Microeconomics Exam Review number 2
Microeconomics Exam Review number 2 Econ 10223
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This 10 page Study Guide was uploaded by Jade Frederickson on Monday March 14, 2016. The Study Guide belongs to Econ 10223 at Texas Christian University taught by Dr. Watson in Spring 2016. Since its upload, it has received 119 views. For similar materials see Microeconomics in Economcs at Texas Christian University.
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Date Created: 03/14/16
Microeconomics Review Exam 2 Chapter 6 1 Price controls are usually enacted when policymakers believe that the market price of a good or service is unfair to buyers or sellers a A PRICE CEILING is a legal maximum on the price at which a good can be sold It is NOT BINDING when it is already set above the equilibrium price and it does not affect the price or quantity sold It is BINDING when it is set below the equilibrium price creating a shortage in which goods must be rationed Effect of Price Celiing P P 5 S P Price Ceiiirigi P P Price 39 D P Celiiiiingi Q 7 Q iNonhinding price Binding price ceiling ceiling C A PRICE FLOOR is a legal minimum on the price at which a good can be sold It is NOT BINDING when it is set below the equilibrium price and it does not affect the price of quantity sold It is BINDING when it is set above the equilibrium price creating a surplus in which there are extra goods Effect of Price Fioor P P S Surpius 5 P Price Fioor P P Price P Fioor D D Q Q Binding Price Nonbinding price floor oor 2 A SHORTAGE occurs when there is a binding price ceiling and there are not enough goods for all the buyers demandgtsupply A SURPLUS occurs when there is a binding price oor and sellers cannot sell all that they want supplygtdemand 3 MINIMUM WAGE is a price oor it is the lowest price for labor that any employer may 1333 a If minimum wage is above equilibrium unemployment ensues and there is a higher income for workers who have jobs and lower income for workers who cannot jobs b Those that are more skilled experience no effect because there wages are already above minimum wage meaning that it is non binding c Those that are less skilled and less experienced already have lower wages and therefore the minimum wage is now binding TAX INCIDENCE is the manner in which the burden of a taX is shared among participants in a market The government uses taxes to raises revenue for public projects a When a taX is levied on SELLERS the supply curve shifts left resulting in a higher equilibrium price and a lower equilibrium quantity I taX reduces the size of the market Impact of a 50 Tax on Sellers Price of looOmani cane A tax on sellers ahlifta Prlea S E lib 3 mpg 12 a g the supply 3 30 U WB Upward 39 i S by the amount largest 39 all the tax w 13 quot qu lllbrampllrllj h out tax Prlce sellers recelve Demand D1 0 96 mo Quantity of c When a taX is levied on BUYERS the demand curve shifts left resulting in a lower equilibrium price and a lower equilibrium quantity I taX reduces the size of the market 39 Price Ema rmly 5 hugEars WEI p p E 3 3 H quot quot Equilibrium wriJmuE tax Prim at lTiam IIErEI E j wgmgm 1 333 4 Eliza inn Inuitale 7 39r EJ1le the chairman a 39 r ELJWE39 mammird A 39 If the satT uf Frlee 39 Equilibrium 5 V fall HE Elmira with El 39 E Lila In I I 39 u e No matter who the taX is levied on the effects are the same and the GOVERNMENT still gains money f Chapter 7 Taxes discourage market activity I the burden is shared by both buyers and sellers buyers pay more and sellers receive less As a result the relative positions of the supply andor demand curves shift 6 Welfare economics is the study of how the allocation of resources affects economic well being It studies how both buyers and sellers benefit in market transactions 7 The WILLINGNESS TO PAY WTP is the maXimum amount that a buyer will pay for a good It is how much the buyer values a particular good 8 If the good is priced less than the buyer is willing to pay there is a CONSUMER SURPLUS CS CSWTP price Lower prices raise consumer surplus and also encourage more buyers to enter the market thus raising consumer surplus even more The demand curve is also known as the willingness to pay curve Graphically the CS is the area below the demand curve and above price thisrnatterlom 08 0 5 0 0 O 278 Market consumer Market consumer surplus at market price surplus at market price Additional Pmarkar P mmmmm mt 39 m i I A ower market V mg Additional consumer Df new butters 3i EMS an d39dmgml I sunplus of buyers who the lower39 price 3quot 39 39 were wiiiing to pay the preiiriouis market price Plawar I i i an a 9 2 I r 1 3 EL ll I Demanidi Quantity Demand Quantity 8 Cost is a measure of the WILLINGNESS TO SELL WTS It is the value of everything that a seller must give up to produce a good 8 If the price paid for a good is more than a seller was willing to provide it for there is a PRODUCER SURPLUS PS PSprice WTS The supply curve is also known as the willingness to sell curve Graphically the PS is the area below price and above the supply curve Producer Surplus p5 5x jii2 whoa price FEE Price When Price riEEE to 51E existing EEIErE gai39l 3535524 4quot an fJ i E 2 I Supply V a Whng Price lSE39E IE END new sellers gain ail 555 flualrillitgr Figure Pmd ueer 3111131115 E 9 TOTAL SURPLUS is the combination of both producer and consumer surplus in a market A r Total Surplus 4 a thismattaxom CEQQQ Total unplus consumer Dru s u mer S UWIU S b cm 4 Taxes decrease the s1ze of both consumer and r r i Markeance 23353 producer 1 producer surplus result1ng in a smaller total Surplus i surplus 35 i Bo i i dig5w Chapter 8 L l 9 Quantity 10 DEADWEIGHT LOSS is the fall in total surplus that results from market distortions such as taxes leftward by the size of the taX V 39 Ennsumer fquot surplus sold Q I TR T X Q 1rrl Rent ceilian Producer D swqpllus a b quantity C an E iquot 33 an E a 396 7 1 a Cl 1 i I I 772 39l Elf l 5 CI Guunlil Ehouis nds all units per month AM This is created because a taX shifts both the supply and the demand curves The government receives money from the taX taX revenuesize of taX T X The larger the taX the larger the deadweight SMALL TAX MEDIUM TAX P LARGE TAX 01 00 s a 39 i e The Q Q greater the elasticities of the supply and demand ie the more elastic or at the curve is Pride Pniee 3upply 39 mm the greater the deadweight loss of Nate that the deed weighi Iloee is smaller 1when eunply is inellaetic taxation Dee dweight Le 55 Deedweight Deni and Lose Demeinid Quantity Qua ntiity Price Pniee Sued Sunnw Hate that the dead weight leee ie Smaller when demand is inelastic Demand V Dee dweigm L0 55 Dreeldwenglht DES Demand nuanuty Quan r f Because the deadweight loss is greatest when a good is elastic it is most efficient to taX inelastic goods ie the labor taX i Some people believe that the labor supply is fairly inelastic most people will work full time no matter what so the taX on labor creates a small deadweight loss ii Others believe that the labor supply is more elastic exible hours second earners choosing to retire illegal economic activity so that the taX on labor creates a larger deadweight loss 11 The LAFFER CURVE states that taX revenue will grow over time as the taX size increases but eventually taxes will be so high that it disincentivizes people to work and the amount of taX revenue actually decreases Eqm b um EDMt Mn mmm Revenue quotram 3 Rewanue Mani EEMEHUE 5 Tm Rules mm Chapter 9 12 Trade makes everyone better off but in order to determine whether you should IMPORT OR EXPORT you must compare the domestic price with the world price a If the domestic priceltworld price eXport the good because the country has the comparative advantage b If the domestic pricegtworld price import the good because the world has the comparative advantage c In either situation the domestic price will rise or fall to meet what the world price 1s d For example in an EXPOTING COUNTRY the domestic price rises to meet the world price meaning that there is greater quantity supplied than quantity tr demanded This results in a surplus s which are goods that exported out of F l IT Exports Brigg T H I the country After trade B PROCDUCER SURPLUS has now Emma quot quot39 39 39 39 39 39I39 39 quot increased by the addition of areas B D and F e In an IMPORTING COUNTRY the domestic price drops to meet the world price meaning that there is greater quantity demanded than there is supplied This results in a shortage in which the country imports the rest of the goods in EM 39 After trade CONSUMER SURPLUS a has increased by the addition of areas B and D P rtsvauuuuuuuunnp Imports f Thus importing or exporting increases consumer or producer surplus respectively resulting in an overall increases in total surplus I trade makes everyone better off 13 A TARIFF is a taX on goods produced aboard and sold domestically on imports a Tariffs raise the domestic price above the world price by the amount of the tariff A Price 39 39 5 Demand Cunaum er Surplus Pt ri h I I I n A r L I I I H d F IJ r a I re ulcer MI US Ta Revenue gt 1 H5 Eacietall IE ciEtal g PamId m n quot 391 V EE EE mi A 1 I I I I I I I I I I I I I I I I I I I I i351 quot i352 Q a quot39 D 1 Quantity Quantity I Irmaart HHI39it l39I39I E Humnit mi Import withnut tadFF b A tariff raises prices for consumers resulting in a reduction of consumer surplus but an increase in producer surplus shown by the green and yellow areas respectively The government benefits as well from the taX revenue The amount imported is represented by the long side of the blue rectangle I this is less than what would have been imported had there not been a tariff Finally the reddish areas represent the deadweight loss of a taX the amount of money and goods not recovered by the tariff or taX Total surplus thus decreases by the amount of this deadweight loss c While free trade is best trade with a tariff is still better than no trade at all 14 There are many arguments for RESTRICTING TRADE altogether a The jobs argument trade with other countries destroys domestic jobs but free trade creates jobs at the same time that it destroys them b The infant industry argument new industries need temporary trade restriction to help them get started but the temporary policy is hard to remove C The unfair competition argument free trade is better only if all countries play by the same rules however trade leads to a total surplus for the country as a whole d The protection as a bargaining chip argument trade restrictions can be useful when we bargain with trading partners but the threat may not always work 15 The North American Free Trade Agreement NAFTA was established in 1993 and lowered trade barriers among the US MeXico and Canada 16 The General Agreement on Tariffs and Trade GATT is a continuing set of negotiations among many of the worlds countries with the goal of promoting free trade a It was founded after WW2 in response to high tariffs proposed during the Great Depression b Successfully reduced trade form 40 to 5 c Deals with 97 if the world s trade d Enforced by the World Trade Organization WTO 17 Government action is sometimes needed to improve upon market outcomes when markets fail to allocate resources efficiently This is known as a MARKET FAILURE Government actions can potentially improve the market s allocation of goods a Externalities are the uncompensated impact of one person s actions on the well being of a bystander and are a type of MARKET FAILURE i A NEGATIVE EXTERNATLIY is one in which there is an adverse impact on the bystander such as pollution noise or ugly scenery 1 There is a social cost involved with negative extemalities because there is a private cost to the producers supply and the adverse cost to the bystanders This curve is above the supply curve and yields an optimum less than what the equilibrium was thought to be I means an overproduction terna liiw Price of IStill 1 1 Social Cost Private39Cnst Exte rinal Cost to the Stancietii Equilibrium 1 Pollution Produced Prigte Value POSTIVE D mp m market Quantity of Oil EXTERNALITY occurs when the impact on the bystander is beneficial such as aesthetically pleasing areas education lowering crime rates or iA new technology 1 There is a social value associated with it that is greater than the private value and thus the social value curve is above the demand curve As a result the market can actually produce more than the market equilibrium Price at Rel SUWIF private mat Uptlmum i 39 External Eerief lt EqiLJillllblrium a 1 39 39 Seeialiiialiiie private 1ii39aiilue and external bene t quot Demand private 1iii39ailiiieji Quantity el READ MARHET mIijl iFi39ll39l M U M b So in a negative externality the government must internalize the extemality by altering incentives so that people take account of the external effects of their actions As a result the government establishes a corrective taX so that the market does not produce more than is socially desirable In a positive externality the government internalizes the externality by administering a subsidy so that the market actually produces more than what the supposed equilibrium was i ii Corrective taxes decrease amount produced in negative extemalities Subsidies increase amount produced in positive extemalities 18 Command and control policies regulate behavior directly and are not as fleXible They are more corrective and not as rewarding 19 Market based policies provide incentives so that private decision makers will choose to solve the problem on their own a CORRECTIVE TAXES SUBSIDIES and TRADEABLE POLLUTION PERMITS fall under this category i ii iii Corrective taxes induce private decision makers to take account of the social costs that arise from a negative externality Usually they are used to put a price on pollution in order to reduce pollution costs to society and raise money for the government Tradeable pollution permits can be purchased by producers They give a company the right to pollute up to a certain amount however the permits can be transferred from one firm to another Thus there is a market for these permits that operates outside government in uence Either method allows firms to pay for their pollution corrective taxes you pay to the government whereas pollution permits people pay other companies to buy more permits 20 The COASE THEOREM states that if private parties can bargain without cost over the allocation of resources they can solve the problem of externalities on their own a Interested parties involved in the bargaining will reach an agreement in which everyone is better off and the outcome is efficient b This is a private solution to externalities ie no government involvement whereas the other three solutions are public solutions ie involve outside in uencehelp C Private solutions do not always work because bargaining can incur high costs simply breaks down or there are too many parties involved
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