Calhoun Exam 3 Study Guide Chapters 4 5 9 Chapter 4 Supply and Demand Applications and Extensions The link between Resource and Product Markets An increase decrease in demand for a product will increase decrease demand for resources that make that product When the product price rises the resource price will eventually rise The economics of Price Controls Price Ceiling o Puts an upper limit on price generates a shortage and deadweight o Puts a lower limit on price generates a surplus and a deadweight Deadweight loss loss of gains from trade loss Price Floor loss Impact of a Tax Incidence o Statutory incidence who is legally responsible to pay the tax This is the tax burden it hinders exchange o Actual incidence who really pays the tax This is the more important issue o The burden is shared between firms and consumers Ways to analyze o If the tax is legally imposed on sellers shift the supply curve o If the tax is legally imposed on buyers shift the demand curve o You ll reach the same conclusion either way What determines how the burden is shared o The size of the deadweight loss and the actual burden depend on supply and demand elasticity s Summary the more inelastic group has the biggest share of the burden Tax Rates Tax Revenues and the Laffer Curve Tax Rate o Value most common a percent is applied to the sales price o Per unit an amount is applied to each unit sale Ex 1 per every unit sold Gas is another example Tax Revenue o Rate X Sales The Laffer Curve o Graphical representation of the relationship between the tax rate and revenue Starting at high tax rates an increase in the tax rate may actually lower revenue Starting at high tax rates larger revenue may be generated by lowering taxes Impact of a Subsidy Subsidy o A payment the government makes to either the buyer or seller usually on a per unit basis when a good or service is purchased or sold o Who receives the biggest benefit from subsidies Ignoring secondary effects the group with the smallest elasticity receives the largest benefit If supply is relatively inelastic and demand is relatively elastic then suppliers receive most but not all of the benefit If supply is relatively elastic and demand is relatively inelastic then consumers receive most but not all of the benefit Taxes and Subsidies distort incentives and create secondary effects which are sometimes undesirable Chapter 5 Difficult Cases for the Market and the Role of Government Potential Shortcomings of the Market o Markets will usually generate an efficient outcome Sometimes they do not four reasons why the market may produce an inefficient outcome A lack of competition If there are only a few firms then supply may be restricted which will lower the quantity available and raise price Poor information Public goods Externalities Not all costs and benefits will be used in decision making external costs and benefits are typically ignored With an external cost too many units are produced and price is too low With an external benefit too few units are produced and price is too low External costs and benefits are ignored difficult to measure or hard to distribute to affected parties Negative Externality o A cost imposed on you for an activity you re not directly involved in and you would like to see less of the activity Positive Externality o A benefit accrued to you for an activity you re not directly involved in and you would like to see more of the activity Externalities are caused by a lack of property rights Key Terms o Economic Efficiency o A public good has two distinguishing characteristics Many people can consume the good simultaneously referred to as joint consumption or non rival People who don t pay for the good can still consume it referred to as non excludable o Why does a public good pose a problem Because of its characteristics it will be hard to generate funds to pay for its production Individuals have a strong incentive to free ride not pay wait for someone else to pay then consume the good This typically leads to a underproduction of public goods i e an inefficient amount being produced A situation that occurs when a All activities generating more benefit than costs are undertaken and b No activities are undertaken for which cost exceeds benefit o External Costs o External Benefits o Free Rider it Spillover effects that reduce the well being of nonconsenting third parties Spillover effects that generate benefits for nonconsenting third parties A person who receives the benefit of a good without paying for Chapter 9 Price Takers and the Competitive Process Characteristics of Price Takers Markets o A price taker must set prices equal to the market equilibrium price because Each firm is small relative to the market Each firm sells and identical product There are many buyers in the market No barriers to entry exit exist How Does the Price Taker maximize product o The firms decision is a two step process Decide to open or close Close temporarily if you expect to cover variable costs in the near future close permanently if you don t If open decide how much to produce Competition promotes prosperity o Why economists like competition Costs are reduced Prices are reduced Firms become more efficient and have a stronger incentive to Resources are moved from unproductive areas to productive innovate areas When profits are present profit seeking entrepreneurs will put more resources into these markets supply will expand and eventually the price will be driven down to the unit cost Key Terms o Marginal Revenue The incremental change in total revenue derived from the sale of one additional unit of a product o Shutdown A temporary halt in the operation of a firm Because the firm anticipates operating the future it does not sell its assets and go out of business The firm s variable cost is eliminated by the shutdown but its fixed costs continue o Going out of business The sale of a firm s assets and its permanent exit from the market Allows the company to avoid fixed costs
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