ECON 201

Denise values a stainless steel dishwasher for her new house at $500, but she succeeds in buying one for $350. Denise's consumer surplus is:

$150.

The government auctions off 500 unit of pollution rights. They sell for $50 per unit, raising total revenue of $25,000. This policy is equivalent to a corrective tax of ____ per unit of pollution.

$50

Marginal Product of Labor (MPL)

(delta)Q = Change in output. (delta)L = Change in labor

Putting the Four Cost Curves Together

1. Marginal cost is upward sloping because of diminishing returns. 2. Average variable cost also is upward sloping but is flatter than the marginal cost curve. 3. Average fixed cost is downward sloping because of the spreading effect. 4. The marginal cost curve intersects the average total cost curve from below, crossing it at its lowest point.

Total Cost (TC)

= FC + VC The cost structure of a firm depends on the nature of the production process.

Profit

= Total Revenue - Total Cost

Economic Profit

= Total Revenue - Total Costs (Explicit & Implicit)

Accounting Profit

= Total Revenue - Total Explicit Costs

If the external benefit is $10 per extinguisher, describe a government policy that would yield the efficient outcome.

A government policy that would result in an efficient outcome would be to subsidize people $10 for every fire extinguisher they buy. This would shift the demand curve up to the social value curve, and the market quantity would increase to the optimum quantity.

An externality is an example of:

A market failure.

Corrective Tax

A tax designed to induce private decision makers to take account of the social costs that arise from a negative externality. Move economy towards a more efficient outcome.

Economies of Scale

ATC falls as Q increases.

Diseconomies of Scale

ATC rises as Q increases.

Constant Returns to Scale

ATC stays the same as Q increases.

If the production of a good yields a negative externality, then the social-cost curve lies _____ the supply curve, and the socially optimal quantity is ____ than the equilibrium quantity.

Above, less.

Internalizing The Externality

Altering incentives so that people take account of the external effects of their actions.

Marginal Product

Any input is the increase in output arising from an additional unit of that input, holding all other inputs constant.

Why is the marginal cost curve eventually upward sloping?

Because there are diminishing marginal products of inputs. At a very low output level, hiring additional workers allows greater specialization of their task and leads to increasing marginal product.

Total surplus:

Can be used to measure a market's efficiency. Is the sum of consumer and producer surplus. Is the value to buyers minus the cost to sellers.

If the government were to limit the release of air pollution produced by a glue factory to 75 parts per million, the policy would be considered a:

Command-and-control policy.

Transaction Costs

Costs parties incur through agreeing to and following through on a bargain.

Deadweight loss of a tax is the:

Decline in total surplus that results from a tax.

Implicit Costs

Do not require an outlay of money. Example: The opportunity cost of the owner's time.

Fixed Costs (FC)

Do not vary with the quantity of output produced. Examples: Cost of equipment, interest payments.

Denise values a stainless steel dishwasher for her new house at $500. The actual price of the dishwasher is $650. Denise:

Does not buy the dishwasher, and on her purchase she experiences a consumer surplus of $0.

A decrease in the size of a tax is most likely to increase tax revenue in a market with:

Elastic demand and elastic supply.

Average Total Cost (ATC)

Equals total cost divided by the quantity of output: ATC = TC/Q.

Draw a graph of the market for fire extinguishers, labeling the demand curve, the social-value curve, the supply curve, and the social-cost curve.

Equilibrium Output = Qe Efficient Output = Qd

Positive Externality

Externality benefits bystanders. Example: Vaccinations.

Negative Externality

Externality harms bystanders. Example: Air pollution from a factory.

Deadweight Loss (DWL)

Fall in total surplus that results from a market distortion, such as a tax. = Total Surplus Without Tax - Total Surplus With Tax

Why might fire extinguishers exhibit positive externalities?

Fire extinguishers exhibit positive externalities because even though people buy them for their own use, they may prevent a fire from damaging the property of others.

Average Fixed Cost (AFC)

Fixed cost divided by the quantity of output: AFC = FC/Q.

Which of the following is an example of externality?

Hillary's newly cut lawn makes her neighborhood more attractive.

The Coase Theorem

If private parties can costlessly bargain over the allocation of resources, they can solve the externalities problem on their own.

Social Cost

In the presence of a negative externality, a good includes private cost & external cost.

Social Value

In the presence of a positive externality, a good includes private value & external benefit.

Tomato sauce and spaghetti noodles are complementary goods. A decrease in the price of tomatoes will:

Increase consumer surplus in the market for tomato sauce and increase producer surplus in the market for spaghetti noodles.

If a market is allowed to move freely to its equilibrium price and quantity, then an increase in supply will:

Increase consumer surplus.

When a country is on the downward-sloping side of the Laffer curves, a cut in the tax rate will:

Increase tax revenue and decrease the deadweight loss.

When the government levies a tax on a good equal to the external cost associated with the good's production, it ______ the price paid by consumers and makes the market outcome _______ efficient.

Increases, more.

The deadweight loss from a tax of $8 per unit will be smallest in a market with:

Inelastic demand and inelastic supply.

When the government imposes taxes on buyers or sellers of a good, society:

Loses some of the benefits of market efficiency.

Which of the following is an example of a positive externality?

Mary not catching the flu from Sue because Sue got a flu vaccine.

According to the Coase theorem, private markets will solve externality problems and allocate resources efficiently as long as:

Private parties can bargain with sufficiently low transaction costs.

Market-Based Policies

Provide incentives so that private decision makers will choose to solve the problem on their own. Example: Corrective taxes and subsidies.

Taxes cause deadweight losses because taxes:

Reduce the sum of producer and consumer surpluses by more than the amount of tax revenue. Prevent buyers and sellers from realizing some of the gains from trade. Cause marginal buyers and marginal sellers to leave the market, causing the quantity sold to fall.

Command-And-Control Policies

Regulate behavior directly. Example: Requires firms adopt a particular technology to reduce emissions in the case of pollution.

Explicit Costs

Require an outlay of money. Example: Paying wages to workers.

Long-Run Average Total Cost Curve (LRATC)

Shows the relationship between output and average total cost when fixed cost has been chosen to minimize ATC for each level of Q.

Production Function

Shows the relationship between the quantity of inputs used to produce a good and the quantity of outputs of that good.

Laffer Curve

Shows the relationship between the size of the tax and tax revenue.

Total Revenue

The amount a firm receives for the sale of its input.

External Cost

The cost of the negative impact on bystanders.

Private Cost

The direct cost to sellers (private parties involved directly).

Private Value

The direct value to buyers.

Suppose sellers of perfume are required to send $1.00 to the government for every bottle of perfume they sell. Further, suppose this tax causes the price paid by buyers of perfume to rise by $0.60 per bottle. Which of the following statements is correct?

The effective price received by sellers is $0.40 per bottle less than it was before the tax.

Economists disagree on whether labor taxes cause small or large deadweight losses. This disagreement arises primarily because economists hold different views about:

The elasticity of labor supply.

Suppose that flu shots create a positive externality equal to $12 per shot. What is the relationship between the equilibrium quantity and the socially optimal quantity of flu shots produced?

The equilibrium quantity is less than the socially optimal quantity.

Which of the following statements is correct regarding a tax on a good and the resulting deadweight loss?

The greater are the price elasticities of supply and demand, the greater is the deadweight loss.

Marginal Cost (MC)

The increase in the total cost from producing one more unit.

Which of the following statements is not correct?

The invisible hand can remedy all types of market failures.

The Spreading Effect

The larger the output, the more output over which fixed cost is spread, leading to lower average fixed cost.

The Diminishing Returns Effect

The larger the output, the more variable input required to produce additional units, which leads to higher average variable cost.

Diminishing Marginal Product

The marginal product of an input declines as the quantity of the input increase (other things equal).

Total Cost

The market value of the inputs a firm uses in production.

Indicate the market equilibrium, level of output and the efficient level of output. Give an intuitive explanation for why these quantities differ.

The quantities differ because in deciding to buy fire extinguishers, people don't account for the benefits they provide to others.

Efficient Scale

The quantity that minimizes ATC.

Which of the following scenarios is consistent with the Laffer curve?

The tax rate is 1 percent, and tax revenue is very low.

Externality (Spillover)

The uncompensated impact of one person's actions on the wellbeing of a bystander. Example: When I buy a gallon of gasoline to drive my car, the transaction affects me and the gas station, but to others, the emission pollutes the environment.

External Benefit

The value of the positive impact on bystanders.

Which of the following statements about corrective taxes is generally NOT true?

They cause deadweight losses.

Why Private Solutions Do Not Always Work

Transaction Costs Coordination Problems Stubbornness

The Coase theorem does NOT apply if:

Transaction costs make negotiating difficult.

At the equilibrium price of a good, the good will be purchased by those buyers who:

Value the good more than price.

Average Variable Cost (AVC)

Variable cost divided by the quantity of output: AVC = VC/Q.

Variable Costs (VC)

Vary with the quantity produced. Example: Cost of materials, cost of utilities.

Suppose Raymond and Victoria attend a charity benefit and participate in a silent auction. Each has in mind a maximum amount that he or she will bid for an oil painting by a locally famous artist. This maximum is called:

Willingness to pay.