EC201 Exam 2

Why does a deadweight loss occur?

Because a tax gives buyers an incentive to consume less and sellers an incentive to produce less

Why are goods with positive externalities generally supplied or subsidized by the government?

Because one of the key economic roles of government is to eliminate or reduce free-riding

Private goods

Both excludable and rival in consumption; i.e. food, clothing

Burden of the tax

Buyers and sellers share the burden

Consider the market for fire extinguishers. 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 fire from damaging the property of others.

Which of the types of public-sector expenditures can enhance economic activity and thus offset the lost output and deadweight loss from the tax

Goods with "Positive Externalities" and "Public Goods"

A market is described by the following supply and demand curves: QS = 2P QD = 300 - P If the government imposes a price ceiling of $90, does a shortage or surplus develop? What are the price, quantity supplied, quantity demanded, and size of the shortage or surplus?

If the government imposes a price ceiling of $90, a shortage develops. The ceiling is below the equilibrium price so it is a binding price ceiling. At the ceiling price of $90, the quantity supplied is 2(90) = 180 units and the quantity demanded is 300 - 90 = 210 units. Consumers want to buy 30 more units than producers want to sell at the price ceiling.

A market is described by the following supply and demand curves: QS = 2P QD = 300 - P If the government imposes a price floor of $90, does a shortage or surplus develop? What are the price, quantity supplied, quantity demanded, and size of the shortage or surplus?

If the government imposes a price floor of $90, neither a shortage nor a surplus develops. The floor is lower than the equilibrium price so it is not a binding price floor. With a price floor of $90, the equilibrium price of $100 will prevail. The quantity supplied and demanded will be the equilibrium quantity of 200 units.

In a market with a binding price ceiling, an increase in the ceiling will ____ the quantity supplied, ____ the quantity demanded, and reduce the _____.

Increase; decrease; shortage

What does tax do to consumer and producer surplus?

It decreases both

What is the optimal quantity in relation to the equilibrium quantity when there is a positive externality?

It is higher

What does a tax do to the supply curve?

It shifts it to the left

Which of the following is an example of a public good?

National defense

Some important public goods include:

National defense, basic research, fighting poverty

Public goods

Neither excludable nor rival in consumption; i.e. national defense

Using the classifications in Figure 1, explain which category each of the following goods falls into: police protection

Police protection is a club good because it is excludable (the police may ignore some neighborhoods) and not rival in consumption. You could make an argument that police protection is rival in consumption, if the police are too busy to respond to all crimes, so that one person's use of the police reduces the amount available for others. In that case, police protection is a private good

Examples of negative externalities

Pollution

Which categories of goods are excludable?

Private goods and club goods

Which categories of goods are rival in consumption?

Private goods and common resources

Examples of positive externalities

Public education, public health and sanitation, transportation, national defense, criminal justice

Common resources

Rival in consumption, but not excludable; i.e. fisheries

Using the classifications in Figure 1, explain which category each of the following goods falls into: rural roads

Rural roads are public goods. They are not excludable and they are not rival in consumption because they are uncongested.

Using the classifications in Figure 1, explain which category each of the following goods falls into: snow plowing

Snow plowing is most likely a common resource. Once a street is plowed, it is not excludable. But it is rival in consumption, especially right after a big snowfall, because plowing one street means not plowing another street

price ceiling

a legal maximum on the price at which a good can be sold

Price floor

a legal minimum on the price at which a good can be sold

In the presence of a positive externality, where is the optimal quantity found?

Where the social cost and supply curves intersect

Non-rival

Your consumption does not diminish my consumption

Sofia pays Sam $50 to mow her lawn every week. When the government levies a mowing tax of $10 a week on Sam, he raises his price to $60. Sofia continues to hire him at the higher price. What is the change in producer surplus, change in consumer surplus, and deadweight loss?

$0, -$10, $0

Club goods

Excludable, but not rival in consumption; i.e. cable TV

Consider the market for fire extinguishers. 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 the 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.

When is a price floor effective?

A price floor is placed above the market equilibrium price

Define and give an example of a public good. Can the private market provide this good on its own? Explain.

A public good is a good that is neither excludable nor rival in consumption. An example is national defense, which protects the entire nation. No one can be prevented from enjoying the benefits of it, so it is not excludable. An additional person benefiting from it does not diminish the value of it to others, so it is not rival in consumption. The private market will not supply the good, because no one would pay for it because they cannot be excluded from enjoying it even if they don't pay for it.

What does a price ceiling cause?

A shortage

Which causes a shortage of a good- a price ceiling or a price floor? Justify your answer with a graph.

A shortage of a good arises when there is a binding price ceiling. A binding price ceiling is one that is placed below the market equilibrium price. This leads to a shortage because quantity demanded exceeds quantity supplied.

A cost-benefit analysis

A study that compares the costs and benefits to society of providing a public good

What does a price floor cause?

A surplus

When a government imposes a binding price floor, it causes

A surplus of the good to develop

What does a tax do to the price paid by buyers, the price received by sellers, and the quantity sold?

A tax on a good increases the price paid by buyers, reduces the price received by sellers, and reduces the quantity sold

How does a tax on a good affect the price paid by buyers, the price received by sellers, and the quantity sold?

A tax on a good raises the price buyers pay, lowers the price sellers receive, and reduces the quantity sold

Internalizing the externality

Altering incentives so that people take into account the external effects of their actions; i.e. with a tax

Give an example of a price ceiling and an example of a price floor.

An example of a price ceiling is rent control. An example of a price floor is the minimum wage.

Explain what is meant by a good being excludable. Explain what is meant by a good being rival in consumption. Is a slice of pizza excludable? Is it rival in consumption?

An excludable good is one that people can be prevented from using. A good that is rival in consumption is one for which one person's use diminishes other people's use of the same good. Pizza is excludable, because a pizza producer can prevent someone who does not pay for the pizza from eating it. Pizza is also rival in consumption, because when one person eats it, no one else can eat it.

Positive externality

An externality with a beneficial impact

Negative externality

An externality with an adverse impact

Using the classifications in Figure 1, explain which category each of the following goods falls into: city streets

City streets are common resources when congested. They are not excludable, because anyone can drive on them. But they are rival in consumption, because congestion means that every additional driver slows down the progress of other drivers. When they are not congested, city streets are public goods, because they are no longer rival in consumption

The market for pizza is characterized by a downward-sloping demand curve and an upward-sloping supply curve. Suppose that the government forces each pizzeria to pay a $1 tax on each slice of pizza sold. Illustrate the effect of this tax on the pizza market, being sure to label the consumer surplus, producer surplus, government revenue, and deadweight loss. How does each area compare to the pre-tax case?

Consumer and producer surplus decrease. Government revenue and deadweight loss

Government debt v. deficit

Deficit is the difference between govt revenues and tax receipts; usually measured annually Debt is the accumulated deficits

Using the classifications in Figure 1, explain which category each of the following goods falls into: education

Education is a private good (with a positive externality). It is excludable, because someone who does not pay can be prevented from taking classes. It is rival in consumption, because the presence of an additional student in a class reduces the benefits to others.

Non-exclusive

Even if you don't pay for them, I can't exclude you from consuming

Give an example of a negative externality and an example of a positive externality.

Examples of negative externalities include pollution, barking dogs, and consumption of alcoholic beverages. Examples of positive externalities include the restoration of historic buildings, research into new technologies, and education.

A market is described by the following supply and demand curves: QS = 2P QD = 300 - P Solve for the equilibrium price and quantity.

Solve for the equilibrium price and quantity by setting the quantity supplied equal to the quantity demanded: 2P = 300 - P; 3P = 300; P = $100. When the equilibrium price is $100, the equilibrium quantity is 2(100) = 200

Where does a price ceiling leave buyers and sellers?

Some buyers are better off and sellers are worse off

Where does a price floor leave buyers and sellers?

Some sellers are better off and buyers are worse off

Free rider

Someone who receives the benefit of a good but does not pay for it

What is infrastructure spending called?

Stimulus

When a good is taxed, the burden of the tax falls mainly on consumers if

Supply is elastic, and demand is inelastic

Total tax revenue

Tax on the good * quantity sold

Fiscal policy

Taxation, government spending, and government borrowing

The Keynesian Multiplier

The additional output generated by an increase in government spending

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

The attractiveness of a neighbor's property enhances the value of your property - i.e. it is a positive externality

What area of the graph reflects the cost of the effects of production?

The difference between the social cost curve and the supply curve

Deadweight loss

The fall in total surplus that results from a market distortion, such as a tax

Why do you think the government provides items that are not public goods?

The government may provide goods that are not public goods, such as education, because of the positive externalities associated with them.

Tax incidence

The manner in which the burden of a tax is shared among participants in a market

Which side of the market bears more of the burden?

The more inelastic side

In the presence of a negative externality, what does the point where the demand curve and social cost curve intersect represent?

The optimal quantity from the standpoint of society as a whole

Suppose the federal government requires beer drinkers to pay a $2 tax on each case of beer purchased. Draw a supply-and-demand diagram of the market for beer without the tax. Show the price paid by consumers, the price received by producers, and the quantity of beer sold. What is the difference between the price paid by consumers and the price received by producers?

The price paid by consumers is the same as the price received by producers

If the government places a $500 tax on luxury cars, will the price paid by consumers rise by more than $500, less than $500, or exactly $500? Explain.

The price will rise by less than $500. The burden of any tax is typically shared by both producers and consumers- the price paid by consumers rises and the price received by producers falls, with the difference between the two equal to the amount of the tax. The only exceptions would be if the supply curve were perfectly elastic or the demand curve were perfectly inelastic, in which case consumers would bear the full burden of the tax and the price paid by consumers would rise by exactly $500.

Social cost

The private cost of the producers plus the costs to those bystanders affected adversely

Consider the market for fire extinguishers. 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.

What area of the graph represents the government's tax revenue?

The rectangle between the supply and demand curves

Externality

The uncompensated impact of one person's actions on the well-being of a bystander

The market for pizza is characterized by a downward-sloping demand curve and an upward-sloping supply curve. Draw the competitive market equilibrium. Label the price, quantity, consumer surplus, and producer surplus. Is there any deadweight loss? Explain.

There is no deadweight loss, as all the potential gains from trade are realized; total surplus is the entire area between the demand and supply curves.

When are price ceilings effective?

To be effective, a price ceiling is placed below the market equilibrium price

What are the types of public-sector expenditures?

Transfers- eg Social Security, Medicaid, and Medicare Goods with "Positive Externalities" and "Public Goods"- eg Education, Public Health, Public Transportation, National Defense, and Criminal Justice

Public goods (def)

Typically goods with positive externalities that have two additional, special characteristics of non-rivalry and non-excludability

Suppose the federal government requires beer drinkers to pay a $2 tax on each case of beer purchased. Now draw a supply-and-demand diagram of the market for beer without the tax. Show the price paid by consumers, the price received by producers, and the quantity of beer sold. What is the difference between the price paid by consumers and the price received by producers? Has the quantity of beer sold increased or decreased?

When the tax is imposed, it drives a wedge of $2 between supply and demand, as shown in Figure 6. The price paid by consumers is P2, while the price received by producers is P2 - $2. The difference between the price paid by consumers and the price received by producers is the $2 tax. The quantity of beer sold declines to Q2.

When is the market equilibrium not sufficient?

When there are externalities