ECO2030 1nd Edition Exam 2 Study Guide Lectures 16 29 Chapter 7 Welfare economics the study of economic well being which is affected by the allocation of resources Willingness to pay WTP how much a consumer is willing to pay for a good Consumer surplus CS WTP P of a good eg if John is willing to pay 200 for something and the price is 100 then his CS is 100 Total CS is the area triangle under the demand curve down to the price Individual CS is the difference between the price of the good and the WTP of the individual The two reasons CS falls Buyers leave the market because the price increases above their WTP and the fall in CS because the remaining buyers have to pay a higher price Producer surplus PS P Cost to supply good service eg If Johns cost to cut a tree is 100 but the price is 200 then his PS is 100 Total PS is the area triangle above the supply curve and up to the price of the good service The two reasons PS falls Sellers leave the market because price falls to where it exceeds their cost and the fall in PS because the sellers still in the market receiving less for their goods services Total Surplus CS PS Efficiency when total surplus is maximized Efficiency is when the goods are consumed by those that value them most and produced by those that can produce them at the lowest cost Changing the price or quantity of a good does not increase total surplus Total surplus is maximized at the market equilibrium quantity efficient Government cannot increase total surplus by changing the allocation of resources The market equilibrium is the most efficient This is why free market economies are much more efficient than centrally planned economies There is a role for government if there is a market failure eg externalities market power Chapter 8 If buyers have to pay a tax on a good demand curve shifts left by the amount of the tax If sellers have to pay a tax on a good they sell supply curve shifts left by the amount of the tax If you draw this out you will notice that the result is the same regardless who pays the tax In both situations the price buyers pay rises and the price sellers receive falls Either way there is a lower quantity sold The tax burden is shared by the producers and the consumers Who pays more depends on the elasticity of the supply and demand for the good A tax always decreases the size of the market because quantity sold decreases A tax on a good reduces welfare decreases both CS and PS creates government tax revenue price A Tax revenue the size of the buyer tax times the quantity sold B s pay C In the graph the tax revenue is equal Pri to A B E ce D The Deadweight Loss C E Price w F Total surplus with a tax Government revenue Seller o is included in the total surplus with a tax s tax because we assume the tax is for our benefit Qua Quant receiv therefore total surplus with the tax is A B ntity ity e D F w w o w o the tax Total surplus A B D tax tax F C E For every tax the deadweight loss is the revenue raised from the tax The amount of the deadweight losses depends on the elasticities of the supply and demand curves Remember the less steep the demand supply curve the more elastic it is The more elastic either curve the greater the deadweight losses from the tax you can draw this out to get a better understanding The argument about taxes raises the question about how be government should be The larger the deadweight losses from taxes the more expensive the government program is So if these taxes cause large deadweight losses we should have a smaller government If the taxes cause small deadweight losses the government program costs less Labor tax if the supply of labor is inelastic steep then the deadweight losses due to taxation are small If the supply of labor is elastic then the deadweight losses from taxation will be large As the tax increases the deadweight losses increase even more S D Tax revenue increases as the tax increases to a certain point before it begins to fall This is because the tax distorts incentives to much a higher tax reduces the size of the market The laffer curve Shows how increasing the size of a tax increases Ta revenue to a certain point if the tax gets to great x revenue falls Re Ronald Reagan actually ran on the Laffer ve platform promising people to cut taxes and nu saying it would increase revenue he was right e He noticed that high taxes reduced peoples Ta willingness to work and that lower taxes increased motivation to work x Chapter 9 International Trade Si Trade makes everyone better of ze The Equilibrium without trade has only domestic consumers and producers The price and quantity is determined by the domestic market Total benefits CS and PS World price the price of the good established in the world economy Domestic price the opportunity cost of producing the good in the domestic market Allowing for free trade Comparative Advantage If domestic price world price the country has the comparative advantage If the world price domestic price world has comparative advantage When a country opens up free trade the price of the good will drop or increase to match world price If a country has a comparative advantage price will rise they should export the good If world has comparative advantage price will fall country should import the good In other words if the world price is lower than the domestic price country should import good if would price is higher than domestic price country should export good In the graph on the right world price is higher than domestic price so Dom country exports estic A price Exports So when trade is allowed the Suppl After World D domestic price increases to B y trade Pric Price reach the world price e C The area D is the increase in Bef total surplus due to trade ore trad e Domes tic Quantit Dome stic Dema Domes Quantit nd tic y Quantit deman ded supplie d As a result CS decreases from A B to A and PS increases from C to C B D The gains in PS the losses in CS therefore increasing total economic well being In the Graph to the right The world price is lower than the domestic price so the country imports Dom the domestic price decreases estic A to the world price Pric Suppl Again the area D is the e y increase in total surplus due Bef B D price to trade ore C Imports World After CS increases from A to trad Price tradee A B D and PS decreases Dome from B C to C stic The Gains in CS than the Dema Domes …