P of Good 2  Income Elasticity  

the % change of QD divided by the % change of income  negative=inferior  

positive=normal  

Elasticity of Demand  

the % change in QD/the % change in P  

Break Even Point  

when the ATC intersect D  

Maximize Profit  

MC=MR  

Maximize Revenue  

MR=0  

the Herfindahl-Hirschman Index  

summing the squares of market share of each firm in an industry

Chapter 14: Economic Efficiency and the Competitive Ideal  

The Meaning of Economic Efficiency  

 —efficiency  

 -the absence of waste  

 -the waste of an opportunity to make someone better off without harming  anyone else  

 —economic efficiency is achieved when all activities that can make at least one person  better off without making anyone else worse off at taking place  

 —an efficient economy is not necessarily a fair economy  

Pareto Improvements  

 —Pareto improvement  

 -any actions that makes at least one person better off and does not harm  anyone  

 ex. when two kids exchange their sandwiches at lunch because they prefer the  other  

 —hundreds of million of Pareto improvements take place every day   ex. if you pay $30 for a pair of jeans then the jeans must be worth more than  the $30 paid; thus you are better off after making a purchase  

 —economic efficiency  

 -a situation in which every possible Pareto improvement is being exploited   -the term in applied loosely because no market or economy can exploit all  Pareto improvement that are possible  

 -an economy that encourages Pareto improvement and exploits them is  regarded as an efficient economy  

 -requires that goods be allocated among consumers in a way that exploits all  Pareto movements  

Side Payments and Pareto Movements  

 —side payments  

 -if one side of the market makes a special kind of payment to the other   ex. the owner of an empty lot wants to build a movie theatre and although  many people do gain from the theatre, nearby residents might be harmed because the  theatre will ring noise and traffic  

 if total benefits are $100,000 and total harmed is value at $70,000   building the theatre alone would not be considered a Pareto  improvement because others would be hurt even though this benefits some   but we can change this by conducting a side payment   if side payment is $80,000, those who benefit are left with $20,000(still a  again) and those who lose end up gaining $10,000  

*ANY payment between $70,000 and $100,000 would make building the theatre an  improvement*  

 —the appropriate side payment is not always easy to arrange

Competitive Markets and Economic Efficiency  

Reinterpreting the Demand Curve  

 -  

 

—Flo values this guitar lesson more than anyone else but will not spend over $25 per lesson   -anything below $25 she will buy  

 -when she decides to buy the lesson, she has to be getting a value that is forth (even if  just a little) more than the $25 she is giving up  

 -each consecutive lesson is worth a little less to Flo (first $25, then $23, then $21)  —the height of the market demand curve at any quantity shows us the value of the last unit of  the good consumed  

Reinterpreting the Supply Curve

—this depicts those who supply guitar lessons  

—@ a P of $13, Martin would offer one lesson, @ a P of $15, Martin would offer two lessons per  week etc..  

—it tells us the Q supplied at each P  

—it tells us the minimum P a seller must get in order to offer/supply the lesson  —it takes higher prices to get more supply of something; in this case higher prices get more  lesson…why?  

 -offering lessons is COSTLY to guitar teachers (rent studio space and use up time  —the height of the market supply curve @ any Q shows us the additional cost of the last unit of  a good supplied  

How Perfect Competition Ensures the Efficient Quantity  

 —at equilibrium for supply and demand curves, the value where they intersect is also  considerer the economically efficient quantity  

 -this means that all Pareto movements have been exploited   —a well functioning, perfectly competitive market will automatically achieve the  efficient quantity  

 -the economy will not overproduce the less-popular goods or under-produce  the goods that are more popular  

Measuring Market Gains  

Consumer Surplus  

 —consumer surplus: the difference between the value of a unit of a good to the buyer  and what the buyer actually pays for it  

 —market consumer surplus

 -the total consumer surplus enjoyed by all consumers in the market   -on a graph, it would be the shaded area under the demand curve and above  the price  

Producer Surplus  

 —producer surplus: the difference between what the seller actually gets for a unit of a  good and the cost of providing this unit of it  

 —the price of something minus the lowest amount that would get the producer to sell/ supply it (it would be the good or service)  

 —market producer surplus  

 -the total producer surplus gained by ALL sellers in a market   -on a graph, it would be the shaded area above the market supply curve and  below the market price  

Total Benefits and Efficiency  

 —market consumer surplus

 -the area under the demand curve and above the market price   —market producer surplus

 -under the market price and above the supply curve

 —total benefits  

 -the sum of consumer and producer surplus in a particular market   —each time a Pareto movement is made it increases total benefits   —a market is efficient when total benefits are maximized in that market  

Inefficiency and Deadweight Loss  

The Inefficiency of a Price Ceiling  

Deadweight loss—dollar value of potential benefits not achieved  

 —inefficiency in a particular market  

 -the loss of potential benefits (measured in $)  

the loss of potential benefits (measured in dollars) due to a deviation from the efficient  outcome  

A is the producer surplus after the price ceiling, B and the area next to it is the loss after the  price ceiling  

what is the source of inefficiency? underproduction  

Calculating the Deadweight Loss  

 —(1/2) x base x height  

The Inefficiency of a Price Floor  

consumer surplus before the floor is the big triangle below the $19  

where is the floor price? above equilibrium  

short side of the market? demand  

underproduction is 1,000, and then find the area of supply and demand only at that interval  and that is what you use to calculate the measure of inefficiency  

after the floor, only H becomes the surplus  

total area of the triangle is 26,000  

DWL=(1/4)(4)(1000)=2000  

Market Power:  

recall:  

a firm that has some degree of market power can influence the price of its product  

Market Loss  

 —monopolists, oligopolists, and monopolistic competitors have some degree of  market power because they set price in order to maximize profit  

 —monopoly and imperfectly competitive markets are generally inefficient

 -prices are too high and output is too low for it to maximize the total benefits in  the market  

The Deadweight Loss from Monopoly  

DWL=300,000=1/2(200,000)(5-2)  

=unshaded triangle  

CS+PS that is lost on units that would have been produced if the industry was perfectly  competitive

Taxes and DWL  

Recall (chapter 4)  

 —imposing a tax on a competitive market changes the equilibrium (P.Q) AWAY from  the efficient level and creates a DWL  

Impact of an excise tax on a competitive market:  

ex) consider the impact of an excise tax on a competitive market for airline travel  pre-tax market equilibrium =(Q*-22, P*=400)  

=efficient outcome—max total surplus  

Deadweight Loss From an Excise Tax  

Q* falls to 12  

P* rises to 500  

Buyers pay $500 per ticket and sellers receive $300  

difference is $200  

total revenue  

=12 m(200)=$2400 million  

post tax CS and PS shrink  

DWL>0  

when demand is more INELASTIC

more of a welfare loss  

all else equal, taxes create smaller deadweight losses when they are imposed on markets in  which …  

if you're the government and you want o raise revenue by imposing taxes, which of these  markets would you get more revenue from? elastic or inelastic demand market?   —-efficiency loss in inelastic market is much smaller than in elastic

Chapter 15: Government’s Role in Economic Efficiency

The Legal and Regulatory Infrastructure  

Economic Role of Law  

 —the law encourages people make choices that will improve Pareto movements  and not harm others in any way  

 -if we didn’t have laws, people would try to benefit themselves  economically at the expense of others  

 —the law supports an pushes through Pareto improvements that would have  otherwise been difficult/impossible to take place  

 -this is done through contract law: establishes procedures for  compensation and fuels productivity  

Regulation  

The Importance of Infrastructure  

 —there is a strong relation between infrastructure and output per worker   —americans take their infrastructure for granted; other countries have their  authorities stealing from them and quite a few are low key run by mafias  **legal and regulatory infrastructure create fertile ground for markets to operate and  generate Pareto movements**  

what role should the government play in economic life  

 —markets may fail to provide an efficient level of some goods OR fail to provide them  at all  

 -can the government correct this situation??  

examples: physical infrastructure,  

 institutional infrastructure  

Market Failures  

Consider the following cases of market failures:  

 —monopoly markets  

 —externalities  

 —public goods  

 —information summary  

Monopoly  

reminder: faces downward sloping demand curve  

consumer surplus and producer surplus is NOT maximized  

 -price is too hight and output is too low

the government is not against all monopolies….but if theres a market in which they feel it will  be better if there wasn't a monopoly and a free market instead and break up the monopoly   ex. standard oil  

there are cases where the government encourages monopoly  

 —uses patents and copyrights in order to encourage new discoveries and innovation   -provides incentive to make new discoveries  

 -keeps prices low so that the efficient quantity will be provided  government tries to balance two conflicting interests  

 —of providing incentives to make new discoveries and  

 —of keeping prices low  

 

Special Case of Natural Monopoly  

ABF trainee would be deadweight welfare loss without regulation  

CBC is with the regulation  

best thing for the regulator is to charge a price that will cover monopoly's long run average  cost  

“fair rate of return”  

 —monopoly makes zero economic profit  

 —price covers all costs including ALL opportunity costs of owners’ funds  Externality

 —ex1.your roommate is indulging in an activity that gives him/her pleasure, like  listening to music  

 -but it’s keeping you up at night  

=External Cost; negative externality  

 

 —ex2. walking to the train station and you walk by a garden  

 -it smells nice, gives you pleasure but it wasn’t built for you  =External Benefits; positive externality  

think about utility companies emitting carbon dioxide in the air  

 —negative externality  

..these companies and these people don't take these costs into account  how much are valuing this thing you are enjoying eve if it wasn't meant for you  

under certain conditions, the two parties can work things out without the government  intervening to try to resolve this externality  

example (small). very morning there’s a nosy truck that take a short cut off a highway and  goes past a private resident’s house waking him up  

 —the driver benefits: saves time  

 —the resident doesn’t: loses sleep  

*as long as the rights to the road are clearly defines, the efficient outcome WILL result without  direct government intervention  

if harm($10) >benefit($4)  

 —resident will tell trucker to not use the road  

 —net benefit 6  

if benefit($10)>harm($4)  

 —the trucker with make a side payment to access the road (between 4 to 10)   =net benefit>0  

what if the trucker has the right to the road?  

 “well i have the right to the road and i will use it”; $4 of harm is created , benefit is 10  and so net benefit is 6, which is greater than 0  

THEREFORE, we just showed the outcome will be efficient no matter what party has the right  to the road as long as the property right is define  

NOTE: we are assuming that side payments do NOT have transaction costs  Coase Theorem

 —when a side payment can be arranged and negotiated without cost, the private  market will solve an externality problem on its own always arriving at the efficient outcome   —the allocation of legal rights determine gains and losses among the parties  (distribution) but does not affect the action taken  

 —same outcome, different distribution  

 —if trucker has right, resident makes side payment and vice versa  this theorem works, but not in all cases  

the condition is satisfied if  

 1. legal rights are CLEARLY defines  

 2. the number of people involved is very small  

the thing is…  

 —usually the number of people involved is not small  

in such cases, it’s difficult to know the benefit and harm to each and costly to get even  benefiting to contribute towards side payments  

NOW we need government intervention  

the role of government in resolving negative externalities  

 —there is a market for gasoline  

negative externality..the competitive market over produces

 

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