ECO- Test 2 Study Guide
ECO- Test 2 Study Guide Eco2023
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This 8 page Study Guide was uploaded by Cara Johnson on Monday October 26, 2015. The Study Guide belongs to Eco2023 at Florida State University taught by Dr. McCaleb in Fall 2015. Since its upload, it has received 79 views. For similar materials see Microeconomics in Economcs at Florida State University.
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Date Created: 10/26/15
Test 2 Study Guide Elasticities of Demand and Supply The demand for a good is elastic if when it s price changes the percentage change in the quantity demanded exceeds the percentage change in price The demand for a good is inelastic if when its price changes the percentage change in the quantity demanded is less than the percentage change in the price The price elasticity of demand for a good depends on how easy it is to nd substitutes for the good and on the proportion of income spent on it Price elasticity of demand A Quantity DemandedA Price Elasticity gt 1 demand is elastic Elasticity lt 1 demand is inelastic Elasticity 1 demand is unit elastic Elasticity 0 demand is perfectly inelastic If demand is elastic a rise in price leads to a decrease in total revenue If demand is unit elastic a rise in price leaves total revenue unchanged If demand is inelastic a rise in price leads to an increase in total revenue There is no relationship between elasticity and slope Mid Point method If you don t know the percentage change in quantity demanded use this to calculate it as a percent of average of new and initial A Quantity new quantity initialnew quantity initial2 x 100 Same for price Plug into A Quantity DemandedA Price for elasticity The supply of a good is elastic if when its price changes the percentage change in the quantity supplied exceeds the percentage change in the price The supply of a good is inelastic if when its price changes the percentage change in the quantity supplied is less the percentage change in price The main in uences on price elasticity of supply are the exibility of production possibilities and the storage possibilities Cross elasticity of demand shows how the demand for a good changes when the price of one of its substitutes or complements changes Cross elasticity is positive for substitutes and negative for complements Income elasticity of demand shows how the demand for a good changes when income changes For a normal good the income elasticity of demand is positive For an inferior good the income elasticity of demand is negative Ef ciency of Competitive Markets The methods of allocating scarce resources are market price command majority rule contest rstcome rstserved sharing equality lottery personal characteristics and force Allocative ef ciency occurs when resources are used to create the greatest value which means the marginal bene t marginal cost Marginal bene t is measured by the maximum price consumers are willing to pay for another unit of a good or service A demand curve is a marginal bene t curve Value is what people are willing to pay Price is what they must pay Consumer surplus the area of the triangle above the price and below the demand curve Marginal cost is measured by the minimum price producers must be offered to increase production by one unit A supply curve is a marginal cost curve Opportunity cost is what producers must pay Price is what producers receive Producer surplus the area of the triangle below the price and above the supply curve In a competitive equilibrium marginal bene t marginal cost and resource allocation is ef cient Price and quantity regulations taxes subsidies externalities public goods common resources monopoly and high transactions costs lead to market failure and create deadweight loss Deadweight loss is the loss of consumer and producer surplus happens from either underproduction or overproduction Ideas about fairness divide into two groups fair rules and fair result Fair rules require private property rights and voluntary exchange Fair result requires income transfers from rich to poor Invisible Hand Principle open competitive market and unregulated prices allocate resources ef ciently Sources of market inefficiency Taxes and subsidies Regulated prices and quantities 0 Positive and negative externalities Public goods Monopoly and other limits to competition 0 Asymmetric information Taxes and Subsidies Consumer and producer surplus are less than without the tax or subsidy The loss in consumer and producer surplus creates a deadweight loss Tax incidence Legal incidence who is legally liable for payment of the tax determined by the tax laws 0 Economic incidence who ultimately bears the real economic burden of the tax determined by the market forces of demand and supply unrelated to legal incidence Determining Economic Incidence o If price is higher by the full amount of the tax then the economic burden of the tax is on the buyer 0 If the price is the same with or without the tax the real economic burden is on the seller 0 If the price is higher but by less than the full amount of the tax the economic burden is split between the buyer and seller No matter who bears the legal incidence Perfectly inelastic demand buyer pays Perfectly elastic supply buyer pays Perfectly elastic demand seller pays Perfectly inelastic supply seller pays General Principle 0 Whichever side of the market has better alternatives will have a higher elasticity and will be more able to avoid the tax 0 Whichever side of the market has less alternatives will have a higher inelasticity and will be less able to avoid the tax Price Ceilings and Price Floors A price ceiling set above the equilibrium price has no effect A price ceiling set below the equilibrium price creates a shortageunderproduction and increased search activity or a black market A price ceiling is inefficient and unfair A rent ceiling is an example of a price ceiling A price oor set below the equilibrium price has no effect A price oor set above the equilibrium price creates a surplusoverproduction and increased search activity or illegal trading A price oor is inefficient and unfair Minimum wage is an example of a price oor A price support increases the quantity produced decreases the quantity consumed and creates a surplus To maintain a support price the government buys the surplus and subsidizes the producer A price support is inefficient and usually unfair Effects of rent control on rental housing markets Decrease in quantity of rental housing 0 Decline in quality Inefficient use of rental housing space housing gridlock Who gains from rent control 0 Consumers who obtain rentcontrolled housing units and who don t move again 0 These people tend to be 0 Older more established longerterm less transient 0 Middle and upper income with good credit 0 Better connected with better access to market info 0 In possession of skills valued by landlords VVholoses Anybody who is unable to nd the quality and quantity of rental housing Tend to be 0 Younger new to community 0 Have lower incomes with no or poor credit 0 Lack connections and do not have access to good market info 0 Have families especially larger families 0 Individuals who choose not the live in the community because of shortage Taxpayers who bear the cost of enforcing ordinances o In the long run even in rentcontrolled apartment may lose if they pay a lower price and quality goes down Price gouging is temporary and usually only during times of extreme need or tragedy or state of emergency With no antiprice gouging laws the incentives are 0 More likely to not buy extra conserve leaving more available to others 0 Greater supply With antiprice gouging laws no incentive to Conserve Bring in extra supplies Price Floors Ef ciency in the market Demand for labor is employers Supply for labor is workers Equilibrium quantities are ef cient Price oor above equilibrium is inef cient creates unemployment Who gains 0 Workers who succeed in obtaining as many hours of employment as they want at the higher wage 0 Higher wage workers often unionized for whom lowwage unskilled workers are substitutes By raising the wage that employers must pay for lowerwage unskilled workers minimum wage makes that worker less competitive with higher wage workers VVholoses Employers Lowwage unskilled workers who are unable to nd work 0 Workers who initially nd jobs but use their extra wage searching o All lowwage unskilled workers may lose in the long run if employers substitute labor for capital ls minimum wage effective 2550 of workers who earn minimum wage are not poor 0 More than half of poor people do not work 0 Minimum wage is not high enough to lift minimum wage workers out of poverty Externalities External costs are costs of production that fall on people other the producer of the good or service Marginal social cost marginal private cost marginal external cost Producers take account only of marginal private cost and produce more than the ef cient quantity when there is a marginal external cost Sometimes it is possible to overcome a negative externality by assigning a property right When property rights cannot be assigned government might overcome a negative externality by mandating clean technologies imposing pollution taxes or using a capandtrade program External bene ts are bene ts that are received by people other than the consumer of a good or service Marginal social bene t marginal private bene t marginal external bene t External bene ts from education arise because bettereducated people are better citizens commit fewer crimes and support social activities Vouchers or subsidies to private schools or the provision of public education below cost can achieve a more ef cient provision of educa on Negative Externalities Private cost amp social cost with externality 0 MC MEC MSC An external cost creates a wedge between social cost and private cost 0 Social cost will always be greater than private when a negative externality is present lnef ciency o Equilibrium l S D MB MB lt MSC 0 At equilibrium MB lt MSC inef cient because of overproduction o Creates deadweight loss Overproduction and overconsumption Correcting negative externalities Problem overproduction Solution decrease quantity 0 Possible policies to decrease 0 Regulation 0 Marketable permits 0 Pollution taxes and emission charges 0 Reduction of pollution abatement Pollution taxes 0 With tax MSC MC Tax 0 Tax increases costs of production and provides incentive for producer to reduce quantity Advantages of markets prices and incentives over regulation Align private incentives with social objectives 0 Provide incentives for polluters to conform with social policy 0 Allow pollutees freedom to determine how they will meet social objectives Incentives to reduce pollution at lowest possible cost Positive Externalities 0 Private bene t and social bene t with an externality o Marginal social bene t marginal private bene t marginal external bene t 0 External bene t creates a wedge between social and provide bene t lnef ciency with External Bene t 0 At equilibrium MSB gt MC the equilibrium quantity is inef cient because of underproduction Deadweight loss is created lnternalizing Positive Externalities Problem underproduction Solution increase quantity 0 Possible policies 0 Regulation 0 Public provision 0 Producer subsidies o Vouchers consumer subsidies Producer Subsidies 0 Payment from government to supplier With subsidy tuition costs are lower for students HINT How big does subsidy have to be to achieve number wanted Same amount as positive externality MEB The Coase Theorem 0 Private bargaining can correct for an externality 0 When conditions of the Coase theorem are met government actions to correct for an externality are unnecessary The individuals who are affected by an externality have the incentive to negotiate an ef cient solution o If property rights are clearly de ned and enforced only a small amount of individuals are involved and transaction costs are low then private negotiation among affected individuals can correct the inef ciency that arises from an externality Common Resources 0 A resource for which rights are held in common by a group property rights are not clearly de ned and are nonexclusive An individual who has the right to use the resource but not to change its form or transfer to others would increase the value of the resource 0 An individual has no guarantee of future use of the resource no future interest lnef ciency of Market Equilibrium Characterized by overproduction only face private cost not social cost 0 DWL from overproduction Achieving Efficient Quantity 0 Production quotas 0 An upper limit to the quantity of a good that may be legally produced 0 But also has disadvantages Every incentive to ignore regulation and catch more sh 0 lTQs right to catch sh 0 Sell permits to others if you re willing to catch less 0 Private Property Rights 0 With property rights S MC MSC o No one else is impacted by the amount of sh you take because you own them 0 Lack incentives for conservation with common ownership 0 Property rights encourage ef cient conservation for the future as well as ef cient use today 0 Prevent depletion As resource becomes scarcer supply decreases price rises Higher prices provide incentives for consumers to conserve for present and future
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