ECON 101 MIDTERM 1
factors that shift the demand curve
# of buyers, price of other things, income, preferences, expectations, network effects and congestion
factors that shift supply curve
# of sellers, price of other things, price of inputs, productivity and technology, expectations
comparative advantage
ABILITY TO DO A TASK AT A LOWER OPPORTUNITY COST
different taxes we pay are implemented for different purposes
INCOME tax - generate revenue for gov't services CIGARETTE tax - discourage "bad" behavior ("sin taxes") CARBON tax - correct for externalities EXCISE tax - taxes on specific products that are paid every time you buy it (ex: sales tax)
goal of a business/supplier
MAXIMIZE PROFITS (total revenue - total cost)
marginal external cost
extra cost IMPOSED ON BYSTANDERS from producing an extra unit
tax
government-mandated price changes
elasticity
measure of the CHANGE IN BEHAVIOR of buyers and sellers IN RESPONSE TO A PRICE CHANGE for a good or service
opportunity cost principle
the NEXT BEST ALTERNATIVE THAT YOU GIVE UP WHEN YOU MAKE A CHOICE; the true cost of something
productivity + technology as factors that shift the supply curve
whenever firms learn to produce more output with fewer inputs, SUPPLY INCREASES (more productive); ex: automation dramatically increased the supply of cars
PPF graph
- BELOW the frontier shows us doing less than our limits (INEFFICIENT) - ABOVE the frontier shows us doing more than our limits (UNATTAINABLE) - Moving ALONG the frontier lets us VISUALIZE OPPORTUNITY COSTS - PPF will always slope down (we always have some opportunity cost) always express opportunity cost in terms of what we give up Frontier's SHAPE gives information about opportunity costs: - STRAIGHT means OC stays the SAME - CONCAVE (bulging out) frontier would mean OCs are INCREASING; REPRESENTS ABILITY TO GROW causing the limit to what you can do to be bigger
determinants of price elasticity of supply
- INVENTORIES make supply MORE elastic - EASILY AVAILABLE INPUTS make supply MORE elastic - EXTRA CAPACITY makes supply MORE elastic - BARRIERS TO ENTRY + EXIT makes supply LESS elastic - over TIME, supply becomes MORE elastic
price elasticity of demand
- a measure of HOW RESPONSIVE BUYERS ARE TO PRICE CHANGES - measure percent change in quantity demanded that follows from a 1% price change (% Qd ÷ %P - midpoint formula) MORE RESPONSIVE = ELASTIC LESS REPONSIVE = INELASTIC ALWAYS NEGATIVE - because when prices go up, demand always goes down and vice versa comes down to SUBSTITUTABILITY - do consumers have alternatives that they can buy to satisfy their needs?
externality
- a side effect of an economic activity that affects a third party (bystander) whose interests aren't taken into account - ex: secondhand smoke causes cancer, everyone driving at once creates congestion, local bee hives can pollinate plants and farms - can be good or bad
economic efficiency
- an OUTCOME IS MORE ECONOMICALLY EFFICIENT IF IT YIELDS MORE ECONOMIC SURPLUS - recall that economic surplus is the excess benefit left over from a given decision after we take into account the costs - if surplus measures the size of the economic pie, efficiency is the idea of making that pie bigger: increasing efficiency means that there's more pie to go around - rely on the idea of economic efficiency to decide the best course of action - ex: AI-created art - using efficiency to make our value judgment
criticisms of efficiency
- controversy over people being harmed by efficiency - ALL policy creates winners and losers and the ARGUMENT FOR EFFICIENCY is that we can compensate those who lose - however it can be tough to identify everyone who is hurt by a policy, and even more difficult to figure out how much they are owed (DIFFICULT TO QUANTIFY HARM)
positive analysis
- describing what is happening, explaining why, or predicting WHAT WILL HAPPEN - concerned with things that are FALSIFIABLE (can be true or false) - concerned with OBJECTIVE STATEMENTS (facts) - ex: the unemployment rate in July was 3.5%
deadweight loss
- how far actual economic surplus falls below the efficient outcome - can also calculate using area of triangle
subsidies
- opposite of taxes - a PAYMENT made by the government TO THOSE WHO MAKE A SPECIFIC CHOICE - LOWER MARGINAL COSTS when given to SUPPLIERS - RAISE MARGINAL BENEFITS when given to BUYERS just like with taxes: - change equilibrium - create deadweight loss - incidence of subsidy split between buyers and sellers whichever is less elastic gets to keep more of the surplus (opposite of taxes)
normative analysis
- prescribing what SHOULD happen; always involves a value judgment (prioritization of something/someone over another) - concerned with MATTERS OF OPINION - all about DECIDING WHICH OPTION IS BEST: involves choosing WHO is going to bear the costs or reap the benefits of a particular decision (efficiency!!) - ex: we should get rid of the minimum wages to increase employment or Chapel Hill should rezone more neighborhoods to allow apartments
equilibrium
- the point at which there is NO TENDENCY FOR CHANGE - point at which there is not tendency for buyers or sellers to change what they are doing in a market (buyers don't want to buy more and sellers don't want to sell more) - when quantity supplied = quantity demanded - happens when buyers and sellers are in AGREEMENT: suppliers are willing to sell exactly as much as demanders want to buy
3 step method to figuring out equilibrium changes
1) determine WHICH CURVE IS SHIFTING - demand, supply, or both 2) determine HOW each curve is shifting - decreasing (left) or increasing (right) 3) determine HOW PRICES + QUANTITIES WILL CHANGE in the new equilibrium - compare old and new equilibrium values to see how it has changed
determinants of price elastiicty
1. competing markets 2. market specificity 3. necessity 4. budget
absolute advantage
ABILITY TO DO A TASK USING FEWER RESOURCES; tells us who can (do/make/produce) more, given the same inputs
rational rule for sellers
CONTINUE MAKING AND SELLING PRODUCT UNTIL MARGINAL COST = PRICE (aka Golden rule of profit maximization) so long as price > MC, selling one more means that my profits must be going up BUT, firms don't want to sell infinite stuff because of DIMINISHING MARGINAL RETURNS - eventually the cost to produce more rises and then keeps rising (ensures that firms obey law of supply) firms supply up until the point where they can't make any extra profit by selling one more additional unit, where P = MC (but if price rises, golden rule might justify selling another unit)
solving a NEGATIVE externality
CORRECTIVE TAX - induce people to take into account the negative externalities they create; holding people accountable must be set equal to marginal external cost think of lawsuits, social norms (farting in an elevator)
marginal principle
DECISIONS ABT QUANTITIES ARE BEST MADE INCREMENTALLY; break down "how many" questions into a series of smaller decisions, weighing marginal benefits and marginal costs
tax incidence
DIVISION OF ECONOMIC BURDEN OF A TAX BTW BUYERS AND SELLERS (ex: soda tax causes buyers to pay $.33 more and sellers to get $.17 less)
what determines who pays the economic cost of a tax?
ELASTICITY: - when DEMAND IS MORE ELASTIC THAN SUPPLY is more elastic than supply, then SELLERS end up BEARING MOST OF TAX INCIDENCE (buyers can simply switch brand of product) - when SUPPLY IS MORE ELASTIC than demand, then BUYERS end up BEARING MOST OF TAX INCIDENCE (ex: even if prices rise, most smokers will still buy the same amount of cigarettes)
why are externalities bad for society/why do they create market failure?
EXTERNALITIES REPRESENT A MARKET FAILURE we can also put a $ value on how much society is losing from these bad trades - DEADWEIGHT LOSS
quota/cap
LIMITS THE MAXIMUM QUANTITY of a good or service that can be sold when a quota is BINDING, it requires the quantity produced to be less than it would be the supply = demand equilibrium
neccesity
MORE NECESSARY A GOOD IS, THE LESS ELASTIC IS DEMAND MORE OF A LUXURY THE GOOD IS, MORE ELASTIC THE DEMAND (because luxuries are almost guaranteed to have more substitutes)
consequences of a tax
RAISES REVENUE FOR GOV'T REDUCES CS + PS - revenue that government gets is "taken" from this surplus CREATES DEADWEIGHT LOSS - tax reduces quantity sold at equilibrium which can make some trades "too costly" for society (calculated with area of a triangle)
marginal external benefits
REDUCE EFFECTS ON BYSTANDER; show these benefits by adding them to the DEMAND line
taxes on BUYERS
SHIFTS DEMAND CURVE (reflected by moving down amt of tax on y-axis) LOWERS MARGINAL BENEFIT for buyers (giving away some money)
taxes on SELLERS
SHIFTS SUPPLY CURVE (reflected by moving up amt of tax on y-axis) RAISES MARGINAL COST FOR SELLERS - in addition to all the costs from before, now sellers have to pay tax to the government IMPACT: QUANTITY DECREASES - since sellers face higher costs, they certainly won't want to sell as much PRICE INCREASES (not by amt of tax) - buyers are paying more and sellers are receiving less
marginal social (public) benefit
SOCIAL DEMAND CURVE that shows the benefit to the individual who is doing the externality plus the benefit to bystanders
solving a POSITIVE externality
SUBSIDY - encourages more people to consume goods that produce positive externalities must be EQUAL TO MARGINAL EXTERNAL BENEFIT think of warm glow or social recognition (giving blood)
marginal social cost (public)
SUM OF MARGINAL INTERNAL + EXTERNAL COSTS OF A MARKET ACTIVITY what you pay vs what you force others to pay
price ceiling
a MAXIMUM price that sellers can legally charge (ex: rent control, laws limiting medical costs) represented as HORIZONTAL LINE - price can't go ABOVE the line
price floor
a MINIMUM price that sellers can legally charge (ex: minimum wage laws, alcohol prices in Scotland) represented as HORIZONTAL lines - price can't go BELOW the line causes a SURPLUS
cap and trade
a QUANTITY REGULATION implemented by ALLOCATING a fixed number of pollution PERMITS, which can then be TRADED; similar to corrective tax but instead RAISES OPPORTUNITY COST CAP: government REGULATES the quantity of NEGATIVE EXTERNALITIES directly TRADE: government implements this by issuing pollution permits which can be traded
inferior goods
a good for which higher income causes an DECREASE in demand (ex: ramen noodles, at-home hair dye)
normal goods
a good for which higher income causes an INCREASE in demand (ex: housing)
quota
a legal MAXIMUM on the AMT THAT CAN BE BOUGHT OR SOLD graphed as a VERTICAL line - for a quota, quantity CANNOT GO FURTHER RIGHT than the line if a quota is BINDING - quantity below the competitive equilibrium - then buyers and sellers will be stuck with the lower quantity set by the quota LEADS TO A PRICE "WEDGE" BTW BUYERS AND SELLERS if buyers cannot demand more than the quota, then sellers will compete to be the one to sell; prices will fall to the minimum that sellers can profitable afford
negative externality
a side effect that HARMS bystanders
positive externality
a side effect that HELPS bystanders
economic burden
actual burden created by changes in price due at a tax (felt by both buyers AND sellers)
substitutes-in-production
alternative uses of the SAME RESOURCES; SUPPLY of a good will DECREASE if the PRICE of a substitute-in-production RISES ex: if the price of whisky rises, a corn farmer could use their crops to produce whiskey but they cannot supply as much ethanol (corn demand goes down while whisky supply increases)
assigning an owner
assigning property rights prevents one person from overusing something and not paying for the privilege (solves the tragedy of the commons) ENSURES THAT SOMEONE OWNS THE COMMON RESOURCES WHICH INCENTIVIZES PEOPLE TO ENSURE THAT ITS NOT OVERUSED
cost-benefit principle
before making a decision, EVALUATE ALL THE COSTS + BENEFITS OF A DECISION; only make the decision if the BENEFITS ARE AT LEAST AS LARGE AS THE COSTS
statutory burden
burden of being ASSIGNED BY GOVT TO PAY TAX (ex: soda sellers are the ones paying Philly government)
reason why trade creates value
by focusing on what we are least bad at, we reduce the opportunity cost we need to pay in other words, trade creates value by FACILITATING SPECIALIZATION - focusing on specific tasks
scarcity
condition in which DESIRE/demand from something IS GREATER THAN THE SUPPLY of that thing; impacts everyone!
unintended consequences of price ceilings
don't need to worry about losing some customers which leads to LOWER QUALITY, EMERGENCE OF BLACK MARKETS, SUPPLIERS FINDING ALTERNATIVE WAYS TO USE THEIR INPUTS
law of diminshing marginal returns
each additional unit yields a smaller marginal benefit than the previous one; if quantity is increasing you will pay less
consumer surplus (CS)
economic surplus from BUYING something (MB - P); reflected by portion of demand line below demand curve and above price line
producer surplus (PS)
economic surplus from SELLING something (P - MC); reflected by area above supply line and below price line measuring all surplus using AREA OF A TRIANGLE: A = ½ bh
how do we solve the externality problem
externality problems are really PROPERTY RIGHTS PROBLEMS markets with an externality will not be efficient NEED A WAY TO GET BUYERS + SELLERS TO INTERNALIZE THE CONSEQUENCES OF THEIR ACTIONS internalize = take into account the external costs (or benefits) of doing something in extreme externality situations a BAN might be a reasonable policy suggestion
marginal internal (private) cost
extra costs PAID BY SELLERS from producing an extra unit
cross-price elasticity of demand
focuses on how products' price impacts demand for another - change in quantity as a result of change in price of another good MEASURE OF HOW RESPONSIVE THE DEMAND OF ONE GOOD IS TO PRICE CHANGES OF ANOTHER POSITIVE FOR SUBSTITUTES - if the price of a substitute rises, you buy more of the good in question NEGATIVE FOR COMPLEMENTS - if the price of a complement rises, you buy less of the good in question
competing markets
for some products there are lots of DIFFERENT BRANDS THAT BASICALLY SUPPLY THE SAME THING; most of the time, we don't really care which just the cheapest
complementary goods
goods that GO TOGETHER; DEMAND for a good will DECREASE if the PRICE of a COMPLEMENTARY good RISES, and will increase if the price of a complementary good falls (inverse relationship)(ex: shoes + socks, gas + cars)
substitute goods
goods that REPLACE EACH OTHER; DEMAND for a good will INCREASE if the PRICE of a SUBSTITUTE GOOD RISES, and it will fall if the price of a substitute good falls (direct relationship) (ex: gas-powered and electric cars)
complements-in-production
goods that are MADE together; SUPPLY of a good will INCREASE if the PRICE of a complement-in-production RISES ex: beef and leather, gas and kerosene, raw materials found together CAN MAKE ONE THING MORE CHEAPLY BC ALSO ARE MAKING SOMETHING ELSE
price controls
government influencing markets by setting direct REGULATIONS ON PRICE OR QUANTITY
quantity controls
government regulation of quantity is most common in the form of QUOTAS
how can we solve a public goods problem?
government should purchase public goods for everyone to use paid for from tax revenues - GOVERNMENT PROVISION OF PUBLIC GOODS why the military, police, and public parks are all paid for out of our taxes, rather than being underproduced by private businesses
the law of demand
holding all else equal, the quantity demanded for a good falls if the price for that good rises, and the quantity demanded rises if the price falls IF THE PRICE OF SOMETHING WERE HIGHER, YOU'D BUY LESS
law of supply
holding all else equal, the quantity of a good supplied rises if the price for that good rises, and the quantity supplies falls if the price falls IF THE PRICE OF SOMETHING GOES UP, MORE PEOPLE WILL SELL IT (ex: willing to sell shoes for $100 if everyone else is selling for $100 or more) firms decide HOW MUCH to sell using MARGINAL THINKING
the coase theorem
if bargaining is costless and property rights are clearly established and enforced, then EXTERNALITY PROBLEMS CAN BE SOLVED BY PRIVATE BARGAINS (side payments) - remember, we don't want to eliminate externalities, we just want to get back to the social optimum - bystander won't offer to make side payments that are bigger than their benefits/costs - buyers and sellers won't change their behavior unless the side payments are big enough - SIDE PAYMENTS CREATE OPPORTUNITY COSTS, which incentivize buyers and sellers to change their behavior - it doesn't matter who is assigned property rights so long as someone has them
price of inputs as a factor that shifts the supply curve
if input PRICES RISE, SUPPLY will FALL (inversely related); ex: rise in semiconductor price caused car prices to rise and sales to fall
production possibilites frontier (PPF)
let us see what combinations a (person/business/nation) can produce; DESCRIBES THE LIMITS OF WHAT WE CAN DO
price elasticity of supply
measure of how responsive sellers are to price changes; = %Qs ÷ %P ALWAYS POSITIVE - supply always goes up how responsible supply is to price all comes down to FLEXIBILITY - when prices go up, businesses want to be able to sell more, just a matter of if they can make more without losing profits
unintended consequences of price floor
more demand than supply means BUYERS WILL BE CHOOSY, STORES SELLING ON BLACK MARKETS, FREQUENT GOV'T INTERVENTION TO BUY THE SURPLUS
market specificity
more narrowly we define a market, more elastic is demand (ex: lots of substitutes/types of cars)
free rider problem
occurs when SOMEONE ENJOYS THE BENEFITS OF SOMETHING W/O BEARING THE COSTS ex: if you enjoy beautiful architecture or breathing clean air you are likely free-riding on the work of others don't pay for the benefits they receive and are therefore BYSTANDERS, ENJOYING POSITIVE EXTERNALITIES
social optimum
outcome that is most efficient for society as a WHOLE, including sellers, buyers and bystanders EQUILIBRIUM WHERE ALL SOCIALLY BENEFICIAL TRADES HAPPEN where supply line meets demand line using social optimum as a reference point, we can see that markets lead to OVERPRODUCTION of goods with NEGATIVE EXTERNALITIES UNDERPRODUCTION of goods that contain POSITIVE EXTERNALITIES
expectations as a factor that shifts the supply curve
people choose WHEN TO BUY suppliers can time their decisions to sell based on price expectations; ex: Spirit Halloween when producers expect the price of a good to rise in the future, they supply LESS (only if a good is storable/non-perishable)
expectations as a factor that shifts the demand curve
people choose when to buy when people expect PRICE of a good to FALL, they DEMAND LESS when people expect PRICE to RISE in the future, they DEMAND MORE
preferences as a factor that shifts the demand curve
people's feelings about products change - when desire/preferences increases, DEMAND INCREASES, same relationship when it falls
income elasticity of demand
percent change in quantity demanded that follows from a 1% change in income POSITIVE FOR NORMAL GOODS - if your income rises, you buy more of a normal good NEGATIVE FOR INFERIOR GOODS - if your income rises, you buy less of an inferior good
binding price ceiling
price ceiling that PREVENTS the market from reaching competitive equilibrium price; lead to persistent SHORTAGES
equilibrium price
price that a good is being sold at equilibrium (P*)
how are prices useful?
prices fulfill 2 roles in marketplaces: 1. price is a MESSAGE TO BUYERS (communicating VALUE) and SELLERS (communicating SCARCITY and COST) 2. price is an INCENTIVE to buyers and sellers - for SELLERS, prices incentivize PRODUCTION + INNOVATION - for BUYERS, high prices incentivize DECREASED CONSUMPTION, leaving MORE SUPPLY FOR THOSE W/ HIGHER MARGINAL BENEFIT
equilibrium quantity
quantity that is being sold at equilibrium (Q*)
market
setting that brings together potential buyers and sellers or more broadly trading partners; every market will include a PRICE for transactions (i.e. money, beauty, hard work, etc)
market supply
the SUM of all individual quantities SUPPLIED BY EACH SELLER TO GRAPH market supply: take every firm's individual supply at a certain price and ADD IT ALL UP also notice that QUANTITY SUPPLIED INCREASES BECAUSE NEW SELLERS ENTER THE MARKET
marginal benefit
the extra BENEFIT from one extra unit
marginal cost
the extra COST from one extra unit every time we take a step where MB>MC our excess benefits go up (maximizing economic surplus)
inelastic supply
when a change in price leads to a proportionally smaller change in quantity supplied (Es < 1)
congestion as a factor that shifts the demand curve
when a good becomes less useful if other people use it; ex: highways (traffic), a specific piece of clothing (wearing the same outfit as someone else); demand DECREASES
network effects as a factor that shifts the demand curve
when a good becomes more useful if other people use it (DEMAND INCREASES)
how we get to equilibrium
when a market is out of equilibrium, PRICES and our ECONOMIC FUNDAMENTALS are going to push it toward equilibrium
elastic supply
when a price change leads to a proportionally bigger change in quantity supplied (Es > 1)
inelastic demand
when absolute value of percent change in quantity is smaller than absolute value of percent change in price; in other words, WHEN PRICE CHANGES CAUSE PROPORTIONALLY SMALLER QUANITTY CHANGES (Ed > -1) MORE POSITIVE, closer to 0 HORIZONTAL LINE - no matter how much price changes, people still buy the same amount
budget
when an item takes up a bigger share of your budget, you will be more sensitive to price changes (more elastic)
market failure
when markets function poorly, there is no guarantee that the market outcome is efficient when the forces of supply and demand lead to an inefficiency most market failures don't lead to a total breakdown of a market but, market failures means were LOSING SOME OF OUR GAINS FROM TRADE
elastic demand
when price changes cause proportionally larger quantity changes; PEOPLE RESPONDING A LOT TO PRICE CHANGES (Ed < -1) MORE NEGATIVE, farther from 0 VERTICAL LINES - people will stop buying entirely if prices rise by even a little
individual demand to market demand
when prices fall, the people who were willing to buy before still buy, but now they get to buy at a lower price MARKET DEMAND = SUM of all individual quantities demanded by each buyer in the market
shortage
when the QUANTITY DEMANDED EXCEEDS QUANTITY SUPPLIED demanded exceeds the quantity supplied at a given price (people want more than what is sold)
surplus
when the QUANTITY SUPPLIED EXCEEDS QUANTITY DEMANDED at a given price (businesses want to sell more than you want to buy)
interdependence principle
your best choice depends on OTHER CHOICES, the CHOICES OF OTHER PEOPLE, developments in other MARKETS, and EXPECTATIONS about the future; when any of these factors change, your best choice might change