MICROECONOMICS MIDTERM EXAM #2 NOTES Chapters 5-8 1 ...
MICROECONOMICS MIDTERM EXAM #2 NOTES Chapters 5-8 CHAPTER 5: Scare resources might be allocated by: - Market price - Command - Majority rule - Contest - First-come, first-served - Sharing equally - Lottery - Personal characteristics - Force Market Price: When a market allocates a scarce resource, the people who get the resource are those who are willing to pay the market price. Command System: allocates resources by the order (command) of someone in authority. Example: if you have a job, most likely someone tells you what to do. Your labour time is allocated to specific tasks by command. Majority Rule: allocates resources in the way the majority of voters choose Contest: A contest allocates resources to a winner (or group of winners) First-come, first-served: allocates resources to those who are first in line Lottery: allocate resources to those with the winning number, draw the lucky cards, or come up lucky on other gaming system Personal Characteristics: allocate resources to those with the “right” characteristics. Example: people choose marriage partners on the basis of personal characteristics. Force: Force plays a role in allocating resources. Example: war has played an enormous role historically in allocating resources. Value is what we get, price is what we pay. The value of one more unit of a good or service is its marginal benefit. We measure value as the maximum price that a person is willing to pay. But willingness to pay determines demand. A demand curve is a marginal benefit curve. The relationship between the price of a good and the quantity demanded by one person is called individual demand. The relationship between the price of a good and the quantity demanded by all buyers in the market is called market demand.
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MICROECONOMICS MIDTERM EXAM #2 NOTES Chapters 5-8 Consumer Surplus: the excess of the benefit received from a good over the amount paid for it. We can calculate consumer surplus as the marginal benefit (or value) of a good minus its price, summed over the quantity bought. - Consumer Surplus = (MB – price) / quantity bought Firms:
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In business to make profit To make profit, firms must sell their output for a price that exceeds the cost of production
Cost is what the producer gives up; price is what the producer receives. The cost of one more unit is its marginal cost. Marginal cost is the minimum price that a firm is willing to accept. A supply curve is a marginal cost curve. The relationship between the price of a good and the quantity supplied by one producer is called individual supply The relationship between the price of a good and the quantity supplied by all producers in the market is called market supply Producer Surplus: the excess of the amount received from the sale of a good over the cost of producing it. (The producer surplus is the value of the pizza sold in excess of the cost of producing it) - Producer Surplus = (price received – marginal cost) / quantity sold Competitive Market efficiency: When production is: - Less than equilibrium quantity, MSB > MSC - Greater than the equilibrium quantity MSC > MSB - Equal to the equilibrium quantity, MSC = MSB (most efficient, meaning total surplus is maximized) The Invisible Hand: Idea proposed by Adam Smith which states that competitive markets send resources to their highest valued use in society. Consumers and producers pursue their own self-interest and interact in markets. Market Failure: arises when a market delivers in inefficient outcome. Market failure can occur because too little of an item is produced (underproduction), or too much of an item is produced (overproduction) Sources of Market Failure: - Price and quantity regulations - Taxes and subsidies - Externalities - Public goods and common resources - Monopoly 2
MICROECONOMICS MIDTERM EXAM #2 NOTES Chapters 5-8 -
High transactions costs
Price and Quantity Regulations: - price regulations sometimes put a block of the price adjustments and lead to underproduction. - Quantity regulations that limit the amount that a farm is permitted to produce also leads to underproduction. Taxes and Subsidies: - Taxes increase the prices paid by buyers and lower the prices received by sellers. Taxes decrease quantity produced and lead to underproduction. - Subsidies lower the prices paid by buyers and increase the prices received by sellers. So subsidies increase the quantity produced and lead to overproduction. Externalities: a cost or benefit that affects someone other than the seller or the buyer of a good. Public Goods and Common Resources: - A public good benefits everyone and no one can be excluded from its benefits. It’s in everyone’s self-interest to avoid paying for a public good (called the free-rider problem), which leads to underproduction. - A common resource is owned by no one but can be used by everyone. It’s in everyone’s self-interest to ignore the costs of their own use of a common resource that fall on others (called tragedy of the commons). Leads to overproduction. Monopoly: a firm that has sole provider of a good or service. High Transaction Costs: the opportunity cost of making trades in a market. Some markets are just too costly to operate. When transaction costs are high, the market might under produce. Is the Competitive Market Fair? Can be divided into two groups: - It’s not fair if result isn’t fair. - It’s not fair if the rules aren’t fair It’s Not Fair if the Result Isn’t Fair: idea that only equality brings efficiency is called utilitarianism. Utilitarianism: “Greatest good for the greatest amount of people” It’s Not Fair if the Rules Aren’t Fair: idea that’s based on the symmetry principle. Symmetry Principle: the requirement that people in similar situations be treated similarly. In economics, this principle means equality of opportunity, not equality of income.
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MICROECONOMICS MIDTERM EXAM #2 NOTES Chapters 5-8 CHAPTER 6: A price ceiling or price cap is a regulation that makes it illegal to charge a price higher than a specified level. - When a price ceiling is applied to a housing market it is called a rent ceiling Search Activity: The time spent looking for someone with whom to do business Black Market: is an illegal market that operates alongside a legal market in which a price ceiling or other restriction has been imposed Rent Ceilings: - According to fair rules: unfair because it blocks voluntary exchange, and also does not generally benefit the poor - Also decrease the quantity of housing and the scarce housing is allocated by: lottery, first-come first-served, and discrimination Minimum Wage: - Leads to an inefficient outcome - Quantity of labour employed is less than the efficient quantity - Supply of labour measures the marginal social cost of labour to workers (leisure forgone) - Demand of labour measures the marginal social benefit from labour (value of goods produced) - Most economists believe that minimum wage laws increase the unemployment rate of low-skilled younger workers Tax incidence: - The division of the burden of a tax between buyers and sellers - Doesn’t depend on tax law Tax Incidence and Elasticity of Demand: - Perfectly inelastic (vertical demand curve) demand: Buyers pay the entire tax. Examples: alcohol, tobacco, and gasoline - Perfectly elastic (horizontal demand curve) demand: Sellers pay the entire tax - The more inelastic the demand, the larger is the buyers’ share of the tax Tax Incidence and Elasticity of Supply: - Perfectly inelastic (vertical supply curve) supply: sellers pay the entire tax. Example: labour - Perfectly elastic (horizontal supply curve) supply: Buyers pay the entire tax - The more elastic the supply, the larger is the buyers’ share of the tax Taxes and Fairness: 4
MICROECONOMICS MIDTERM EXAM #2 NOTES Chapters 5-8 Economists propose two conflicting principles of fairness to apply to a tax system: - The benefits principle - The ability-to-pay principle The Benefits Principle: the proposition that people should pay taxes equal to the benefits they receive from the services provided by government. - This arrangement is fair because it means that those who benefit most pay the most taxes. The Ability-to-Pay Principle: the proposition that people should pay taxes according to how easily they can bear the burden of the tax. - A rich person can more easily bear the burden than a poor person can. - Ability-to-Pay principle can reinforce the benefits principle to justify high rats of income tax on high incomes. Intervention in markets for farm products takes two main forms: - Production quotas - Subsidies Production Quota: an upper limit to the quantity of a good that may be produced during a specified period. Subsidy: a payment made by the government to a producer. CHAPTER 7: Imports: the goods and services that we buy from people in other countries Exports: the goods and services we sell to people in other countries National comparative advantage as the ability of a nation to perform an activity or produce a good or service at a lower opportunity cost than any other nation International Trade Restrictions: Governments restrict international trade to protect domestic producers from competition. Governments use four sets of tools: - Tariffs - Import quotas - Other import barriers - Export subsidies Tariff: a tax on a good that is imposed by the importing country when an imported good crosses its international boundary. Import Quota: a restriction that limits the maximum quantity of a good that may be imported in a given period.
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MICROECONOMICS MIDTERM EXAM #2 NOTES Chapters 5-8 Other Import Barriers: Thousands of detailed health, safety and other regulations restrict international trade. Export Subsidies: a payment made by the government to a domestic producer of an exported good. Two Arguments Against Free Trade: 1) The Infant-Industry Argument: it is necessary to protect a new industry from import competition to enable it to grow into a mature industry that can compete in world markets 2) The Dumping Argument: Dumping occurs when a foreign firm sells its exports at a lower price than its cost of production. This argument doesn’t justify protection because: - It is virtually impossible to determine a firm’s costs, - Hard to think of a global monopoly, so even if all domestic firms are driven out, alternatives would still exist, - If the market is truly a global monopoly, better to regulate it rather than restrict trade Other common arguments for protection are that it: - Saves jobs - Allows us to compete with cheap foreign labour - Penalizes lax environmental standards - Prevents rich countries from exploiting developing countries Outsourcing: occurs when a firm in Canada buys finished goods, components, or services from firms in Canada or buys finished goods, components or services from firms in other countries. Offshoring: Occurs when a firm in Canada hires foreign labour, and produces in other countries or buys finished goods, components, or services from firms in other countries. Offshoring Outsourcing: occurs when a firm in Canada buys finished goods, components, or services from firms in other countries. Rent Seeking: lobbying and other political activity that seeks to capture gains from trade. (Reason why international trade restrictions are popular in Canada and most other developed countries)
Free trade benefits consumers but shrinks the producer surplus of firms that compete in markets with imports
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MICROECONOMICS MIDTERM EXAM #2 NOTES Chapters 5-8 CHAPTER 8:
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MICROECONOMICS MIDTERM EXAM #2 NOTES Chapters 5-8 Consumer Surplus: the excess of the benefit received from a good over the amount paid for it. We can calculate consumer surplus as the marginal benefit (or value) of a good minus its price, summed over the quantity bought. - Consumer Surplus = (MB – price) / quantity bought Firms:
-
In business to make profit To make profit, firms must sell their output for a price that exceeds the cost of production
Cost is what the producer gives up; price is what the producer receives. The cost of one more unit is its marginal cost. Marginal cost is the minimum price that a firm is willing to accept. A supply curve is a marginal cost curve. The relationship between the price of a good and the quantity supplied by one producer is called individual supply The relationship between the price of a good and the quantity supplied by all producers in the market is called market supply Producer Surplus: the excess of the amount received from the sale of a good over the cost of producing it. (The producer surplus is the value of the pizza sold in excess of the cost of producing it) - Producer Surplus = (price received – marginal cost) / quantity sold Competitive Market efficiency: When production is: - Less than equilibrium quantity, MSB > MSC - Greater than the equilibrium quantity MSC > MSB - Equal to the equilibrium quantity, MSC = MSB (most efficient, meaning total surplus is maximized) The Invisible Hand: Idea proposed by Adam Smith which states that competitive markets send resources to their highest valued use in society. Consumers and producers pursue their own self-interest and interact in markets. Market Failure: arises when a market delivers in inefficient outcome. Market failure can occur because too little of an item is produced (underproduction), or too much of an item is produced (overproduction) Sources of Market Failure: - Price and quantity regulations - Taxes and subsidies - Externalities - Public goods and common resources - Monopoly 2
MICROECONOMICS MIDTERM EXAM #2 NOTES Chapters 5-8 -
High transactions costs
Price and Quantity Regulations: - price regulations sometimes put a block of the price adjustments and lead to underproduction. - Quantity regulations that limit the amount that a farm is permitted to produce also leads to underproduction. Taxes and Subsidies: - Taxes increase the prices paid by buyers and lower the prices received by sellers. Taxes decrease quantity produced and lead to underproduction. - Subsidies lower the prices paid by buyers and increase the prices received by sellers. So subsidies increase the quantity produced and lead to overproduction. Externalities: a cost or benefit that affects someone other than the seller or the buyer of a good. Public Goods and Common Resources: - A public good benefits everyone and no one can be excluded from its benefits. It’s in everyone’s self-interest to avoid paying for a public good (called the free-rider problem), which leads to underproduction. - A common resource is owned by no one but can be used by everyone. It’s in everyone’s self-interest to ignore the costs of their own use of a common resource that fall on others (called tragedy of the commons). Leads to overproduction. Monopoly: a firm that has sole provider of a good or service. High Transaction Costs: the opportunity cost of making trades in a market. Some markets are just too costly to operate. When transaction costs are high, the market might under produce. Is the Competitive Market Fair? Can be divided into two groups: - It’s not fair if result isn’t fair. - It’s not fair if the rules aren’t fair It’s Not Fair if the Result Isn’t Fair: idea that only equality brings efficiency is called utilitarianism. Utilitarianism: “Greatest good for the greatest amount of people” It’s Not Fair if the Rules Aren’t Fair: idea that’s based on the symmetry principle. Symmetry Principle: the requirement that people in similar situations be treated similarly. In economics, this principle means equality of opportunity, not equality of income.
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MICROECONOMICS MIDTERM EXAM #2 NOTES Chapters 5-8 CHAPTER 6: A price ceiling or price cap is a regulation that makes it illegal to charge a price higher than a specified level. - When a price ceiling is applied to a housing market it is called a rent ceiling Search Activity: The time spent looking for someone with whom to do business Black Market: is an illegal market that operates alongside a legal market in which a price ceiling or other restriction has been imposed Rent Ceilings: - According to fair rules: unfair because it blocks voluntary exchange, and also does not generally benefit the poor - Also decrease the quantity of housing and the scarce housing is allocated by: lottery, first-come first-served, and discrimination Minimum Wage: - Leads to an inefficient outcome - Quantity of labour employed is less than the efficient quantity - Supply of labour measures the marginal social cost of labour to workers (leisure forgone) - Demand of labour measures the marginal social benefit from labour (value of goods produced) - Most economists believe that minimum wage laws increase the unemployment rate of low-skilled younger workers Tax incidence: - The division of the burden of a tax between buyers and sellers - Doesn’t depend on tax law Tax Incidence and Elasticity of Demand: - Perfectly inelastic (vertical demand curve) demand: Buyers pay the entire tax. Examples: alcohol, tobacco, and gasoline - Perfectly elastic (horizontal demand curve) demand: Sellers pay the entire tax - The more inelastic the demand, the larger is the buyers’ share of the tax Tax Incidence and Elasticity of Supply: - Perfectly inelastic (vertical supply curve) supply: sellers pay the entire tax. Example: labour - Perfectly elastic (horizontal supply curve) supply: Buyers pay the entire tax - The more elastic the supply, the larger is the buyers’ share of the tax Taxes and Fairness: 4
MICROECONOMICS MIDTERM EXAM #2 NOTES Chapters 5-8 Economists propose two conflicting principles of fairness to apply to a tax system: - The benefits principle - The ability-to-pay principle The Benefits Principle: the proposition that people should pay taxes equal to the benefits they receive from the services provided by government. - This arrangement is fair because it means that those who benefit most pay the most taxes. The Ability-to-Pay Principle: the proposition that people should pay taxes according to how easily they can bear the burden of the tax. - A rich person can more easily bear the burden than a poor person can. - Ability-to-Pay principle can reinforce the benefits principle to justify high rats of income tax on high incomes. Intervention in markets for farm products takes two main forms: - Production quotas - Subsidies Production Quota: an upper limit to the quantity of a good that may be produced during a specified period. Subsidy: a payment made by the government to a producer. CHAPTER 7: Imports: the goods and services that we buy from people in other countries Exports: the goods and services we sell to people in other countries National comparative advantage as the ability of a nation to perform an activity or produce a good or service at a lower opportunity cost than any other nation International Trade Restrictions: Governments restrict international trade to protect domestic producers from competition. Governments use four sets of tools: - Tariffs - Import quotas - Other import barriers - Export subsidies Tariff: a tax on a good that is imposed by the importing country when an imported good crosses its international boundary. Import Quota: a restriction that limits the maximum quantity of a good that may be imported in a given period.
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MICROECONOMICS MIDTERM EXAM #2 NOTES Chapters 5-8 Other Import Barriers: Thousands of detailed health, safety and other regulations restrict international trade. Export Subsidies: a payment made by the government to a domestic producer of an exported good. Two Arguments Against Free Trade: 1) The Infant-Industry Argument: it is necessary to protect a new industry from import competition to enable it to grow into a mature industry that can compete in world markets 2) The Dumping Argument: Dumping occurs when a foreign firm sells its exports at a lower price than its cost of production. This argument doesn’t justify protection because: - It is virtually impossible to determine a firm’s costs, - Hard to think of a global monopoly, so even if all domestic firms are driven out, alternatives would still exist, - If the market is truly a global monopoly, better to regulate it rather than restrict trade Other common arguments for protection are that it: - Saves jobs - Allows us to compete with cheap foreign labour - Penalizes lax environmental standards - Prevents rich countries from exploiting developing countries Outsourcing: occurs when a firm in Canada buys finished goods, components, or services from firms in Canada or buys finished goods, components or services from firms in other countries. Offshoring: Occurs when a firm in Canada hires foreign labour, and produces in other countries or buys finished goods, components, or services from firms in other countries. Offshoring Outsourcing: occurs when a firm in Canada buys finished goods, components, or services from firms in other countries. Rent Seeking: lobbying and other political activity that seeks to capture gains from trade. (Reason why international trade restrictions are popular in Canada and most other developed countries)
Free trade benefits consumers but shrinks the producer surplus of firms that compete in markets with imports
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MICROECONOMICS MIDTERM EXAM #2 NOTES Chapters 5-8 CHAPTER 8:
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