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Econ Notes 5

by: Leah Barton

Econ Notes 5 ECON 2010

Leah Barton
GPA 3.8

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About this Document

These are the notes of the week covering Chapters 6, 8 , and 10. Essential to know for the upcoming test next week.
Principles of Microeconmics
Class Notes
Econ, PPF, Microeconomics, demand, Graphs, market
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This 8 page Class Notes was uploaded by Leah Barton on Thursday April 7, 2016. The Class Notes belongs to ECON 2010 at Western Michigan University taught by Kim in Summer 2015. Since its upload, it has received 45 views. For similar materials see Principles of Microeconmics in Economcs at Western Michigan University.


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Date Created: 04/07/16
Chapter 6 and 8 Q: Why do governments intervene in the market? A: 1. Correcting market failures. (Must push the market towards equilibrium) Ex: Monopolies. When there is only one seller, they will charge very high prices to make a profit. Governments will prevent monopolies and keep the market flowing. 2. Changing the distribution of benefits. Government pushes markets to focus on equality for all participants in the market. 3. Encouraging or discouraging consumption of certain goods. Generally the will do this by taxing bad goods. Ex: Cigarettes, alcohol, and drugs Government Policies that Alter the Private Market Outcome Price ceiling -A legal maximum on the price of a good or service. -This is to protect buyers Ex: During war time, this prevents goods that are necessities from being priced too high. Price floor -A legal minimum on the price of a good or service -This is to protect sellers -Ex: Farmers cannot sell milk lower than a certain price because they need to make a profit to survive and stimulate the economy. Q: How does this affect the market? -There are 500 people looking for a job. -Equilibrium price for a labor market is $4. -Say the price floor is set at $3. -This is not binding and is therefore illegal. Cannot have price floor below equilibrium. -Now the price floor is raised to $8. -At $8, the available jobs is at 400, and therefore now there is unemployment. Q: Will you have more or less unemployment with a price floor if the demand is inelastic? -You will have reduced unemployment Q: If there is an increase in high school dropouts? -You will have an increase in unemployment. Taxes -The government can make buyers or sellers pay a specific amount on each unit bought/sold. Ex: The Market for Apartments -Rent control will help low income families to find housing. (New York apartments) -Apartments cost $800 -Quantity of apartments in 300 -The price ceiling is $1000 -A price ceiling above the equilibrium price is not binding – has no effect on the outcome of the market. -Now the price ceiling changed to $500. -This is more affordable and the equilibrium price is above the ceiling and therefore illegal. -The ceiling is a binding constraint on the price, and causes a shortage. -In the long run, supply and demand is more elastic, so the shortage increases. -Rent control hurts the people it tries to help. Shortages and Rationing -With a shortage, sellers must ration the goods among buyers. -Long waiting lists  low quality housing -Discrimination according to sellers’ biases  black market -Unintended consequences -It is unfair, and inefficient: the goods do not necessarily go to the buyers who value them most highly. Q: Who benefits and who loses from price ceilings? Apartment owners?  Losers. Because they cannot charge higher rent. Current Tenants?  Winner. Because you currently live there and now pay lower rent. You have low quality housing, however. Potential tenants?  Loser. Even though you are willing to pay, it is difficult to find housing. -There will always be winners and loses. Minimum Wage -The laws do not affect highly skilled workers. -They do affect teen workers -If you increase min wage by 10%, teen unemployment raises by 1-3%. Q: Who gains and who loses from min. wage? Employers?  Losers. They have to pay more to their employees. Unskilled workers?  Winners. They already have a job and make more money. Potential workers?  Losers. They have a difficult time finding a job. Q: Any positives? -Raising the minimum wage will not affect the economy badly. -More money will allow people to spend more on business and small businesses and therefore stimulate the economy and raise families. -Could decrease poverty. Evaluating Price Controls -Prices are the signals that guide the allocation of society’s resources. This allocation is altered when policymakers restrict prices. -Price controls often intended to help the poor, but often hurt more than help. Taxes -Revenue to pay for national defenses, public schools, etc. -Either buyers or sellers pay the taxes. -The tax can be a % of the good’s price, or a specific amount of each unit sold. Excise Taxes -Does not equal VAT -Taxes that are already embedded n the price, such as gasoline. -For simplicity, we analyze per-unit taxes only. Q: How the burden of a tax is shared among market participants -Buyers pay more -Seller get less Tax = wedge (Pb & Ps) -The outcome will be the same whether the tax is imposed on the buyers or sellers! Tax on buyer  Demand decreases Tax on seller  Supply decreases Tax incidence and Elasticity Elastic Demand -Buyers are sensitive to price changes -Sellers pay more taxes Elastic Supply -Sellers are very price sensitive -Buyers pay more taxes Revenue from tax Size of the tax x Quantity tax Q: What determines the size of the Dead Weight Loss? A: It depends on the price elasticity of supply and demand Elastic D or S = bigger DWL Chapter 10: Externalities Externality -A type of market failure -The uncompensated impact of one’s persons’ actions on the well-being of a bystander. -The can be negative or positive depending in whether the impact on bystanders is adverse or beneficial. -Self-interest people consider direct private costs and benefits when they make the decision -Self-interested buyers and sellers neglect the external costs or benefits of their actions, the market outcome is not efficient. External costs -Negative externality Ex: Air pollution, neighbors’ barking dog, second-hand smoke, texting while driving, talking to your neighbor in class External benefits -Positive externality Ex: Ex: Driving to Chicago -Negative externalities = gas, mileage, wear and tear, parking, more traffic -Positive externalities = convenience, own transportation Private costs (Marginal Cost) -All direct costs that are taken into consideration in private decision-making. Private benefits (Marginal Benefit) -All direct benefits that are taken into consideration in private decision-making Social costs -Private costs + external costs Social benefits -Private benefits + external benefits In the case of no externalities -Marginal Private Costs = Marginal Social Costs & Marginal Private Benefit = Marginal Social Benefit In the case of a negative externality -Marginal Social Costs > Marginal Private Costs In the case of a positive externality -Marginal Social Benefit > Marginal Private Benefit Internalized Externality -Altering incentives so that people take account of the external effect of their actions. If tax = MEC, MPC (with tax) = MSC  Market eq. = socially optimal outcome There is a difference between socially optimal outcome and market equilibrium outcome!!! Socially Optimal Outcome is where the Marginal Externality Benefits meets the supply line. Marginal Equilibrium Outcome is where the market outcome line meets the supply line. Internalizing the Externalities -Used to remedy overproduction and underproduction in the market. 1. Government taxes and subsidies 2. Government regulations: Quotas  Command-and-Control policies 3. Government standards with distribution of marketable permits 4. Assign property rights 5. The Coase Theorem Corrective tax (Pigouvian tax) -A tax designed to induce private decision-makers to take account of the external costs that arise from a negative externality. -The ideal corrective tax = MEC for negative externalities -The ideal corrective subsidy = MEB for positive externalities Problems? -Marginal External Cost increases -Corrective taxes are more efficient and better for the environment than Government regulations because is gives them a incentive. (Ex: Either reduce pollution, or pay a tax) -Government regulations requiring all firms to reduce pollution would not work because there is no incentive for firms to do it. Tradable Pollution Permits -Create a market for pollution -Set the level of total sustainable pollution  Distribute Permits -Reduces pollution at lower cost than regulation -Low abatement cost firms  Sell permits -High abatement cost firms  Buy permits -Result: Pollution reduction is concentrated among those firms with lowest costs. Assign Property Rights -One way to internalize an externality -Marginal external cost becomes a private cost -Well-defined, divisible, and defendable goods Coase Theory -overcomes monitoring cost by using local information.


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