Ch. 5: Markets, efficiency, and amp; Government Involvement
positive externalities
Benefits received by a third party
marginal decision rule
If the marginal benefit of an additional unit of an activity exceeds the marginal cost, the quantity of the activity should be increased. If the marginal benefit is less than the marginal cost, the quantity should be reduced.
What is the term for a quantity control that restricts the quantity sold in a market?
Quota
common property resource
Resources for which no property rights have been defined.
demand curve
a graphic representation of the relationship between price and quantity demanded of a certain good or service, with quantity on the horizontal axis and the price on the vertical axis
supply curve
a line that shows the relationship between price and quantity supplied on a graph, with quantity supplied on the horizontal axis and price on the vertical axis
marketable permit program
a permit that allows a firm to emit a certain amount of pollution; firms with more permits than pollution can sell the remaining permits to other firms
transferable property right
a property right that allows the owner of a resource to sell or lease it to someone else
demand schedule
a table that shows a range of prices for a certain good or service and the quantity demanded at each price
supply schedule
a table that shows a range of prices for a good or service and the quantity supplied at each price
pollution charge
a tax imposed on the quantity of pollution that a firm emits
positive externality
beneficial side effect that affects an uninvolved third party
Marginal social cost is equal to
marginal private cost plus marginal external cost
Black market
market where goods and services are sold illegally
Ceteris Paribus
other things being equal
free riders
people or firms that consume a public good without paying for it
Renewable resources are those for which
periodic use can be continued indefinitely.
PC
private costs
marginal cost
the amount by which an additional unit of an activity increases its total cost
intellectual property
the body of law including patents, trademarks, copyrights, and trade secret law that protect the right of inventors to produce and sell their inventions
Law of Supply
the common relationship that a higher price leads to a greater quantity supplied and a lower price leads to a lower quantity supplied, while all other variables are held constant
law of demand
the common relationship that a higher price leads to a lower quantity demanded of a certain good or service and a lower price leads to a higher quantity demanded, while all other variables are held constant
social benefits
the dollar value of all benefits of a new product or process invented by a company that can be captured by other firms and by society as a whole
private benefits
the dollar value of all benefits of a new product or process invented by a company that can be captured by the investing company
Biodiversity
the full spectrum of animal and plant genetic material
reservation price(willingness to sell)
the lowest price that a seller is willing to accept
reservation price(willingness to pay)
the maximum price a consumer is willing to pay for a product or service based on the total perceived consumer benefits
unemployment
the minimum wage creates a surplus of 8 million hours of labor
equilibrium price
the price where quantity demanded is equal to the quantity supplied
equilibrium quantity
the quantity at which quantity demanded equals quantity supplied are equal for a certain price level
demand
the relationship between price and the quantity demanded of a certain good or service
supply
the relationship between price and the quantity supplied of a certain good or service
factors of production(inputs)
the resources such as labor, materials, and machinery that are used to produce goods and services
Inputs
the resources such as labor, materials, and machinery that are used to produce goods and services; also called factors of production
Equilibrium
the situation where quantity demanded is equal to the quantity supplied; the combination of price and quantity where there is no economic pressure from surpluses or shortages that would cause price or quantity to change
net benefit
the total benefit of an activity minus its opportunity cost
quantity demanded
the total number of units of a good or service consumers are willing to purchase at a given price
quantity supplied
the total number of units of a good or service producers are willing to sell at a given price
When the free market produces less than the socially optimal quantity of a good
there has been a market failure.
free rider
those who want others to pay for the public good and then plan to use the good themselves; if many people act as free riders, the public good may never be provided
economic profit
total revenue - total cost
Social Costs (SC)
true costs SC = PC + XC
command-and-control regulation
types of laws, which specify allowable quantities of pollution and which also may detail which pollution-control technologies must be used.
Full compensation
wages + fringe benefits + training opportunities
price
what a buyer pays for a unit of the specific good or service
shift in demand
when a change in some economic factor (other than price) causes a different quantity to be demanded at every price
shift in supply
when a change in some economic factor (other than price) causes a different quantity to be supplied at every price
nonexcludable
when it is costly or impossible to exclude someone from using the good, and thus hard to charge for it
private rates of return
when the estimated rates of return go primarily to an individual; for example, earning interest on a savings account
social rate of return
when the estimated rates of return go primarily to society; for example, providing free education
A public good, such as a community's emergency warning sirens, typically
imposes both benefits and costs on many individuals.
area of consumer surplus
1/2 x base x height
external costs
A cost imposed on others outside of any market exchange.
private good
A good for which exclusion is possible and for which the marginal cost of another user is positive.
public good
A good for which the cost of exclusion is prohibitive and for which the marginal cost of an additional user is zero.
price ceiling
A maximum allowable price.
price floor
A minimum allowable price set above the equilibrium price.
Exclusive property right
A property right that allows its owner to prevent others from using the resource.
property rights
A set of rules that specify the ways in which an owner can use a resource.
Efficiency condition
A situation that requires a competitive market with well-defined and transferable property rights.
excise tax
A tax that's levied on the purchase or sale of a particular good or service.
Why will a binding price ceiling result in an inefficient allocation of resources? A. At the quantity exchanged MB>MC and there is a shortage in the market. B. At the quantity exchanged, MB<MC and there is a shortage. C. At the quantity exchanged, MC=MB and there is a shortage. D. At the quantity exchanged, MB>MC and there is a surplus. E. At the quantity exchanged, MB<MC and there is a surplus.
A. At the quantity exchanged MB>MC and there is a shortage in the market. explanation: A price ceiling reduces the price in the market, which decreases the quantity supplied and therefore the quantity exchanged in the market. Consumers' marginal benefit of this quantity is higher than the marginal cost of this quantity, and an efficient allocation of resources occurs when marginal cost equals marginal benefit.
All of the following are true about quotas EXCEPT which option? A. They generate tax revenue. B. Total welfare is lower with quotas than with free trade. C. Consumer surplus decreases when a quota is imposed. D. Producer surplus for license holders increases when a quota is imposed. E. They cause deadweight loss.
A. They generate tax revenue explanation: A quota is a price control, but a tariff is a tax. Therefore tariffs generate tax revenue while a quota only alters the price, quantity, and surplus in the market.
Which of the following best describes something nonrival in consumption? A. watching a streaming video service with unlimited bandwidth B. a delicious chocolate tart C. a dance party in a small venue that requires a ticket to be let in D. a seat on an airplane going to a tropical beach E. five friends splitting gas money to drive to school
A. watching a streaming video service with unlimited bandwidth explanation: This best describes something nonrival in consumption because usually more than one person can watch the same show on the same streaming service. For example, you and I could both watch "Hamsterville, Live!" from two different places and two different accounts from the same service.
external benefit
An action taken by a person or firm that creates benefits for others in the absence of any market agreement.
third-party payer
An agent other than the seller or the buyer who pays part of the price of a good or service.
The demand and supply schedules for lawn mowing are given below: Price: Quantity demanded: Quantity Supplied: $20 0 12 $18 2 10 $16 2 8 $14 3 6 $12 4 4 $10 5 2 $8 6 0 Which of the following is a binding (in other words, effective) price floor in this market? A. $0 B. $14 C. $10 D. $12 E. $8
B. $14 explanation: A binding price floor is a minimum legal price that alters incentives in a market. Binding price floors are always higher than the equilibrium price in the market.
The Cliffs of Hamsterville are a popular tourist attraction, however as more people visit them the paths get worn down and it gets more difficult to see them. The Cliffs are on land owned by the government, and there are currently no restrictions on who can visit them. What kind of good are the Cliffs of Hamsterville, and what issue does it face? A. Private goods; markets cannot provide this good efficiently B. Common resource; the tragedy of the commons C. Positive externalities; inefficiently low consumption of the good D. Artificially scarce; inefficiently low consumption E. Public good; the free rider problem
B. Common resource; the tragedy of the commons
Assume that demand and supply curves are neither perfectly elastic or perfectly inelastic. What are the effects of tariffs in an importing country? A. Consumer surplus decreases, producer surplus increases, and total surplus increases. B. Consumer surplus decreases, producer surplus increases, tax revenue is generated, and total surplus decreases. C. Consumer surplus increases, producer surplus increases, and total surplus increases. D. Consumer surplus increases, producer surplus decreases, and total surplus decreases. E. Consumer surplus is unchanged, producer surplus increases, and total surplus increases.
B. Consumer surplus decreases, producer surplus increases, tax revenue is generated, and total surplus decreases. explanation: When a tariff is placed on a market, this raises the price in the market from the world price to the world price plus the tariff. The higher price lowers the quantity imported, and the combination of higher prices and lower quantity hurts buyers of the good. Some of the surplus lost to buyers is reallocated to sellers, increasing producer surplus, and some is collected as tax revenue. However, some consumer surplus is lost entirely to deadweight loss, reducing total surplus.
What must be true about private goods? A. They do not exist in centrally planned economies B. Governments sometimes produce them C. They are only produced by monopolies D. They are non-rival and non-excludable E. They suffer from the tragedy of the commons
B. Governments sometimes produce them explanation: Sometimes governments choose to produce private goods for a variety of reasons. For example, the private sector might provide an inefficient quantity if there are positive externalities, or the government simply wants to provide a good for free.
What must be true about a perfectly competitive market in equilibrium that is allocatively efficient? A. Deadweight loss is the highest it can be B. Total surplus is the highest it can be C. Consumers have more surplus than producers D. Total surplus equals deadweight loss E. Producers have more surplus than consumers
B. Total surplus is the highest it can be explanation: Total surplus in a perfectly competitive market with no government intervention equals consumer surplus plus producer surplus, and deadweight loss equals zero. Any imposition on this market, such as altering the price or quantity sold, results in deadweight loss and total surplus decreases.
T/F: Private property rights are easily assigned to open-access resources.
False
The nation of Hamsterville has passed a law that from this day forth, nobody shall sell a bowl of gazpacho for more than $10 per bowl. Nobody really cares, however, because the equilibrium price of gazpacho in Hamsterville is $8. What is the term for the price control described above? A. A non-binding price floor B. A binding price floor C. A non-binding price ceiling D. A binding price ceiling E. A quota
C. A non-binding price ceiling explanation: A non-binding price ceiling is a maximum legal price set above the equilibrium price. A binding price control is effective, but a non-binding price control has no effect on a market. The market already clears at a price higher than the new legal minimum price, so it has no effect on this market.
The nation of Gatorland has passed a law that nobody shall sell anchovies for less than $20 per pound. Nobody really cares, however, because the equilibrium price of anchovies in Gatorland is $25 per pound. What is the term for the price control described above? A. A binding price ceiling B. A tariff C. A non-binding price floor D. A binding price floor E. A non-binding price ceiling
C. A non-binding price floor explanation: A non-binding price floor is a minimum legal price that is set below the equilibrium price. It has no effect on a market because the market already clears at a price higher than the legal minimum price.
T/F: When the activity results in the creation of external benefits, markets will produce more than the socially optimal level of that activity.
False
HamsterCraft is a multiplayer online game. When too many people try to play at the same time the server crashes. There is no charge to play. What kind of good is this game? A. public good B. artificially scarce C. common resource D. private good E. club good
C. common resource explanation: Common resources are rival and non-excludable. This game is rival because too many players crash the server and non-excludable because it is free to play.
fossil fuels
Coal, oil, natural gas, and other fuels that are ancient remains of plants and animals.
externality
Cost or benefit resulting from production or consumption of a good that is imposed on someone other than it's buyers or sellers.
The Hamsterville Hatchetfish football team's home stadium is Deep Sea Stadium. Fans of the team were angry about high prices to football games at the stadium and successfully petitioned the government to impose a price ceiling of $45 per ticket. Previously, tickets sold for $75. Deep Sea Stadium sells out every game even before the price of tickets was lowered. What is a likely consequence of this price ceiling? A. Amenities at Deep Sea Stadium will improve B. All fans will benefit from the new lower price C. More people will be able to attend football games D. A black market may develop E. The opportunity cost of attending a game will decrease
D. A black market may develop explanation: At the new lower price, quantity demanded will exceed quantity supplied which causes a shortage. Markets try to return to equilibrium, and one way this happens when shortages occur is the development of an illegal side market.
In an attempt to help turnip farmers, the nation of Burginville imposed a $3 per pound price floor on turnips. Before the price floor, the price of turnips was $1 per pound. What of the following best describes a consequence of this price floor? A. There will be a shortage of turnips B. The marginal benefit of the quantity sold will be less than the marginal cost of the quantity sold C. Sellers may sell above the price floor D. Fewer turnips get sold E. All turnip farmers will definitely benefit
D. Fewer turnips get sold explanation: Sellers will be more willing to sell turnips at the higher price, but buyers will be less willing to buy at the new higher price. As a result, the quantity sold of turnips decreases and there will be a surplus of turnips.
Assume a market has a downward sloping demand curve and an upward sloping supply curve. Which of the following statements about the impact of a per unit tax on this market is NOT true? A. Deadweight loss is the surplus that is lost from buyers and sellers that are no longer able to participate in the market B. The tax burden is the consumer and producer surplus that becomes government revenue C. Unless both supply and demand are perfectly inelastic, a tax results in deadweight loss. D. When a per unit tax is imposed on a market, the price that buyers pay will always increase by the amount of the tax E. The more the quantity sold in the market decreases, the larger the deadweight loss will be
D. When a per unit tax is imposed on a market, the price that buyers pay will always increase by the amount of the tax explanation: The tax incidence will be shared by the buyer and the seller, so the price that buyers pay will not go up by the full amount of the tax
efficient
The allocation of resources when the net benefits of all economic activities are maximized.
marginal benefit
The amount by which an additional unit of an activity increases its total benefit
consumer surplus
The amount by which the total benefits to consumers from consuming a good exceed their total expenditures on the good.
producer surplus
The difference between the total revenue received by sellers and their cost.
full economic price
The dollar amount paid to a firm under a price ceiling, plus the nonpecuniary price.
Externality
The effect of a market exchange on a third-party who is outside or "external" to the exchange
market failure
The failure of private decisions in the market place to achieve an efficient allocation of scarce resources.
nopecuniary price
The implicit amount paid through the opportunity cost.
deadweight loss
The loss in net benefits resulting from a failure to carry out an activity at the most efficient level.
The market demand curve for a public good
is the horizontal sum of all individual demand curves.
inefficient
Total surplus is below its potentially achievable level, i.e. there is a deadweight loss.
constraint
a boundary that limits the range of choices that can be made
inferior good
a good in which the quantity demanded falls as income rises, and in which quantity demanded rises and income falls
normal good
a good in which the quantity demanded rises as income rises, and in which quantity demanded falls as income falls
substitute
a good that can replace another to some extent, so that greater consumption of one good can mean less of the other
additional external cost
additional costs incurred by third parties outside the production process when a unit of output is produced
total surplus
amount of total gains from trade received by the market participants consumer surplus + producer surplus
A good that is rival and nonexclusive is called
an open-access good or common resource.
An externality is
any cost or benefit of a transaction that is not accounted for in the market price.
excess supply
at the existing price, quantity supplied exceeds the quantity demanded; also called a surplus
surplus
at the existing price, quantity supplied exceeds the quantity demanded; also called excess supply
excess demand
at the existing price, the quantity demanded exceeds the quantity supplied; also called a shortage
shortage
at the existing price, the quantity demanded exceeds the quantity supplied; also called excess demand
The table below shows the marginal costs of the last croissant produced by four different bakeries. Assume that any bakery willing to sell croissants at the market price sells 100 croissants and that all bakeries have the same costs. Bakery: Marginal Cost: A $2.25 B $2.75 C $3.00 D $3.25 How much producer surplus is earned in this market at a price of $3.00? a. $1 b. $75 c. $100 d. $0 e. $200
c. $100 At a price of $3.00 bakeries A, B, and C are all willing to sell croissants. Bakery A $0.75 in surplus on each of the 100 croissants it sells, earning producer surplus of $75. Bakery B $0.25 in surplus on each of the 100 croissants it sells, earning producer surplus of $25. Bakery C is also selling croissants, but it earns no surplus on the croissants it sells. Therefore producer surplus in this market is $100.
social surplus/economic surplus/total surplus
consumer surplus + producer surplus
negative externalities
costs imposed on a third party
nonrivalrous
even when one person uses the good, others can also use it
The incidence of an ___________ _____ falls more heavily on the side of the market that is less elastic.
excise tax
XC
external costs
international externalities
externalities that cross national borders and that cannot be resolved by a single nation acting alone
spillovers
externalities that occur in market transactions affect other parties beyond those involved
public good
good that is nonexcludable and nonrivalrous, and thus is difficult for market producers to sell to individual consumers
complements
goods that are often used together so that consumption of one good tends to enhance consumption of the other
price control
government laws to regulate prices instead of letting market forces determine prices
negative externality
harmful side effect that affects an uninvolved third party