ECON 0110: Midterm #1, ECON 0110: Midterm #2, ECON 0110: Midterm #3, ECON: Post-Midterm 3

substitute good

Products or services that can be used in place of each other. When the price of one falls, the demand for the other product falls; conversely, when the price of one product rises, the demand for the other product rises. ex: two mint gum brands - cross-price elasticity is positive

opportunity cost

The amount of one good given up when producing more of another good

change in supply

a shift in the supply curve - caused by a change in a variable that affects the amount producers wish to supply of a good other than the price of the good

supply schedule

a table that shows the relationship between price and quantity

Circular-Flow Diagram

shows the flow of goods and services, factors of production, and monetary payments between households and firms

market supply curve

shows the total quantity supplied of a good at each price, while all other factors that affect how much producers wish to sell are held constant.

change in equilibrium price and quantity table

supply + demand increase: quantity increases, price ambiguous supply increases, demand decreases : quantity ambiguous, price decreases supply decreases, demand increases: quantity ambiguous, price increases supply + demand decrease: quantity decreases, price ambiguous

A prohibitive tariff/import quota

tariff or import quota that is so restrictive that it returns the domestic market to its original no-trade equilibrium - occurs if (tariff ≥ difference between world price and no-trade domestic price) or (if import quota is set at zero)

marginal benefit

the additional benefit to a consumer from consuming one more unit of a good or service

Factors deciding whether a demand curve tends to be price elastic or inelastic

- Availability of close substitutes: The demand for goods with close substitutes is more sensitive to changes in prices and, thus, is more price elastic. - Necessities versus luxuries: The demand for necessities is inelastic while the demand for luxuries is elastic. Because one cannot do without a necessity, an increase in the price has little impact on the quantity demanded. However, an increase in price greatly reduces the quantity demanded of a luxury. - Definition of the market: The more narrowly we define the market, the more likely there are to be close substitutes and the more price elastic the demand curve. - Time horizon: The longer the time period considered, the greater the availability of close substitutes and the more price elastic the demand curve.

Reasons why free market equilibrium maximizes total surplus

- Free markets allocate output to the buyers who value it the most—those with a willingness to pay greater than or equal to the equilibrium price. Therefore, consumer surplus cannot be increased by moving consumption from a current buyer to any other nonbuyer. - Free markets allocate buyers for goods to the sellers who can produce at the lowest cost—those with a cost of production less than or equal to the equilibrium price. Therefore, producer surplus cannot be increased by moving production from a current seller to any other nonseller. - Free markets produce the quantity of goods that maximizes the sum of consumer and producer surplus or total surplus. If we produce less than the equilibrium quantity, we fail to produce units where the value to the marginal buyer exceeds the cost to the marginal seller. If we produce more than the equilibrium quantity, we produce units where the cost to the marginal seller exceeds the value to the marginal buyer.

Midpoint method for price elasticity of demand

- If price elasticity of demand is greater than one, demand is elastic. - If elasticity is less than one, demand is inelastic. - If elasticity is equal to one, demand is said to have unit elasticity. - If elasticity is zero, demand is perfectly inelastic (vertical). - If elasticity is infinite, demand is perfectly elastic (horizontal). - the flatter the demand curve, the more elastic - the steeper the demand curve, the more inelastic

who benefits from import permits being terminated

- If the import permits are given away, the permit holders earn the surplus generated from the world price being below the domestic price - If the government sells the import permits for the maximum possible amount, it will collect revenue equal to the tariff revenue and a tariff and a quota become identical - If quotas are "voluntary" in the sense that they are imposed by the exporting country, the revenue from the quota accrues to the foreign firms or governments.

Factors that shift the supply curve

- Input Prices: A decrease in the price of an input makes production more profitable and increases supply. - Technology: An improvement in technology reduces costs, makes production more profitable, and increases supply. - Expectations: Expectations about the future will affect the supply of a good today. - Number of Sellers: An increase in the number of sellers will lead to an increase in the market supply for a good because there are more individual supply curves to horizontally sum.

Private solutions to the externality problem

- Moral codes and social sanctions: People "do the right thing" and do not litter. - Charities: People give tax-deductible gifts to environmental groups and private colleges and universities. - Private markets that harness self-interest and cause efficient mergers: The beekeeper merges with the apple orchard, and the resulting firm produces more apples and more honey. - Private markets that harness self-interest and create contracts among affected parties: The apple orchard and the beekeeper can agree to produce the optimal combined quantity of apples and honey.

Public policies towards externalities

1) Command-and-control policies 2) Market-based policies

Sources of tariff-related deadweight loss

1) Increase in the price due to the tariff causes the production of units that cost more to produce than the world price (overproduction) 2) Increase in price causes consumers to fail to consume units where the value to the consumer is greater than the world price (underconsumption)

Arguments for restricting trade

- The Jobs Argument: Opponents of free trade argue that trade destroys domestic jobs. However, while free trade does destroy inefficient jobs in the importing sector, it creates more efficient jobs in the export sector, industries where the country has a comparative advantage. This is always true because each country has a comparative advantage in the production of something. - The National-Security Argument Some industries argue that their product is vital for national security, so it should be protected from international competition. The danger of this argument is that it runs the risk of being overused, particularly when the argument is made by representatives of industry rather than the defense establishment. - The Infant-Industry Argument New industries argue that they need temporary protection from international competition until they become mature enough to compete. However, there is a problem choosing which new industries to protect, and once protected, temporary protection often becomes permanent. In addition, industries government truly expects to be competitive in the future don't need protection because the owners will accept short-term losses. - The Unfair-Competition Argument Opponents of free trade argue that other countries provide their industries with unfair advantages such as subsidies, tax breaks, and lower environmental restrictions. However, the gains of consumers in the importing country will exceed the losses of the producers in that country, and the country will gain when importing subsidized production. - The Protection-as-a-Bargaining-Chip Argument Opponents of free trade argue that the threat of trade restrictions may result in other countries lowering their trade restrictions. However, if this does not work, the threatening country must back down or reduce trade—neither of which is desirable.

Price elasticity along linear demand curve

- When price is high and quantity low, price elasticity is large because a change in price causes a larger percentage change in quantity - When price is low and quantity high, price elasticity is small because a change in price causes a smaller percentage change in quantity

Shifts in the Demand Curve

- increase in demand --> demand curve shifts right - decrease in demand --> demand curve shifts left

Benefits of free trade

- more economic efficiency (Tariffs cause deadweight losses) - increases variety for consumers - allows firms to take advantage of economies of scale makes markets more competitive - increases productivity - facilitates the spread of technology.

Two main reasons a free market may not be efficient:

1) Market Power: A market may not be perfectly competitive. If individual buyers or sellers (or small groups of them) can influence the price, they have market power and they may be able to keep the price and quantity away from equilibrium. 2) Externalities: A market may generate side effects, or externalities, which affect people who are not participants in the market at all. These side effects, such as pollution, are not taken into account by buyers and sellers in a market, so the market equilibrium may not be efficient for society as a whole.

Two ways taxes place a cost on market participants:

1) Resources are diverted from buyers and sellers to the government. 2) Taxes distort incentives so fewer goods are produced and sold than otherwise. That is, taxes cause society to lose some of the benefits of efficient markets.

2 main characteristics of a perfectly competitive market

1) The goods offered for sale are all exactly the same. 2) The buyers and sellers are so numerous that no one buyer or seller can influence the price. - If a market is perfectly competitive, both buyers and sellers are said to be "price takers" because they cannot influence the price.

Ten principles of economics

1. People face trade-offs 2. The cost of something is what you give up to get it 3. Rational people think at the margin 4. People respond to incentives 5. Trade can make everyone better off 6. Markets are usually a good way to organize economic activity 7. Governments can sometimes improve market outcomes 8. A country's standard of living depends on its ability to produce goods and services 9. Prices rise when the government prints too much money 10. Society faces a short-run trade-off between inflation and unemployment

Factors that shift the demand curve

1. income 2. price of related goods 3. tastes 4. expectations 5. number of buyers

change in the quantity demanded

A change in the price of a good causes a movement along a given demand curve - a movement along the demand curve and is caused by a change in the price of the good

complement good

A good that is consumed jointly with another good. With these, the price of one and the demand for the other move in opposite directions ex: peanut butter and jelly if you only ever have one with the other, razor and razorblades - cross-price elasticity is negative

change in demand

A shift in the demand curve - caused by a change in a variable that affects the amount people wish to purchase of a good other than the price of the good

Corrective tax (Pigovian tax)

A tax enacted to correct the effects of a negative externality - Unlike other taxes, corrective taxes enhance efficiency rather than reduce efficiency. (ex: tax on gasoline is a corrective tax because, rather than causing a deadweight loss, it reduces traffic congestion, auto accidents, and pollution)

Policy implications/interpretations of free market equilibrium ideas

Economists generally advocate free markets because they are efficient. Because markets are efficient, many believe that government policy should be laissez-faire, which means "leave to do," or "let people do as they will." Adam Smith's "invisible hand" of the marketplace guides buyers and sellers to an allocation of resources that maximizes total surplus. The efficient outcome cannot be improved upon by a benevolent social planner. In addition to efficiency, however, policymakers may also be concerned with equality—the uniformity of the distribution of well-being among the members of society.

Where world price is higher than before-trade domestic price

For exporting country, Before trade: - consumer surplus: A+B - producer surplus: C - total surplus was A+B+C After trade: - consumer surplus: A - producer surplus: B+C+D (the area below the price and above the supply curve) - Total surplus: A+B+C+D for a gain of area D 1) When a country allows trade and becomes an exporter of a good, domestic producers are better off and domestic consumers are worse off. 2) Trade increases the economic well-being of a nation because the gains of the winners exceed the losses of the losers.

Where world price is lower than before-trade domestic price

For importing country, Before trade: - consumer surplus: A - producer surplus: B+C - total surplus was A+B+C After trade: - consumer surplus: A+B+D (the area below the demand curve and above the price) - producer surplus: C - Total surplus: A+B+C+D for a gain of area D 1) When a country allows trade and becomes an importer of a good, domestic consumers are better off and domestic producers are worse off. 2) Trade increases the economic well-being of a nation because the gains of the winners exceed the losses of the losers.

demand is inelastic

If the quantity demanded changes little from a change in price - steep, vertical

Absolute advantage

The producer that requires fewer resources (say fewer hours worked) to produce a good is said to have an absolute advantage in the production of that good - compares the ACTUAL cost of production for each producer

Comparative advantage

The producer with the lower opportunity cost of production is said to have a comparative advantage - compares OPPORTUNITY costs of production for each producer - It is impossible for one person to have a comparative advantage in both goods - Gains from trade will always be realized unless opportunity costs are the same

Effect of elasticities on deadweight loss

The size of the deadweight loss from a tax depends on the elasticities of supply and demand - the greater the elasticities of supply and demand, the larger the deadweight loss of a tax

inferior good

a good for which an increase in income leads to a decrease in demand ex: bus transportation - income elasticity is negative

normal good

a good for which an increase in income leads to an increase in demand ex: most things, iPhones, clothes, etc. - income elasticity is positive

market

a group of buyers and sellers of a particular good or service - can be highly organized like a stock market or less organized like the market for ice cream - competitive market = a market in which there are many buyers and sellers so that each has a negligible impact on the market price

deadweight loss

a loss of potential gains from trade; the reduction in total surplus that results from a tax - Taxes cause deadweight losses because taxes prevent buyers and sellers from realizing some of the gains from trade - increases as the square of the factor of increase in the tax. For example, if a tax is doubled (ex 2: tripled), the deadweight loss rises by a factor of four (ex 2: nine) - useful for government revenue (biproduct of taxes) - Higher elasticity = more deadweight loss

monopoly

a market that has only one seller - other types of markets fall between the extremes of perfect competition and monopoly

income elasticity of demand

a measure of how much the quantity demanded responds to a change in consumers' income

cross-price elasticity of demand

a measure of the response of the quantity demanded of one good to a change in the price of another good

effect of tax

a tax levied on buyers has the same effect as a tax levied on sellers - A tax discourages market activity. That is, the quantity sold is reduced. - Buyers and sellers share the burden of a tax because the price paid by the buyers increases while the price received by the sellers decreases. - The effect of a tax collected from buyers is equivalent to a tax collected from sellers. - The government cannot legislate the relative burden of the tax between buyers and sellers. The relative burden of a tax is determined by the elasticity of supply and demand in that market.

Tariff

a tax on goods produced abroad and sold domestically. Therefore, is placed on a good only if the country is an importer of that good - Trade can make everyone better off if the winners compensate the losers. Compensation is rarely paid, so the losers lobby for trade restrictions, such as tariffs - restrict international trade - raises the price of the good - reduces the domestic quantity demanded - increases the domestic quantity supplied - reduces the quantity of imports - moves the market closer to the no-trade equilibrium. - increases producer surplus and government revenue but reduces consumer surplus by a greater amount than the increase in producer surplus and government revenue - increases deadweight loss

Tradable pollution permits

allow the holder of the permit to pollute a certain amount

law of supply

an increase in the price of a good increases the quantity supplied of the good, while a decrease in the price of a good reduces the quantity supplied of the good

law of demand

an increase in the price of a good reduces the quantity demanded of the good, while a decrease in the price of a good increases the quantity demanded of the good

change in the quantity supplied

change in the price of a good causes a movement along a supply curve - movement along the supply curve and is caused by a change in the price of the good

price taker

country takes the world price as given and cannot influence the world price - small countries without much production/influential power tend to be these

positive statements vs normative statements

describe the world as it is vs how the world ought to be

Laffer curve

diagram that shows as the size of a tax on a good is increased, revenue first rises and then falls

narrow market

elastic ex: chocolate ice cream price goes up, people just get another flavor

Positive externality

externality that has a beneficial effect on people beyond just the buyers - ex: historic building restorations, research into new technologies, education - the social value of education exceeds the private value - Graphically, the social value curve is above the demand curve (private value curve) - Total surplus = true social value - cost to producers - the optimal quantity that maximizes total surplus is greater than the equilibrium quantity generated by the market. - positive externalities can be internalized with subsidies

Negative externality

externality with an adverse effect beyond just the producing firm - ex: pollution from exhaust and noise - the social cost exceeds the private cost of production - Graphically, the social cost curve is above the supply curve (private cost curve) - Total surplus = value to consumers - true social cost of production - the optimal quantity that maximizes total surplus is less than the equilibrium quantity generated by the market. - negative externalities can be internalized with taxes

supply curve

graph of relationship between price and quantity - The supply curve is upward sloping due to the law of supply

Production Possibilities Frontier

graph that shows the combinations of output the economy can possibly produce given the available factors of production and the available production technology Demonstrates the following economic principles: - If the economy is operating on the production possibilities frontier, it is operating efficiently because it is producing a mix of output that is the maximum possible from the resources available. - Points inside the curve are, therefore, inefficient. - Points outside the curve are currently unattainable. - If the economy is operating on the production possibilities frontier, we can see the trade-offs society faces (to produce more of one good, it must produce less of other) - The frontier is bowed outward because the opportunity cost of producing more of a good increases as we near maximum production of that good. This is because we use resources better suited toward production of the other good in order to continue to expand production of the first good. - A technological advance in production shifts the production possibilities frontier outward; demonstration of economic growth

necessities

highly inelastic ex: insulin shots, cigarettes, food

demand is elastic

if the quantity demanded changes substantially from a change in price - flat, horizontal

Shifts in the Supply Curve

increase in supply --> supply curve shifts right decrease in supply --> supply curve shifts left

broad market

inelastic ex: food in general - people will pay because need to eat

equilibrium

intersection of supply and demand

Price elasticity of demand

measures how much the quantity demanded responds to a change in the price of that good - computed as the percentage change in quantity demanded divided by the percentage change in price

Price elasticity of supply

measures how much the quantity supplied responds to a change in the price of that good - If the quantity supplied changes substantially from a change in price, supply is elastic. - If the quantity supplied changes little from a change in price, supply is inelastic.

consumer surplus

measures the benefits received by buyers from participating in a market - computed as willingness to pay - price - area under the demand curve, above the price - when there's a tax, is computed using the price buyers pay - when the price of a good falls, consumer surplus increases because 1) existing buyers receive greater surplus because they are allowed to pay less for the quantities they were already going to purchase, and 2) new buyers are brought into the market because the price is now lower than their willingness to pay

producer surplus

measures the benefits received by sellers from participating in a market - computed as price - cost to product - area above the supply curve, below the price - when there's a tax, is computed using the price sellers receive - When the price of a good rises, producer surplus increases because 1) existing sellers receive greater surplus because they receive more for the quantities they were already going to sell, and 2) new sellers are brought into the market because the price is now higher than their cost

luxuries

more elastic

Formula for price elasticity of demand

percent change in quantity demanded over percent change in price - because price elasticity of demand is always negative, it is customary to drop the negative sign - More vertical curve is more inelastic (less than 1% change in Q), flat curve is more elastic (more than 1% change in Q)

Formula for income elasticity of demand

percentage change in quantity demanded divided by the percentage change in income - For normal goods, income elasticity is positive - For inferior goods, income elasticity is negative

Market-based policies

policies that align private incentives with social efficiency Two types: 1) corrective taxes and subsidies 2) tradable pollution permits.

technology spillover

positive externality for other producers as a result of high technology production - government's current way of promoting this: property rights in form of patent protection, special tax breaks for expenditures on research & development

Command-and-control policies

regulations that require or prohibit (or limit) certain behaviors

price ceiling

sets a legal maximum on the price at which a good can be sold - binding when below equilibrium - when binding, lead to shortage

price floor

sets a legal minimum on the price at which a good can be sold - binding when above equilibrium - when binding, lead to surplus

import quota

sets a limit on the quantity of a good that can be produced abroad and sold domestically - reduces the quantity of imports - raises the domestic price of the good - decreases the welfare of domestic consumers - increases the welfare of domestic producers - causes deadweight losses - moves the market closer to the no-trade equilibrium

Internalizing an externality

the altering of incentives so that people take into account the external effects of their actions - To internalize externalities, government can create taxes / subsidies to shift supply and demand curves until they are the same as true social cost and social value curves - makes equilibrium quantity and optimal quantity the same (market becomes efficient) - Negative externalities can be internalized with taxes while positive externalities can be internalized with subsidies.

quantity demanded

the amount of a good that buyers are willing and able to purchase

quantity supplied

the amount of a good that sellers are willing and able to sell

Total revenue

the amount paid by buyers and received by sellers, computed as price x quantity

marginal buyer

the buyer who would leave the market first if the price were any higher

tax wedge

the difference between what the buyer pays and the seller receives is the tax per unit

market failure

the inability of some unregulated markets to allocate resources efficiently

time horizon

the intended duration of a plan ex: if price of gas goes up, gas cars vs EV but need time to adapt

tax incidence

the manner in which the burden of a tax is shared among participants in a market - tax burden falls more heavily on the side of the market that more inelastic - does not matter who the tax is on to determine the burden, just the elasticities

willingness to pay

the maximum amount that a buyer will pay for the good

willingness to sell

the minimum price the seller would voluntarily accept for the good

Formula for price elasticity of supply

the percentage change in quantity supplied divided by the percentage change in price

formula for cross-price elasticity of demand

the percentage change in the quantity demanded of one good divided by the percentage change in the price of another - positive for substitutes - negative for complements

world price

the price of the good that prevails in the world market for that good - If world price is above domestic price, the country has comparative advantage (good should be exported if trade is allowed) - If world price is below domestic price, foreign countries have comparative advantage (good should be imported if trade is allowed)

The Coase theorem

the proposition that if private parties can bargain without cost over the allocation of resources, they can solve the problem of externalities on their own - ex: if value of peace and quiet > value of owning a barking dog, the party desiring quiet will buy the right to quiet from the dog owner and remove the dog, or the dog owner will fail to buy the right to own a barking dog from the owner of quiet space

marginal seller

the seller who would leave the market if the price were any lower

Macroeconomics

the study of economy-wide phenomena such as the federal deficit, the rate of unemployment, and policies to improve our standard of living

Microeconomics

the study of how households and firms make decisions and how they interact in specific markets

welfare economics

the study of how the allocation of resources affects economic well-being

total surplus

the sum of consumer and producer surplus CS + PS = value to buyers - cost to sellers - area below the demand curve and above the supply curve

Market demand

the sum of the quantities demanded for each individual buyer at each price

market supply

the sum of the quantity supplied for each individual seller at each price

externality

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

Benefits of trade

trade allows for specialization, and specialization increases the total production available to share; allows producers to exploit the differences in their opportunity costs of production so that they can maximize the economy's total production - both producers gain when they trade at a price that lies between their individual opportunity costs - the decision to specialize and the resulting gains from trade are based on comparative advantage, not absolute advantage