ECON CH 4

Discussions of the economic results of rent control and of federal farm programs would be considered ________ analysis, and discussions of whether rent control and the farm programs are good or bad policies would be considered ________ analysis.

positive; normative

Those firms make their decisions about how much to produce based on these _____________ . But because of pollution the _____________ is higher: the total cost to society of producing a good or service, including both the private cost and any external cost.

private costs, social cost

Marginal benefit is

the additional benefit from consuming one more unit.

Marginal cost is

the additional cost of producing one more unit.

Marginal cost

the additional cost to a firm of producing one more unit of a good or service

Consumer surplus is

the difference between the highest price a consumer is willing to pay and the price the consumer actually pays.

Producer surplus is

the difference between the lowest price a firm would be willing to accept and the price it actually receives.

Economists define economic efficiency in this way

to help policymakers understand the negative consequences of price ceilings. to illustrate the benefits of a competitive market equilibrium. to help policymakers understand the negative consequences of taxes. to help policymakers understand the negative consequences of price floors.

Consider the information given in the table on four consumers in the market for orange juice. Consumer Highest Price Willing to Pay Jill $4 Jose $3 Josh $2 Jordan $1 ---------------------------------- If the price of a bottle of orange juice is $0.75, the total consumer surplus received by these consumers is ________. ---------------------------------- Suppose the price of a bottle of orange juice rises to $1.50. ---------------------------------- Once the price of a bottle of orange juice rises to $1.50, the total consumer surplus received by these consumers is ____________.

---------------------------------- $7.00 ---------------------------------- ---------------------------------- $4.50

How does consumer surplus change as the equilibrium price of a good rises or falls? ---------------------------------- As the price of a good rises, consumer surplus _____________, and as the price of a good falls, consumer surplus ___________.

---------------------------------- As the price of a good rises, consumer surplus decreases, and as the price of a good falls, consumer surplus increases.

How does producer surplus change as the equilibrium price of a good rises or falls? ---------------------------------- As the price of a good rises, producer surplus ______________, and as the price of a good falls, producer surplus ____________.

---------------------------------- As the price of a good rises, producer surplus increases, and as the price of a good falls, producer surplus decreases.

Firm A is a new producer in the market for good X, which is characterized by linear demand and supply curves.Initially, to attract customers, the firm prices its product low at $8 per unit. While the firm sells 1,000 units of the product at this price, there is a shortage in the market. This shortage can be cleared if price is increased to $10 per unit. The quantity demanded and supplied at this higher price will be 1,500 units. ---------------------------------- Rajiv Bose, a market analyst with firm A, claims that an increase in producer surplus would necessarily increase average profit for the firm. Which of the following, if true, would weaken Rajiv's claim?

---------------------------------- Costs increase significantly as production expands.

We can think about efficiency in a market in two ways:

1. A market is efficient if all trades take place where the marginal benefit exceeds the marginal cost, and no other trades take place. 2. A market is efficient if it maximizes the sum of consumer and producer surplus (i.e. the total net benefit to consumers and firms), known as the economic surplus.

Price ceiling

A legally determined maximum price that sellers can charge

Price floor

A legally determined minimum price that sellers may receive

Economic efficiency

A market outcome in which the marginal benefit to consumers of the last unit produced is equal to its marginal cost of production and in which the sum of consumer surplus and producer surplus is at a maximum

Why is the demand curve referred to as a marginal benefit curve?

It shows the willingness of consumers to purchase a product at different prices.

Why is the supply curve referred to as a marginal cost curve?

It shows the willingness of firms to supply a product at different prices.

marginal benefit

That depends on the price and their marginal benefit, the additional benefit to a consumer from consuming one more unit of a good or service. If the price is low, many of the consumers benefit. If the price is high, few (if any) of the consumers benefit

consumer surplus

The difference between the highest price a consumer is willing to pay and the price the consumer actually pays

deadweight loss

The reduction in economic surplus resulting from a market not being in competitive equilibrium is known as deadweight loss. Deadweight loss can be thought of as the amount of inefficiency in a market. In competitive equilibrium, deadweight loss is zero.

Property rights

The rights individuals or businesses have to the exclusive use of their property, including the right to buy or sell it

black market

The shortage of apartments may lead to a black market - a market in which buying and selling take place at prices that violate government price regulations.

For example, if you buy a house and the government protects your right to exclusive use of that house, then your private benefit from the house will likely ___________ the social benefit of the house.

equal

[Related to the Chapter Opener] If San Francisco were to repeal its rent control law, the prices for short rentals in the city listed on Airbnb and other peer-to-peer sites would likely

fall because more housing units would become available as the average rent increased.

The taxes and subsidies seen in the last few slides "correct" the externality problem

They are known as Pigovian taxes and subsidies, after the English economist Arthur Cecil Pigou, who first demonstrated the use of government taxes and subsidies in bringing about an efficient level of output in the presence of externalities. The traditional solution to the externality problem is command-and-control: a policy that involves the government imposing quantitative limits on the amount of pollution firms are allowed to emit, or requiring firms to install specific pollution control devices. Example: Requiring car manufacturers to equip cars with catalytic converters.

Economic efficiency

is a market outcome in which the marginal benefit to consumers of the last unit produced is equal to its marginal cost of production.

marginal cost of production.

is a market outcome in which the sum of consumer surplus and producer surplus is at a maximum.

Consumer surplus

is the difference between the highest price a consumer is willing to pay for a good or service and the actual price the consumer pays

Producer surplus

is the difference between the lowest price a firm would be willing to accept for a good or service and the price it actually receives

Economic efficiency is

a market outcome in which the marginal benefit to consumers of the last unit produced is equal to its marginal cost of production and in which the sum of consumer surplus and producer surplus is at a maximum.

Market failure

a situation in which the market fails to produce the efficient level of output

Uber is a company that offers people transportation by drivers who use their own cars for this purpose. Customers pay for their rides with their smartphone apps. Uber's prices fluctuate with the demand for the service. This "surge pricing" can result in markedly different prices for the same distance traveled at different times of day or days of the week. Annie Lowrey, a writer for the New York Times, explained that she paid $13 for a 10 p.m. two-mile trip in downtown Washington, D.C. on New Year's Eve. Three hours later she paid $47 for the return trip to her home. Source: Annie Lowrey, "Is Uber's Surge-Pricing an Example of High Tech Gouging?" New York Times, January 10, 2014. ---------------------------------- Did she receive negative consumer surplus on her return trip?

---------------------------------- Her willingness to pay was no less than $47, so she did not receive negative consumer surplus from this trip.

Uber is a company that offers people transportation by drivers who use their own cars for this purpose. Customers pay for their rides with their smartphone apps. Uber's prices fluctuate with the demand for the service. This "surge pricing" can result in markedly different prices for the same distance traveled at different times of day or days of the week. Annie Lowrey, a writer for the New York Times, explained that she paid $13 for a 10 p.m. two-mile trip in downtown Washington, D.C. on New Year's Eve. Three hours later she paid $47 for the return trip to her home. Source: Annie Lowrey, "Is Uber's Surge-Pricing an Example of High Tech Gouging?" New York Times, January 10, 2014. ---------------------------------- Did she receive negative consumer surplus on her return trip?

---------------------------------- Her willingness to pay was no less than $47, so she did not receive negative consumer surplus from this trip.

Your neighbor John has a barking dog. ---------------------------------- Which of the following statements is true?

---------------------------------- It can create negative externalities by disrupting your sleep and can also create positive externalities by discouraging intruders.

Firm A is a new producer in the market for good X, which is characterized by linear demand and supply curves.Initially, to attract customers, the firm prices its product low at $8 per unit. While the firm sells 1,000 units of the product at this price, there is a shortage in the market. This shortage can be cleared if price is increased to $10 per unit. The quantity demanded and supplied at this higher price will be 1,500 units. ---------------------------------- Which of the following is most strongly supported by this information?

---------------------------------- Producer surplus will increase if the price rises from $8 per unit to $10.

[Related to Don't Let This Happen to You] Briefly explain whether you agree or disagree with the following statement: ---------------------------------- "If there is a shortage of a good, it must be scarce, but there is not a shortage of every scarce good."

---------------------------------- The statement is correct because every good (except undesirable things) is scarce.

A student makes the following argument: "When a market is in equilibrium, there is no consumer surplus (The difference between the highest price a consumer is willing to pay and the price the consumer actually pays.). We know this because in equilibrium, the market price is equal to the price consumers are willing to pay for the good." ---------------------------------- Briefly explain whether you agree with the student's argument.

---------------------------------- The student is incorrect because the price consumers are willing to pay and the market price are only equal for the last unit consumed.

On a shopping trip, Melanie decided to buy a light blue coat made from woven fabric. A tag on the coat stated that the price was $79.95. When she brought the coat to the store's sales clerk, Melanie was told that the coat was on sale, and she would pay 20 percent less than the price on the tag. After the discount was applied, Melanie paid $63.96, $15.99 less than the original price. ---------------------------------- The value of Melanie's consumer surplus from this purchase is

---------------------------------- at least $15.99 since this is the difference between the price Melanie is willing to pay for the coat and the actual price she pays, but she could have be willing to pay more than $79.95 for the coat.

Do producers tend to favor price floors or price ceilings? Why? ---------------------------------- Producers favor

---------------------------------- price floors because, when binding, price floors increase price above the equilibrium and may increase producer surplus.

A student argues: "Economic surplus is greatest at the level of output where the difference between marginal benefit and marginal cost is largest." ---------------------------------- This statement is false because

---------------------------------- the level of output where the difference between marginal benefit and marginal cost is largest will be below the output level needed to have the maximum economic surplus.

Subsidy

An amount paid to producers or consumers to encourage the production or consumption of a good

Can economic analysis provide a final answer to the question of whether the government should intervene in markets by imposing price ceilings and price floors? Why or why not?

Economic analysis cannot provide such an answer because it seeks to address positive questions such as "what is."

Why do some consumers tend to favor price controls while others tend to oppose them?

Price ceilings generate shortages. Consequently, the consumers who obtain the product at a lower price win, but other consumers will lose because they would like to purchase the product but are unable to because of a shortage.

Briefly discuss the relationship between property rights and the existence of externalities.

Without property rights (or if property rights are difficult to enforce), externalities are likely to result.

Externality

a benefit or cost that affects someone who is not directly involved in the production or consumption of a good or service

In another example, if you buy a college education and you have no property right that will enable you to prevent others from benefiting from your education, then your private benefit will likely be _______________the social benefit.

less than

A price ceiling is a legally determined _____________ price that sellers may charge. A price floor is a legally determined _____________ price that sellers may receive.

maximum, minimum

A price ceiling is a legally determined ______________ price that sellers may charge. A price floor is a legally determined ______________ price that sellers may receive.

maximum, minimum

Externalities might also be positive when the private benefit (the benefit received by the consumer of a good or service) is less than the social benefit (the total benefit from consuming a good or service, including both the private benefit and any external benefit).

• Example: college education

Pollution is an example of a negative externality in production

• Negative externalities might result from consumption. • Example: cigarette smoke

One option a government has for affecting a market is the imposition of a price ceiling or a price floor.

• Price ceiling: A legally determined maximum price that sellers can charge. • Price floor: A legally determined minimum price that sellers may receive. Price ceilings and floors in the USA are uncommon, but include: • Minimum wages • Rent controls • Agricultural price controls