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Study guide midterm#2

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by: Dannit Cohen

Study guide midterm#2 ECO 211

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Here you have a studyguide of the content that will be evaluate the proffesor Spigelman on the second midterm. It includes all the class notes, graphs, and possible test questions.
Econ Principles and Problems
David Spigelman
Study Guide
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This 12 page Study Guide was uploaded by Dannit Cohen on Tuesday November 3, 2015. The Study Guide belongs to ECO 211 at University of Michigan taught by David Spigelman in Fall 2015. Since its upload, it has received 587 views. For similar materials see Econ Principles and Problems in Economcs at University of Michigan.


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Date Created: 11/03/15
ECO 211 Chapter 7: Consumer, Producers and efficiency of markets  welfare economics: the study of how the allocation of resources affects economic well-being  Consumer surplus: difference between their willingness to pay and what they have to pay. o Lower prices raises consumer surplus, and higher prices decreases it. o Consumer surplus= value to buyers – amount paid by buyers. o Area below the Price that consumer’s wat to pay.  Producer surplus: difference between their willingness to sell, and the Price they actually sell it. o Higher prices raises producer surplus, and lower prices decrease it. o Producer surplus= amount received by sellers- cost of sellers.  Total surplus: Total surplus in a market is the total value to buyers of the goods, as measured by their willingness to pay, minus the total cost to sellers of providing those goods. o Is the area between the supply and demand curves up to equilibrium quantity. o Total surplus= value to buyers- cost to sellers  The benevolent social planner: o If an allocation of resources maximizes total surplus it is considered, that the allocation exhibits efficiency. o If an allocation is not efficient, then some of the potential gains from trade among buyers and sellers are not being realized. o In addition to efficiency, the social planner might also care about equality—that is, whether the various buyers and sellers in the market have a similar level of economic well-being. o The gains from trade in a market are like a pie to be shared among the market participants. o That the forces of supply and demand allocate resources efficiently.  Producer and consumer surplus in market equilibrium: o The equilibrium outcome is an efficient allocation of resources. o Equilibrium that maximizes the total benefits to buyers and sellers.  Dead way loss- dead way gain  Loss in total surplus- gain in total surplus  Loss in welfare- gain in welfare  Loss in efficiency/inefficient- efficient  two insights about market outcomes: o 1. Free markets allocate the supply of goods to the buyers who value them most highly, as measured by their willingness to pay. o 2. Free markets allocate the demand for goods to the sellers who can produce them at the lowest cost. o 3. Free markets produce the quantity of goods that maximizes the sum of consumer and producer surplus.  The Efficiency of the Equilibrium Quantity o At quantities less than the equilibrium quantity, such as, the value to buyers exceeds the cost to sellers. At quantities greater than the equilibrium quantity, such as, the cost to sellers exceeds the value to buyers. Therefore, the market equilibrium maximizes the sum of producer and consumer surplus. Chapter 8: the cost of taxation  Deadweight loss of taxation o Impact of a tax on a market outcome is the same whether the tax is levied on buyers or sellers of a good. o When a tax is levied on buyers, the demand curve shifts downward by the size of the tax. o When it is levied on sellers, the supply curve shifts upward by that amount. o When the tax is enacted, the price paid by buyers rises, and the price received by sellers falls. o The elasticities of supply and demand determine how the tax burden is distributed between producers and consumers. This distribution is the same regardless of how it is levied. o The tax places a wedge between the price buyers pay and the price sellers receive. Because of this tax wedge, the quantity sold falls below the level that would be sold without a tax. In other words, a tax on a good causes the size of the market for the good to shrink. o A tax on a good places a wedge between the price that buyers pay and the price that sellers receive. The quantity of the good sold falls. o Tax revenue equals the area of the rectangle between the supply and demand curves.   Welfare with Tax o Taxes have deadweight losses because they cause buyers to consume less and sellers to produce less, and these changes in behavior shrink the size of the market below the level that maximizes total surplus. o A tax on a good reduces consumer surplus (by the area) and producer surplus (by the area). Because the fall in producer and consumer surplus exceeds tax revenue (area), the tax is said to impose a deadweight loss (area). o When there is no tax, tax revenue equals cero. o The equilibrium of supply and demand maximizes the total surplus of buyers and sellers in a market. When the government imposes a tax, it raises the price buyers pay and lowers the price sellers receive, giving buyers and incentive to consume less and sellers an incentive to produce less. As buyers and sellers respond to these incentives, the size of the market shrinks below its optimum. Thus, because taxes distort incentives, they cause markets to allocate resources inefficiently.  The Source of a Deadweight Loss o The fall in total surplus that results when a tax (or some other policy) distorts a market outcome is called a deadweight loss. o When the government imposes a tax on a good, the quantity sold falls from to. At every quantity between and, the potential gains from trade among buyers and sellers are not realized. These lost gains from trade create the deadweight loss.  The Determinants of the Deadweight Loss o The price elasticities of supply and demand, demine if the deadweight loss from a tax is large or small. They measure how much the quantity supplied and quantity demanded respond to changes in the price. o The more elastic the demand curve, the larger the deadweight loss of the tax.  How Deadweight Loss and Tax Revenue Vary with the Size of a Tax o The deadweight loss is the reduction in total surplus due to the tax. o Tax revenue is the amount of the tax times the amount of the good sold. o Small taxes has small deadweight loss, meanwhile larger taxes have larger deadweight loss. Chapter 9: international trade  The Equilibrium without International Trade o When an economy cannot trade in world markets, the price adjusts to balance domestic supply and demand. o People have to compare the Price of a product in their current country vs the Price of the same product in other country.  If the Price of the product in the international market is higher than the domestic Price, the country will export.  If the Price of the product in the international market is lower than the domestic Price, the country will import the products.  International Trade in an Exporting Country o Once trade is allowed, the domestic price rises to equal the world price. o After the domestic price has risen to equal the world price, the domestic quantity supplied differs from the domestic quantity demanded. o If the domestic quantity supplied is greater than the domestic quantity demanded, the country sells textiles to other countries. (Exporter). o Sellers benefit because producer surplus increases by the area. o Buyers are worse off because consumer surplus decreases by the area. o Because the gains of sellers exceed the losses of buyers by the area, total surplus increases. o There is only government revenue when there is TAX o  International Trade in an Importing Country o Once trade is allowed, the domestic price falls to equal the world price. o Imports equal the difference between the domestic quantity demanded and the domestic quantity supplied at the world price. o Buyers are better off (consumer surplus rises), they benefit o Sellers are worse off (producer surplus falls). o Total surplus rises by an amount equal to area D, indicating that trade raises the economic well-being of the country as a whole.  The Effects of a Tariff o Tariff: tax on goods produced abroad and sold domestically o A tariff reduces the quantity of imports and moves a market closer to the equilibrium that would exist without trade. Total surplus falls by an amount equal to area. These two triangles represent the deadweight loss from the tariff. o Tariff reduces the domestic quantity demanded and raises the domestic quantity supplied. o The tariff reduces the quantity of imports and moves the domestic market closer to its equilibrium without trade. o Domestic sellers are better off, and domestic buyers are worse off. o The government raises revenue. o A tariff causes a deadweight loss because a tariff is a type of tax. o Tariff distorts incentives and pushes the allocation of scarce resources away from the optimum. o Consumer gain when the Price is lower. o Consumer loses when the Price is higher. o If trade is efficient welfare goes up. Chapter 10: externalities  If we try to optimize the allocation of public goods, we need to identify marginal cost and marginal benefit.  Externality: something that is side effect of market transaction, it increase or decrease welfare. o Positive externality: increase welfare.  Ex: public education.  o Negative externality: decrease and reduce welfare.  Ex: pollution.  Types of taxes: o Progressive tax: when you tax rich people. o Regressive tax: when you tax poor people. o Flat tax: everyone has to pay the same rate (tend to be more regressive)  People like this because they want to reduce tax compliance (the cost of paying income taxes)  Simplify the tax code. o Negative income tax: possibly a way to encourage to improve the minimum standard of living. If you are below the poverty line, you dint pay taxes, instead, you receive money from the government.  You need to have a real job.  Hard to implant and monitor. o Lump sum tax: per head tax. It wouldn’t distort economic behavior. (efficient)  Is very unequable. o Piguvian tax:  Idea: maximize welfare  If it is a negative externality we tax the producer, supplier.  Subsides the consumer.  We should add the external cost to the private cost, to have an accurate vision, to increase welfare.  If we implement Peruvian taxes and subsidies correctly we will maximize welfare.  If we tax the externality, we get to the highest welfare solution.  NO hay welfare loss en PIguvian  Efficiency Vs equity o West European countries and Scandinavian countries are more equity (fair) o US is more efficient. Chapter 11: Public goods and common resources  Categorizing goods o Rival: if someone use or do something with a good, that diminish the ability of someone else to use that good o Excludable: prevent someone to use that good. If you pay for it is excludable, if you don’t, then is not excludable. Chapter 13: the cost of production  Firms set output when mc=mr  C=5+q 2  Constant: fc  El termino que acompaña a q: vc  Marginal revenue: increase the benefits of the industry by increasing the output.  For a competitive firm p=mr q fc Vc c mc Afc Avc Ac R π 0 5 0 5 0 -5 1 5 1 6 5 1 6 5 -1 2 5 4 9 5/2 2 9/2 10 1 3 5 9 14 5/3 3 14/3 15 1 4 5 16 21 5/4 4 21/4 20 -1 5 5 25 30 1 5 6 25 -5 Cost C=fc+vc Marginal cost: the increase in ∆???? Mc= ∆???? total cost that arises from an extra unit of production Average cost ???? Ac=???? Average fixed cost: ???????? Afc=???? Average variable cost: Avc=???????? ???? Revenue R= PxQ ???????? ???????? ???? Afc+Avc=Ac ????+ ???? = ???? profit Π=R-C Π= (P-Ac) Chapter 14:  Competitive market= perfect competition  What is competitive market? o Market with many buyers and sellers. o Trading identical products. o Each buyer and seller is a Price taker. o Firms can freely enter and exit the market. o Cero profit in long-run equilibrium. o Firms are homogeneous: produce identical products, use same technologies. o The opposite from competitive market is monopoly. o When mc=mr firms set output  Profit maximization o The firms maximize profit by producing the quantity ay which marginal cost equals marginal revenue. Quantity (Q) Total revenue Total cost (tc) Profit (π) Marginal Marginal cost Tr (pxq) revenue (mr) (mc) 1 6 5 1 6 3 2 12 8 4 6 4 3 18 12 6 6 5 4 24 17 7 6 6 5 30 23 7 6 7 6 36 30 6 6 8  Profit maximization for a competitive firm o Always an horizontal line: if Price goes up, the marginal cost and the demand will go up.  What does it mean that Price is determine by technology in a competitive market. o Firms in order to survive have to adapt and adopt the technologies and skills, and consumers will notice/get that. Firms have to be at the point of beauty, and in order to do that, firms have to pick the most efficient technology. o Las firms para sobrevivir tienen que adoptar nuevas tecnologías para sus productos. Si esto es asi, el consumer se va a dar cuenta y va a pagar los nuevos precios  Long run o Demand is horizontal because firms are Price takers. o What do I mean by the phrase the long run supply curve is horizontal in a competitive market?  Supply curve is horizontal because it always has to be in the point of beauty. Firms are going to adjust. If the Price is high firms are going to enter to the market, if the Price is low, firms will get out of the market, so the supply curve will always be in the point of beauty.  It means that in long run, firms have free entry and exit. So, if the Price is high, firms will enter, and if the Price is low firms will leave. So, the firms adjust a go back to the point of beauty making supply curve horizontal.  Shut down rules:  P<AC shutdown o Marginal revenue=Price  Short run o Line of AVC is different from AC o P<AVC shutdown Chapter 15: Monopoly  Monopoly: o A firm is a monopoly if it is the sole seller of its product and if its product does not have close substitutes. o The fundamental cause of monopoly is barriers to entry: A monopoly remains the only seller in its market because other firms cannot enter the market and compete with it. o There is always a welfare loss in monopoly. o In monopoly one firm controls everything. o The firm is the industry. o The marginal revenue curve will bisects the demand curve. o Level of output=q , then you go up to the curve, and that point will help us to define quantity and Price. o Restrict the output: the Price goes up, the consumer surplus decreases and the producer surplus increases. o Monopoly will:  Restrict output.  Raise the Price. o Natural monopoly: the average cost is always a downward sloping.  When a single firm can supply a good or service to an entire market at a lower cost than could two or more firms.  Types:  Walmart strategy: sale product at lower prices. o Economies of scale, if it is downward sloping. (sale mas barato producir más cantidad, porque cada unidad vale menos).  High fixed cost monopoly: o What is the type of natural monopoly that we regulate by setting output?  High fix cost monopoly o How to regulate? Two rules to increase welfare.  1) where Ac crosses the demand curve: profit=0  2) where the demand crosses Mc. Profit=negative number. (the area represents a loss)  o Price discriminating monopoly: o Three conditions for discriminating monopoly:  1) Monopoly power: some ability to earn greater monopoly power. By having a unique product (product differentiation), creating new products development, branding. Get people thinking that your product is better?  2) Able to segment: the market have to set different demand conditions, and know about different market segments.  3) Prevent resale: if you can’t prevent resales you can be a discriminating monopoly. o Difference between perfect competition and monopoly  The key difference between a competitive firm and a monopoly is the monopoly’s ability to influence the price of its output.  A competitive firm is small relative to the market in which it operates and, therefore, has no power to influence the price of its output.  Monopoly is the sole producer in its market, it can alter the price of its good by adjusting the quantity it supplies to the market. o Difference in the demand curve:  Competitive firms have a demand curve horizontal.  Monopoly have no a demand curve horizontal, it is downwardrd-sloping. o Maximizing profit in monopoly: o Chapter 16: monopolistic competition:  Main difference between perfect competition and monopolistic competition. o Some product differentiation. But we still having 0 profit in long run.  Difference between monopolistic competition and perfect competition.  Monopolistic versus perfect Competition o o The perfectly competitive firm produces at the efficient scale, where average total cost is minimized. By contrast, the monopolistically competitive firm produces at less than the efficient scale. o Price equals marginal cost under perfect competition, but price is above marginal cost under monopolistic competition. o Market with many buyers and sellers. o Free entry and exit. o Profit still 0 in long run.  Monopolistic competition: between perfect competition and monopoly Perfect competition Monopolistic monopoly competition Goal of firms Maximize profits Maximize profits Maximize profits Rule for maximizing MC=MR MC=MR MC=MR Can earn economic Yes Yes Yes profits in the short run? Price taker Yes No No price P=MC P>MC P>MC Produces welfare Yes No No maximizing Number of firms Many Many One Entry in long run? Yes Yes No Can earn economic No No Yes profits in long run? Perfect competition Monopolistic competition Monopoly Free entry and exit Free entry and exit Barriers to entry Homogeneous products Somewhat differenced Differential/unique Many buyers and sellers Many buyers and sellers P=mc=mr P>mc,mr P>mc,mr Efficient Not so efficient Not efficient Π= 0 in long run Π= 0 in long run profit  Monopolistic competition in long run. o It is inefficient. We are not at the minimum (not at point of beauty) o Profit= 0: free entry and exit o Ac is tangent to the demand curve. o As in a monopoly market, price exceeds marginal cost. This conclusion arises because profit maximization requires marginal revenue to equal marginal cost and because the downward-sloping demand curve makes marginal revenue less than the price. o As in a competitive market, price equals average total cost. This conclusion arises because free entry and exit drive economic profit to zero.  Short run equilibrium: not long run o Price is not the same tan the average cost (Ac) o


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