ECON CH2

Suppose you sold the car for $17,000. If the minimum price, or "bottom line," you would accept for the car is $13,000 and the most the buyer is willing to pay is $38,000, then the seller surplus is _________ and the buyer surplus is _______. The total surplus created by the transaction is __________

4,000 21,000 25,000

Wealth is created when...

Assets move from lower to higher-valued uses.

Total Surplus

Buyer surplus + Seller surplus

Voluntary transactions between individuals or firms...

Create wealth people create wealth by pursuing self interest

What is the governments role in wealth creation?

Enforcing property rights and contracts, legal tools that facilitate wealth creating transactions Ensures that buyers and sellers keep gains from transactions

True or False: In order to profit from this law, an individual could purchase Sephora products during the day and sell them at a higher price during normal store hours

False

In 2013, France's labor unions won a case against Sephora to prevent the retailer from staying open late and forcing its workers to work "antisocial hours." The cosmetic store does about 20 percent of its business after 9 p.m., and the 50 sales staff who work the late shift are paid an hourly rate that is 25 percent higher than the rate paid to workers on the day shift. Many of the late-hour workers are students or part-time workers, who are put out of work by these new laws. Forcing the retailer to close earlier forces the store's assets, such as the building and merchandise, to be moved from ______ -valued activities to ______-valued activities.

High lower

Inefficiency

Implies the existence of unconsummated wealth creating transactions

Suppose you recently sold your used car. Assume that no new production was involved in this transaction. Wealth was created because the value of your willingness to sell was __________ the buyer's willingness to pay.

Less than

Why are some countries poor?

No property rights No rule of law

What destroys wealth?

Taxes Subsidies Price Controls (Ceilings and floors)

The one lesson of economics

The art of economics consists in not looking merely at the immediate effects but long term effects of any act or policy Tracing consequences to all groups Must look at intended and unintended effects

In 2009, when Kraft bid $16.7 billion for Cadbury, Cadbury's market value rose. However, Kraft's market value fell by more. What does this tell you about the value-creating potential of the deal?

The market thinks that combining these assets will destroy value.

Suppose the government is considering penalizing airlines $27,500 per passenger each time passengers are made to remain on the plane on the tarmac for more than three hours before a flight. True or False: The threat of this fine could increase delays by forcing airlines to deplane and reboard more than necessary

True

Value =

Willingness to pay Desire+Income = You want something + You can pay for it

An economy is efficient if

all assets are employed in their highest valued uses make money by identifying unconsummated wealth creating transactions and devise ways to profitably consummate them

Two similar surgeries, breast reconstruction and breast augmentation, have different prices. Breast augmentation is cosmetic surgery not covered by health insurance. Patients who want the surgery must pay for it themselves. Breast reconstruction following breast removal due to cancer is covered by insurance. The price of one of the surgeries has increased by about 10% each year since 1995, whereas the price of the other has increased by only 2% per year. Breast ____________ surgery likely has the lower rate of inflation, since insurance coverage offers a stronger incentive to undergo breast ________________ , driving up prices.

augmentation reconstruction

Suppose an individual is looking to build a house in a plain that is prone to flooding. Because of the risk of damage due to flooding, the buyer's top dollar for building the house is only $270,000. Suppose the cost of building a house in this area is $310,000. A wealth-creating transaction is not possible since the seller's bottom line (or the cost of building the house) is __________ the buyer's top dollar. The difference between the cost of building the house minus the buyer's top dollar is _________.

greater than 40,000

Suppose the government subsidizes flood insurance for homes in the flood plain. Because of this, the buyer has access to very cheap insurance, worth an expected $60,000. Without such a subsidy, the high likelihood of flood results in extremely high rates for flood insurance. With this subsidy, the individual ______ incentivized to build a house in the flood plain.

is

Buyer surplus

the difference between the buyer's value (what he is willing to pay) and the price (what he has to pay)

Seller Surplus

the difference between the price received by the seller and his or her bottom line