there is not enough to go around so we have to figure out some way to ration our scarce resources. In the free market system we use the price system as our rationing device. Scarcity depends on both demand and supply
costs you cannot change by making a new decision. You are stuck with these costs regardless of what you do now.
what you sacrifice when you make a decision. You can only count the value of your next best opportunity. This can include actual dollars paid as well as costs that are not dollar‐valued.
How do you make a rational decision?
* Private Expected MB vs. Private Expected MC A rational decision may turn out to be bad if you had bad information to base your decision on, but it is rational if you make the best decision you could based on the information you had at the time.
How do you make a good decision?
* Private Actual MB vs. Private Actual MC You have to do an after‐the‐fact cost‐benefit analysis. In other words, once you have access to all the accurate information (which is usually not until after you already made your decision)
when your consumption or production decision impacts those around you and you ignore these costs/benefits when making your decision.
the way economists measure the gain consumers and producers and society earn when decisions are made. * The difference between benefit earned and cost paid.
Positive vs. Normative Statements
a. Positive statements are potentially testable and potentially provable.
b. Normative statements are more generally subjective value statements. Look for words without clear definitions (good, bad, better) or for words like ought, or should.
Economic Efficiency vs. Allocation Efficiency
Economic Efficiency: we are using resources in the best way to produce the best amount of goods and services
Allocation Efficiency: we are making sure the goods and services are going to the people who can best benefit from them
Elasticity of Demand
* Always a negative #
Ed = % Change Qd / % Change P
Inelastic, Unit Elastic, and Elastic
> 1 : inelastic, raise price and consumers still buy
= 1 : unit elastic, price change and consumer demand equal
< 1 : Elastic, consumers are sensitive to prices
Elasticity of Supply
* Always a positive #
Es = % change Qs / % change P
Income Elasticity of Demand
* can be a positive or negative #
Ei = % change Qd / % change I
Cross Price Elasticity of Demand
* can be positive or negative #
Ei = % change Qd / % change P
the Pe and Qe point where Demand and Supply intersect
economic surplus is earned by the consumers whenever they get lucky enough to pay a price which is less than their reservation price.
Area under the demand curve and above price paid
economic surplus is earned by the producers whenever they get lucky enough to sell for a price which is greater than their reservation price.
Area above the supply curve and below the price recieved
amount of surplus lost to society whenever we don’t produce and consume the most efficient amount.
Due to resource misallocation.
• A legally set minimum price allowed to be paid in a market. • Used to protect sellers from prices which the government feels are “too low”. • Designed to increase PS and decrease CS. • Only binding if set above Pe. • If binding, a price floor usually results in RM and DWL (the size of the RM and DWL depend on the responsiveness of consumers and producers to price changes).
• A legally set maximum price allowed to be charged in a market. • Used to protect buyers from prices which the government feels are “too high”. • Designed to increase CS and decrease PS. • Only binding if set below Pe. • If binding, a price ceiling usually results in RM and DWL (the size of the RM and DWL depend on the responsiveness of consumers and producers to price changes).
Tax on a Seller
• A tax always reduces market activity, so it causes “too few units to be bought and sold” • Placing a tax on a seller will increase the marginal cost of production, (move the supply curve up vertical by the amount of the tax). This is a decrease in supply (shift left).
Tax on a Buyer
• A tax always reduces market activity, so it causes “too few units to be bought and sold” • Placing a tax on a buyer will reduce the willingness to pay the seller for the product since now you have to pay the seller and the government (move the demand curve down vertical by the amount of the tax). This is a decrease in demand (shift left).
Subsidy to Seller
• A subsidy always increases market activity, so it causes “too many units to be bought and sold” • Giving a subsidy to a seller will reduce the marginal cost of production, (move the supply curve down vertical by the amount of the subsidy). This is an increase in supply (shift right).
Subsidy to Buyer
• A subsidy always increases market activity, so it causes “too many units to be bought and sold” • Giving a subsidy to a buyer will increase the amount they are willing to pay the seller since really the government is now paying part of the cost for them, (move the demand curve up vertical by the amount of the subsidy). This is an increase in demand (shift right).
The difference between Pb and Ps
Tax Effectiveness Rate
• Taxing goods with low Ed (like necessities) will have a higher tax effectiveness rate but are usually considered less equitable ways to raise tax revenue since the poor spend more of their income on necessities than the rich do. • Taxing goods with high Ed (like luxuries) will have a lower tax effectiveness rate but are usually considered more equitable ways to raise tax revenue since the poor don’t buy as many luxuries, so the rich pay more of this kind of tax.
Rule for how Tax and Subsidy gets shared
* Whoever is more responsive to price changes pays less of the tax and gets less of the subsidy.
* Whoever is less responsive to price changes pays more of the tax and gets more of the subsidy.
The country that can produce the larger quantity of the good
Ex: USA produces 100 cars in a month VS. Canada produces 60 cars in a month
Marginal Opportunity Cost
Ex: 100 cars = 500 bushels of wheat 1 car = the loss of 5 bushels of wheat
Ex: 60 cars = 120 bushels of wheat 1 car = the loss of 2 bushels of wheat
Whichever country can produce at the lowest opportunity cost
Ex: 1 car = the loss of 5 bushels of wheat VS. 1 car = the loss of 2 bushels of wheat
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