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UM / Economics / ECON 211 / What do you mean by welfare economics?

What do you mean by welfare economics?

What do you mean by welfare economics?


School: University of Michigan
Department: Economics
Course: Microeconomics
Professor: David spigelman
Term: Spring 2016
Cost: 50
Name: Study guide midterm#2
Description: 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.
Uploaded: 11/03/2015
12 Pages 11 Views 22 Unlocks

Victor Starr (Rating: )

ECO 211

What do you mean by welfare economics?

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.

What is consumer surplus?

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. If you want to learn more check out phil 2110 study guide

o If an allocation is not efficient, then some of the potential gains from trade among buyers and sellers are  not being realized.  

What is producer surplus?

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  


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. If you want to learn more check out his 1110
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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  If you want to learn more check out phys 0175 pitt

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. If you want to learn more check out death and afterlife rutgers

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  Don't forget about the age old question of What is a coaching code of ethics?

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  


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


▪ If the Price of the product in the international market  

is higher than the domestic Price, the country will  


▪ 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


∙ 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+q2 

∙ 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
































































Marginal cost: the increase in  total cost that arises from an  extra unit of production

Mc= ∆�� 


Average cost


Average fixed cost:


Average variable cost:

Avc= ������


R= PxQ






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

Tr (pxq)

Total cost (tc)

Profit (π)


revenue (mr)

Marginal cost  





































∙ 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:


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




Goal of firms

Maximize profits

Maximize profits

Maximize profits

Rule for maximizing




Can earn economic  

profits in the short run?




Price taker








Produces welfare





Number of firms




Entry in long run?




Can earn economic  

profits in long run?




Perfect competition

Monopolistic competition


Free entry and exit

Free entry and exit

Barriers to entry

Homogeneous products

Somewhat differenced


Many buyers and sellers

Many buyers and sellers





Not so efficient

Not efficient

Π= 0 in long run

Π= 0 in long run


∙ 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)  


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