ECON 103 Exam 2 (GMU, Desierto)

With electricity, we saw that it was important to tax the pollutant rather than the final product itself. In the following cases, will the proposed taxes actually hit at the source of the external cost, or will they only land an inefficient glancing blow? What kind of tax might be better?

*CHAPTER 10

Government Solution to Externality Problems:

*COMMAND & ORDER method in which governments order firms to use or make less (EX: vaccines used to eliminate smallpox and to address the COVID-19 pandemic) *TRADABLE ALLOWANCES - carbon taxes are equal if the tax = the level of the external cost AND the # of allowances = the efficient quantity - carbon taxes and trading allowances are different if there is uncertainty AND there are political preferences for one or the other REMEMBER--> When external costs are significant, market quantity > efficient quantity

5 important effects created by Price Ceiling:

1) Shortages- when the price ceiling is below market price ( Qd > Qs) which leads to a shortage, the shortage is measured by the difference between Qd and Qs at the controlled price, the lower the controlled price is relative to the market equilibrium price, the larger the shortage. 2) Reductions in product quality- at the controlled price, sellers find there is an excess of demand, sellers can evade the law by cutting quality rather than raising price, another way quality can fall is with reductions in service 3) Wasteful lines and other search costs- at the controlled price, demanders are willing to pay more and the price control make a higher price illegal (other ways: bribes, waiting in line which includes value of time

Cont.

4) A loss of gains from trade- as long as Price consumers are willing to pay> Price sellers are willing to accept then there are mutually profitable trades that can be made, with price controls there are some profitable trades that will not be made so this creates a deadweight loss. 5) Misallocation of resources- when prices are controlled, resources do not flow to their highest-valued uses (EX→ A cold winter increases the demand for heating oil, the demanders of heating oil are prevented from bidding up the price of oil, there is no signal and no incentive to ship oil to where it is needed most)

CHAPTER 8 When a price ceiling is in place, keeping the price below the market price, what's larger: quantity demanded or quantity supplied? How does this explain the long lines and wasteful searches we see in price-controlled markets?

A price ceiling will make quantity demanded larger than quantity supplied. Those extra demanders wait in long lines and waste effort searching for scarce goods.

American parents are worried about their children seeing too much profanity on television. Congress decides to tax TV shows based on the number of profane words used on the shows.

A tax would discourage profanity but this would harm adults who like to watch realistic, "gritty" shows. The government only needs to tax (or fine, the same thing) the shows that are on when children watch TV. There's little need to tax late-night profanity, since few children are up at those hours. Even better is the V-chip, which lets parents limit the type of television shows that children watch without limiting the types of shows that are produced. This chip allows individual families—especially parents—to choose what is acceptable or permitted within their households, rather than allowing Congress or some other authority to decide what is best for everyone.

CHAPTER 10 How is it a bad thing if a good or service provides benefits to bystanders? A.Benefits to bystanders are not captured in the market, so the market tends to underproduce these goods. B.Benefits to bystanders tend to be over-emphasized by policymakers, so laws generally lead to overproduction of these goods. C.Benefits to bystanders are not paid for by the bystanders, so there is a free rider problem. D.It is not a bad thing if a good or service provides benefits to bystanders.

A.Benefits to bystanders are not captured in the market, so the market tends to underproduce these goods.

CHAPTER 8 Which of the following is true about the increase in quality that results from a price floor? A.It is wasteful because consumers would rather not pay for higher quality. B.It is wasteful because it is better for the economy to produce more output rather than higher-quality output. C.It is beneficial because higher quality always increases consumer surplus. D.It is beneficial because when producers sell higher-quality output, they earn higher profits and hire more workers.

A.It is wasteful because consumers would rather not pay for higher quality.

CHAPTER 10 A Pigouvian tax is defined as: A.a tax on a good with external costs. B.a tax on a good with private costs. C.a tax on a good with external benefits. D.a tax on a good with private benefits.

A.a tax on a good with external costs.

CHAPTER 10 The costs and benefits that fall on bystanders are called- A.externalities. B.private costs and benefits. C.third-party costs and benefits. D.social surpluses.

A.externalities.

CHAPTER 8 Without surge pricing, the number of Uber rides that take place at 2 a.m. on New Year's Eve would be? A.lower, because the higher price increases the quantity supplied in response to the increase in demand. B.the same, because the price is rising in order to keep the market in equilibrium. C.higher, because many Uber drivers prefer to work when prices are lower. D.higher, because the law of demand says that riders will not want to pay the higher surge prices.

A.lower, because the higher price increases the quantity supplied in response to the increase in demand.

CHAPTER 7 Markets link the world as a result of immense cooperation that is: A.voluntary and carefully managed. B.voluntary and undirected. C.established by trade agreements and difficult to maintain. D.established by trade agreements and carefully managed.

B. voluntary and undirected.

CHAPTER 7 A change in the demand for steel can cause a price change that affects the prices of the goods for which steel is a substitute or an input, causing more price changes that affect still other goods. This demonstrates that: A."Markets link the world." B."Markets link to one another." C."Markets solve the great economic problem." D."A price is a signal wrapped up in an incentive."

B."Markets link to one another."

CHAPTER 8 The misallocation of resources from a price ceiling is the result of having _____ in the market. The misallocation of resources from a price floor is the result of having _____ in the market. A.high-value buyers; low-cost sellers B.low-value buyers; high-cost sellers C.low-cost sellers; high-value buyers D.high-cost sellers; low-value buyers

B.low-value buyers; high-cost sellers

Cont. With these price controls on bread, would you expect bread quality to rise or fall?

Bread quality is likely to fall, just as the quality of any price-controlled good is likely to fall. Think about the matzo balls! But one point to note is that if the quality of the bread falls, so will the length of the line to get it, and we do not want to double count the losses from price controls!

CHAPTER 8 Why are businesses reluctant to let unregulated markets cure the shortage?

Businesses don't like paying higher wages. They'd rather increase the supply of labor.

CHAPTER 10 When external costs are significant, which of the following statements is true at the market equilibrium? A. Private value exceeds social cost, and the quantity is too high. B. Private value exceeds social cost, and the quantity is too low. C. Social cost exceeds private value, and the quantity is too high. D. Social cost exceeds private value, and the quantity is too low.

C. Social cost exceeds private value, and the quantity is too high.

CHAPTER 8 What is a rent control? A.A price floor on rental housing that can lead to a shortage B.A price floor on rental housing that can lead to a surplus C.A price ceiling on rental housing that can lead to a shortage D.A price ceiling on rental housing that can lead to a surplus

C.A price ceiling on rental housing that can lead to a shortage

CHAPTER 7 Why do prediction markets tend to work so well? A.Because today's advanced polling science and computing power make predictions easy to make B.Because strict regulations prevent arbitrage and speculation in prediction markets C.Because prediction markets give participants an incentive to bring their most useful knowledge to the market D.Because prediction markets link the world and link to each other

C.Because prediction markets give participants an incentive to bring their most useful knowledge to the market

CHAPTER 10 Which of these equations is right? A.Private cost = external cost + social cost B.External cost = private cost + social cost C.Social cost = private cost + external cost D.Social cost = private cost × external cost

C.Social cost = private cost + external cost

CHAPTER 7 If an economy has correctly solved the great economic problem, then it has: A.created as many jobs as possible given the output produced. B.generated as little debt as possible given the level of income. C.satisfied as many wants as possible given the resources available. D.kept prices as low as possible given the costs of production.

C.satisfied as many wants as possible given the resources available.

Cont. To keep it simple, assume that people must wait in line to get bread at the controlled price. Would consumer surplus rise, fall, or can't you tell with the information given?

Consumer surplus must fall. The cost of waiting in line for the bread is the key: That "time-wasting" rectangle up any extra value that might have gone to consumers.

CHAPTER 10 In 2019, thousands of economists signed an open letter arguing that: A.climate change could be successfully managed through a command and control approach. B.pollution can be seen as both an external cost and an external benefit. C.the Coase theorem should be used to address the problem of climate change. D.the best way to address the problem of climate change was a carbon tax.

D. the best way to address the problem of climate change was a carbon tax.

CHAPTER 10 Which of the following is a good that is most likely associated with external benefits (positive externalities)? A.A pack of Parliament cigarettes B.A Ford Super Duty F-350 XLT truck C.An in-app purchase for Pokémon GO D.A bachelor's degree in economics

D.A bachelor's degree in economics

CHAPTER 8 What is a price ceiling? A.A predetermined price below which sellers are not allowed to sell B.The price at which the quantity demanded equals the quantity supplied C.The maximum price at which there are gains from trade D.A maximum price allowed by law

D.A maximum price allowed by law

CHAPTER 8 How do economists feel about the long lines that are created by price ceilings? A.Long lines are desirable because they increase the marginal value of the good. B.Long lines are an efficient way to determine who gets what because all people have time but not all people have money. C.Long lines are no better or worse than market prices at rationing goods. D.Long lines are wasteful because nobody receives the value of the time that is lost.

D.Long lines are wasteful because nobody receives the value of the time that is lost.

Prices are: incentives, signals, and predictions → EX: When a price rises, buyers are encouraged to buy less or use less

EX: after a hurricane, prices rise so consumers begin to complain about price spiking so the market signals for others to provide more resources for the area with price rises to help level out Losses are also a signal & in a successful economy, there will be many unsuccessful firms

In the market for fashionable clothes, the marginal social benefit of one more dress per person is $100, and the marginal private benefit is $500.

External Cost or Benefit? Size of External Benefit (or cost if negative) Tax It or Subsidize it? Fashionable clothes, External cost (or negative external benefit), −$400, Tax

In the market for really good ideas, ideas that will dramatically change the world for the better, the private benefit of one more really good idea (from speaker's fees, book sales, patents, etc.) is $1 million. The marginal social benefit is $1 billion.

External Cost or Benefit? Size of External Benefit (or cost if negative) Tax It or Subsidize it? Ideas, External benefit, + $999,000,000, Subsidize

In the market for automobiles, the private benefit of one more small SUV is $20,000 and the social cost of one more small SUV is $30,000. . In the market for really good ideas, ideas that will dramatically change the world for the better, the private benefit of one more cre

External Cost or Benefit? Size of External Benefit (or cost if negative) Tax It or Subsidize it? a.SUVs, External cost, −$10,000, Tax c.Ideas, External benefit, + $999,000,000, Subsidize

CHAPTER 7 Why is it so hard for central planners to solve the great economic problem? I. Because they lack the information needed to solve it II. Because they have little incentive to solve it III. Because they lack the political authority to solve it

I. Because they lack the information needed to solve it II. Because they have little incentive to solve it

CHAPTER 8 The Canadian government has wage controls for medical doctors. To keep things simple, let's assume that they set one wage for all doctors: $100,000 per year. It takes about 6 years to become a general practitioner or a pediatrician, but it takes about 8 or 9 years to become a specialist like a gynecologist, surgeon, or ophthalmologist. What kind of doctor would you want to become under this system?

If both jobs pay about the same, most people would rather be a general practitioner—the job is easier, the hours are better, and you get out of school sooner. That's actually what'shappening in Canada: They have lots of generalists and few specialists.

CHAPTER 7 *successful economies are more likely to have many failing firms* If a nation's government instead made it impossible for inefficient firms to fail by giving them loans, cash grants, and other bailouts to stay in business, why is that nation likely to be poor?

If the most inefficient firms are kept from failing, then many people are spending their days producing less than they would at a more efficient firm. Less production implies that, on average, people will have less to consume. Thus, the country produces less output for any given level of investment of resources.

Maxicon is opening a new coal-fired power plant, but the government wants to keep pollution down. a. Based on what we've seen in this chapter, which way is a more efficient way to reduce pollution: commanding Maxicon to use one particular air-scrubbing technology that will reduce pollution by 25% or commanding Maxicon to reduce pollution by 25%?

It's better to command a low level of pollution than a particular method to reduce pollution. Maxicon could at least look around for a more efficient way to hold pollution down. One size rarely fits all, especially in a technology-driven field like energy. One issue, however, is that if the government commands Maxicon to reduce pollution by 25%, they will need some method of monitoring Maxicon'spollution output.

a. Gas-guzzling cars create more pollution, so the government should tax big SUVs at a higher rate.

It's possible for SUVs to be fuel-efficient. They could run on electricity alone, they could be hybrids, or they could run on hydrogen fuel cells charged by nuclear power plants. An extra tax on all big SUVs would discourage people from driving these cars. Moreover, it's not just miles-per-gallon that matters but how far people drive. An SUV used occasionally is less polluting than a car driven many thousands of miles a year in congested traffic. A tax on gasoline would hit at the source of the problem more directly, and a tax on carbon emissions from all sources would be better yet.

CHAPTER 10 Consider a factory, located in the middle of nowhere, producing a nasty smell. As long as no one is around to experience the unpleasant odor, are any externalities produced?

No

CHAPTER 7 TERMS:

Price System- a component of any economic system that uses prices expressed in any form of money for the valuation and distribution of goods and services and the factors of production Arbitrage- the act of buying an item at a low price and reselling it at a higher price, can be done across locations or over time Prediction Market- a speculative market, traders use real money to buy and sell "shares" of political candidates (EX: if the candidate has a 75% chance of winning, the market price of the share will be 0.75 x $1 which equals $0.75) Speculation- the attempt to profit from future price changes, buying low and selling high across period of time, raises prices today but lowers them in future Futures- standardized contracts to buy or sell specified quantities of a commodity or financial instrument at a specified price with delivery set at a specified time in the future (stocks, etc.), allow people to speculate without accepting or delivering goods, used to reduce risk for fu

CHAPTER 8 TERMS:

Price controls- laws making it illegal for prices to move above a maximum price (price ceilings) or below a minimum price (price floors) so that products are more affordable for consumers, interfere with market signals, delink some markets and link others in ways that are counterproductive Price Ceiling- maximum price allowed by law

CHAPTER 10 TERMS:

Private Cost- cost paid by the consumer or producer Social Cost- the cost to everyone, (private cost + external cost) Social Surplus- consumer + producer surplus Transaction Cost- all the costs necessary to reach an agreement Coase Theorem- if transaction costs are low and property rights are clearly defined, private bargains will ensure that the market equilibrium is efficient even when there are externalities Internalizing an Externality- adjusting incentives so that decision makers take into account all the costs and benefits of their actions, both private and social * External costs are called negative externalities * External benefits are called positive externalities * When there are external costs, market output is too high * When there are external benefits, market output is too low * A tax on an ordinary good increases deadweight loss * A tax on a good with an external cost reduces deadweight loss and raises revenue

a. The price you pay for an iTunes download b. The benefit your neighbor receives from hearing you play your pleasant music c. The annoyance of your neighbor because she doesn't like your achingly conventional music d. The pleasure you receive from listening to your iTunes download e. The price you pay for a security system for your home f. The safety you enjoy as a result of having the security system g. The crime that is more likely to occur to your neighbor once a criminal sees a "Protect

Private cost = a,e External cost = g, c Private benefit = d, f External benefit = b,h

CHAPTER 8 Price controls distribute resources in many unintended ways. In the following cases, who will probably spend more time waiting in line to get scarce, price-controlled goods? Choose one from each pair: a. Working people or retired people? b. Lawyers who charge $800 per hour or fast-food employees who earn $8 per hour? c. People with desk jobs or people who can disappear for a couple of hours during the day?

Retired people, fast-food employees, and people who can disappear for hours are all more willing to stand in line. The opportunity cost of free time is higher for the other groups. Thus, some lawyers might pay some fast-food employees to wait in line on their behalf, as happens with ticket scalping today

Great Economic Problem- to arrange our scarce resources to satisfy as many wants as possible

Solution to Great Economic Problem ↴ Central Planning- problem of information and incentives In the Price System, each user of oil compares the value in their use with the value in alternative uses, each user has incentive to give up the oil if it has a lower value in their use

CHAPTER 10 Suppose that the family clearly possesses the right to a pleasant-smelling environment. Does this mean that the factory will be required to stop producing the bad smell? What could happen instead? There are many right answers. (Hint: Think about the Coase theorem. Actually, it's alwaysa good idea to think about the Coase theorem, whether the topic is smelly factories, labor-management disputes, international peace negotiations, or divorce settlements.)

The family could demand that the factory shut down or use a less-smelly technology, but there are other possibilities. The factory could pay the family to move away and continue to produce the bad smell. The factory could just pay the family a fixed monthly fee for the right to keep producing the smell. The factory could buy the family lovely-smelling flowers for their home. That's the nature of the Coase theorem: There are usually many possible win-win outcomes, and if the parties can calmly negotiate, there's a good chance they'll find an option that's better, in this case, than just shutting down the factory.

CHAPTER 8 Is the minimum wage a "price ceiling" or a "price floor?" What about rent control?

The minimum wage is a price floor, while rent control is a price ceiling

CHAPTER 8 If the government forced all bread manufacturers to sell their products at a "fair price" that was half the current, free-market price, what would happen to the quantity supplied of bread?

The quantity supplied must fall

CHAPTER 8 If a person has a flashlight that she values at $5, but its price on the black market is $40, what gains from trade are lost if the government shuts down the black market?

The total gains from trade if trade is allowed are $35; these gains from trade would be split between the buyer and the seller, depending on the exact price they agreed upon.

In the case of the minimum wage law, the reason they can't make an exchange is because it's illegal for the buyer (the firm) to hire the seller (the worker) at any wage below the legal minimum. But how can this really be a "loss" from the worker's point of view? It's obvious why business owners would love to hire workers for less than the minimum wage; but if all companies obey the minimum wage law, why are some workers still willing to work for less than that?

They'd be willing to work for less than minimum because for many workers a low-paying job is better than not working at all. The minimum wage prices some low-skilled workers out of the market. Nobel Laureate Paul Krugman wrote a famous Slate magazine essay on this topic (widely available online), "Bad jobs are better than no jobs at all."

CHAPTER 8 If a government decides to make health insurance affordable by requiring all health insurance companies to cut their prices by 30%, what will probably happen to the number of people covered by health insurance?

This is just another price ceiling: It will create a shortage in health insurance, and not all people demanding health insurance will be covered.

All-night liquor stores seem to generate unruly behavior in nearby neighborhoods, so owners of all-night liquor stores should pay higher property taxes.

This sounds like the best one can hope for. You could imagine fining the unruly drunks, but police can already go after them for being drunk and disorderly. The transaction costs of finding and fining the drunks sounds extremely high. It's probably better to discourage more liquor stores.

CHAPTER 8 How do unregulated markets cure a "labor shortage" when there are no immigrants to boost the labor supply?

Unregulated markets cure a labor shortage by pushing up the wage

CHAPTER 10 Suppose that a family moves in next door to the smelly factory. Do we now have an externalities problem? If so, who is causing it: the factory by producing the smell, the family by moving in next door, or both?

Yes, there is now an externalities problem. It is caused jointly by the factory and the family

Bell-bottom jeans insist on coming back every few years, and their ugliness creates external costs for all who see them. Therefore, bell-bottom jeans should be taxed heavily.

Yes. This reasoning is flawless. The bell bottoms themselves are the problem. But what is less clear is whether people who wear bell bottoms should be taxed or whether they should be paid not to wear them. The latter case might be more just, since most people think that people have a right to commit fashion crimes no matter how heinous, but then everyone might try to claim the subsidy.

CHAPTER 8 a. What is the total value of wasted time in the price-controlled market? b. What is the value of the sum of lost consumer surplus and lost producer surplus?

a. $50 × 100 = $5,000 b. $50 × 100 × 0.5 = $2,500. This is the triangle formula again.

CHAPTER 7 a. Suppose you learned that growing political instability in Chile (the largest producer of copper) will greatly reduce the productivity of its mines in two years. Ignoring all other factors, which curve (demand or supply) will shift which way in the market for copper two years from now? b. Will the price rise or fall as a result of this curve shift? c. Given your answer in part b, would a reasonable person buy copper to store for later? Why or why not?

a. Supply would decrease, that is, it will shift to the left (up). b. The price will rise. c. A reasonable person would buy and store copper now if the price was going to rise in the future.

Real World Example of Externalities: Antibiotics

externalities: users get all benefits but don't bear all costs because they create bacterial resistance and pollute environment then non-users of antibiotics pay these external costs external benefits: vaccines benefit the person who is vaccinated but also benefit others by discontinuing spread of disease and not harming others