Econ 201

Price Controls

-An attempt to set prices through government involvement in a market. -In general, price controls interrupt the normal activity of the market. As such, they often have negative consequences.

The Effect of Price Floors in the Long Run

-As with a price ceiling, the problems of a price floor are magnified in the long run. -Both supply and demand curves are flatter (more elastic) so the surplus expands

Production function

-Describes the relationship between the inputs a firm uses and the output it creates. -The production function is an extremely important part of firm decision making.In order to maximize profitability, the firm needs a very precise ratio of capital to labor to supplies.

Private Property

-Exclusive provision to the right of ownership allowing for the use and exchange of property -Incentives created by private property: 1.The incentive to maintain property. 2.The incentive to protect property. 3.The incentive to conserve property. 4.The incentive to trade with others, thus assuring that the person with the greatest willingness to pay for a good owns the good. -Most things that cause problems with externalities are not excludable. This means they cannot really be private property. -Clean air and water -Christmas lights

Effects of Price Floors

-Firms are forced to charge a price higher than the equilibrium price. The price they will choose to charge is the price floor amount. -Note that at the higher price, quantity supplied exceeds quantity demanded, resulting in a surplus. -Typically a firm would correct a surplus by charging a lower price. In this case, they can't. Thus, the surplus persists.

Firms in the short run

-If the firm believes they will continue to see losses in the long run, they are likely to shut down. -However, in the short run, a firm that is losing money by operating may want to shut down or it may want to stay open. -The key here is that if the firm chooses to shut down, it has already paid and thus lost the fixed cost. -If selling at the point where MR=MC results in losses greater than the fixed costs, the firm should shut down.

Long Run Effects of Price Ceilings

-In the long run, both demand and supply curves tend to be more elastic -This magnifies the problems with a binding price ceiling. The shortage becomes larger as quantity supplied falls even more and quantity demanded increases even more -Over time however, black market price should decrease somewhat

Effect of Price Floors: Minimum wage

-In this case, with a high wage more people are willing to work. At the same time, firms hire fewer workers because the must pay them a higher wage. -The number of people wanting to work exceeds the number of jobs. This leads to unemployment. -While those who work make more, many people are not able to work at all, and earn nothing. -In practice, minimum wage laws are often not binding. Politicians do this intentionally when a minimum wage increase is politically popular.

Why would the government ever choose to establish a price floor?

-Minimum wage established so that workers could earn a "living wage." -A combinations of tariffs and subsidies means that sugar in the U.S. is roughly twice as expensive as it is in the rest of the world. These rules are in place to protect domestic production

Diminishing marginal product

-Occurs when successive increases in inputs are associated with a slower rise in output. -This does not necessarily mean output falls, just that it increases at a slower rate -This occurs because we are holding the other inputs constant (Ex. Too many cooks in the kitchen) -The firm will hire additional workers until marginal product = wage.

Implicit costs

-The Costs of doing business -Largely made up of opportunity costs, they are the lost opportunity to use the money spent on creating products for another, revenue generating purpose. -Basically, whatever else you could've used the money you used on your company on -Only the highest of the other options should be included, opportunity cost is not the sum of possible options.

Property Rights

-The ability to exercise control over a resource -Those that bear the costs associated with repairing a good have an incentive to take care of the good. -Those that do not bear the costs associated with repairing a good have no such incentive and as such, are much more lax about taking care of the good.

How to calculate consumer surplus

-The area of a triangle is equal to 1/2∗Base of triangle∗Height of triangle -When consumer surplus is represented by a triangle, the height of the consumer surplus triangle is always just Y intercept of Demand Curve-Price paid by consumers where Y intercept is the highest willingness to pay among all consumers. -When consumer surplus is represent by a triangle, the base of the triangle is always just market quantity.

Deadweight loss

-The decrease in economic activity due to market distortions -Deadweight loss can happen for many reasons. Three of the most common are price ceilings, price floors, and taxes.

Consumer Surplus

-The difference between a person's willingness to pay for a good and the price paid to get it. -Because each individual has a different willingness to pay but the price charged to all people is the same, the amount of consumer surplus gained varies from person to person. -When discussing consumer surplus, economists care about the sum of the surplus across all individuals. -To measure this, we examine the area below the demand curve but above price, This area represents consumer surplus.

Producer surplus

-The difference between the price the seller receives and the producer's willingness to sell. -As with consumer surplus, we are interested in the sum of the individual producer surplus values. -To measure this we look at the area below price and above the supply curve.

Total surplus

-The sum of consumer and producer surplus. This is also called social welfare -We say a market is efficient when an allocation of resources maximizes total surplus

How to calculate producer surplus

-To calculate producer surplus we again need to calculate the area of a triangle -As before, the base of the triangle is equal to market quantity. -The height of the triangle is now (Price supplier gets−Y intercept of Supply Curve)

Why would the government ever crate a maximum price for a good?

-To keep necessary goods, such as milk or electricity, affordable -As a means of controlling inflation -Many political and social reasons

Fixed costs (short run)

-Unavoidable costs which do not vary with output. -In the long run, no costs are fixed.

Fixing Positive Externalities

-With positive externalities, the market is producing too little of a good. To correct it we thus need to incentivize the market to produce more. -Government can offer subsidies and price breaks to make the goods more affordable but this strategy is difficult when the good is already free for most people. -Not all externality problems should be fixed. Often the cost outweighs the benefit.

Private good

A good that is both excludable and rival in consumption

Common-resource good

A good that is rival but nonexcludable Ex; Whales

Non-binding price ceiling

A price ceiling with the price set above equilibrium price- no impact on price or quantity

Binding price ceiling

A price ceiling with the price set below equilibrium price

Binding Price floor

A price floor with the price set above equilibrium price.

Binding price floors

A price floor with the price set above equilibrium price.

Non-binding price floors

A price floor with the price set below equilibrium price. No impact on market price.

A binding price ceiling causes what?

A shortage

Tragedy of the commons

A situation that occurs when a good that is rival in consumption but nonexcludable becomes depleted. Common ownership leads to overuse. Public and private ownership do not.

Price taker

A firm with no control over the price set by the market

Average Total Cost=

AVC+AFC

The firm should not shut down though they will be operating at a loss if

AVC<MR<ATC -Sometimes, a firm should operate in the short run, even if that firm loses money. They should do so if the losses associated with being open are less than fixed costs which would be the loss associated with shutting down.

Rival good

Any good that cannot be enjoyed by more than one person at a time

Club good

Any good that is excludable but non-rival Ex; High speed wi-fi

Public good

Any good that is neither excludable nor rival in consumption

Excludable good

Any good that the consumer must purchase before being able to use it

Profits and losses

Are determined by calculating the difference between revenue and expenses

When price control is in place, ________ often arise, and consumers may be forced to pay a ________ price than they would have had to otherwise

Black Markets, higher

Competitive markets

Characterized by having many buyers and sellers and the product being traded must be homogenous.

External costs

Costs of a market activity paid by people who are not participants.

Variable Costs (short run)

Costs that change with the rate of output.

Cap and Trade

Creates a system of pollution permits which are then traded in markets to curb environmental issues related to pollution.

The more relatively _______ demand is, the ______ the deadweight loss and the ______ the tax revenue.

Elastic;Greater;Lower

Examples of Price Ceilings

Examples: -Rent Control: -price ceiling that applies to the housing market. -Price gouging laws: -temporary price ceilings placed on the prices sellers can charge during an emergency

Price floor

Legally established minimum price for goods or services (Good way to remember- you can't go lower than the floor- can't set price lower than price floor)

Because we assume their is always an implicit cost to every decision, economic profit is always _____ than accounting profit

Less

In the long run, the firm will only operate if

MR>ATC

Negative Externalities

Occur when a third party is adversely affected by a market -Pollution -Construction Noise -Cigarette smoke

Positive Externalities

Occur when a third party is positively affected by a market -Vaccines -Condoms -Christmas Lights

Economies of scale

Occur when costs decline as output expands in the long run.

Constant returns to scale

Occur when costs remain constant as output expands in the long run

Diseconomies of scale

Occur when costs rise as output expands in the long run

Third-party problem

Occurs when those not directly involved in a market activity nevertheless experience negative or positive externalities.

Free-rider problem

Occurs whenever someone receives a benefit without having to pay for it.

Goods and services that cause negative externalities tend to be __________ because the producer does not pay the full costs.

Overproduced

Binding price Ceilings, in the long run, increase _______ and decreases ________, creating a _________

Quantity Demanded; Quantity Supplied; Shortage

Profit maximizing rule

States that profit maximization occurs when the firm chooses to produce the quantity that causes marginal revenue to be equal to marginal cost. So firms should optimally produce where MC=MR

Average Fixed Cost=

TFC/Q

Total Cost=

TVC+TFC

Average Variable Cost=

TVC/Q

Explicit costs

Tangible out of pocket expenses

Scale

The Size of the Production output

Total revenue

The amount a firm receives from the sale of the goods and services it produces. -The total dollars a business earns within a given time period (usually annually).

Total cost

The amount a firm spends in order to produce the goods and services it produces.

Welfare economics

The branch of economics that studies how the allocation of resources affects economic well-being. A market is said to be efficient when is maximizes this "well-being" for society.

Marginal product

The change in output associated with a one additional unit of input (ceteris paribus). -EX: Suppose Apple added one worker to it's factory and iPhone production increased from 1000 iPhones per day to 1050. The marginal productivity of that worker would be 50 phones.

Marginal cost (short run)

The change in total cost associated with a one unit increase in output.

Marginal cost

The change in total cost associated with a one unit increase in production

Internal costs

The costs of a market activity paid by an individual participant.

Externalities

The costs or benefits of a market activity that effect a third party.

Factors of production

The inputs used in producing goods and services. They include land, labor, and capital.

Willingness to pay

The maximum price a consumer will pay for a good. Willingness to pay can also be thought of as your valuation of the product in dollar terms.

Willingness to sell

The minimum price a seller will accept to sell a good or service.

Efficient Scale

The output level that minimizes the average total cost

Cost-benefit analysis

The process used by economists to determine whether the benefits of providing a public good outweigh the costs.

Goods and services that are create positive externalities tend to be __________ because the producers to not reap the full benefit of their production.

Underproduced

Surplus

When Quantity supplied exceeds quantity demanded

Internalize

When a firm takes into account the external costs (or benefits) to society that occur as a result of its actions. -Firms supply a socially non-optimal level because they do not have to internalize their externality -By requiring a firm to internalize (pay for) the external costs they produce, we can correct for these negative externalities. Taxes, fines, and government regulation can accomplish this.

Shortage

When firms are unwilling to supply the amount demanded at the new market price that they cannot change

Sunk cost

a cost that has been incurred as a result of past decisions. Ex. Down Payment on a house -As economists, we ignore sunk costs. We ask instead, does the marginal benefit outweigh the marginal cost?

Tax Revenue=

(the price paid by the consumers-the price received by the sellers)*(Market Quantity)

Coase Theorem

If there are no barriers to negotiations, and if property rights are fully specified, interested parties will bargain to correct any externalities that exist.

Price ceiling

Legally established maximum price for goods or services (Good way to remember- you can't go higher than the ceiling- can't set price higher than price ceiling)

For a perfectly competitive firm, MR =

Price -Because a firm is unable to charge a price different than the market price,when the firms sells one more good, the increase in revenue is simply the market price of the good.

Barriers to entry

Restrictions that make it difficult for new firms to enter a market. Ex. Pro Sports Leagues

Marginal revenue

The change in revenue associated with a one-unit increase in production

Total Cost =

explicit costs + implicit costs

In the labor market, the ________ are the workers while the _________ are the firms.

suppliers; demanders

Accounting Profit=

total revenue - explicit costs

Profit (loss) =

total revenue - total cost

Economic Profit=

total revenues - total costs accounting profit - implicit cost

Marginal Cost=

∆TVC/∆Q

Monopoly

a market with only one seller selling a unique product with few substitutes.

Monopoly power

a measure of the ability of firms to set the price for a good. Specifically, it measures how far above marginal cost the firm can set its price.

In the long run

all costs are variable. This gives the firms more control over their costs in the long run and allows them to reach any desired level of output.

Calculating Deadweight Loss

https://www.youtube.com/watch?v=NuLlNAdrom4 Too hard to explain via text. Watch the khan academy video

Social costs=

internal costs + external costs

A firm should shut down in the short run if

1. selling at the point where MR=MC results in losses greater than the fixed costs 2. MR<AVC -This is because each additional unit produced and sold loses the firm even more money.

The charactaristics of a competitive firm are:

1.Many Sellers 2.Similar Products 3.Free entry and exit 4.Price Taking