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Public Finance Midterm (Chapters 1 and 2)
Terms in this set (70)
When should the government intervene?
when there is a market failure and redistributions
problems that causes the market economy to deliver an outcome that does not maximize efficiency
shifting of resources from some groups in society to others
How might the government intervene?
through taxation and subsidization
restricting or mandating private sale of purchase
public financing of private provision
government provides good directly to potentially attain the level of consumption that maximizes social welfare
What is the effect of the intervention on economic outcomes?
there are indirect and direct effects that involve gathering data and develpoing statistical models to asses how people and firms might respond to policy intervention
effects of government interventions that would be predicted if individuals did not change their behavior in response to the interventions
the effects of government interventions that arise only because individuals charge their behavior in response to the interventions
Why do governments choose to intervene in the way that they do?
because they often ask normative and positive questions and how decisions effect individuals and the economy
concerned with how things should be done
concerned with why things are the way they are
What are the key features of governments
centralization, spending, taxes, deficits, and debts
spending is concentrated at higher levels or lower levels
cash flow defecit
shortfall of income below spending
goods for which the investment for anyone individuals benefits everyone in a larger group
What is a budget constraint?
the limit on the consumption bundles that a consumer can afford
What does the slope of the budget constraint equals to?
relative price of the good on the X axis
What happens to the budget constraint when income increases? decreases?
the budget constraint shifts to the right when income increases. When income decreases the budget constraint shifts to the left.
What happens to the budget constraint when there is an increase in the price of one good?
it pivots the budget constraint inward, the opposite occurs when it comes to when there is an decrease the price of one good
shows consumption bundles that give the consumer the same level of satisfaction
What are the four properties of indifference curve?
1. Indifference curves are downward sloping
2.Higher indifference curves are preffered
3.Indifference curves cannot cross
4.Indifference curves are bowed inward
Marginal Rate of Subsitiution
is the slope of indifference curve which is the rate at which a customer is willing to trade one good to another
What occurs at optimization
slope of indifference curve is equivalent the slope of the budget constraint
What is the equation for budget constraint
Holding utility constant, a relative rise in
the price of a good will always
cause an individual to choose
less of that good.
A rise in the price of a good will typically
cause an individual to choose less of all goods because her income can purchase less than
Goods for which demand increases as
Goods for which demand falls as income rises
In terms of wage and labor supply what happens when wage increase
labor supply increases along with it
What does an increase in income do to the budget constraint?
shifts the budget constraint curve to the right
How is utility represented as?
𝑋𝑋1,𝑋𝑋2,𝑋𝑋3, and so on are the quantities of the goods consumed.
𝑓𝑓 is some mathematical function that describes how consumption of each good translates to utility.
The additional increment to utility obtained by consuming an additional unit of a good.
Diminishing Marginal Utility
The consumption of each additional unit of a good makes the individual less happy than the consumption of the previous one
Marginal Rate of Subsitution
The rate at which a consumer is willing to trade one good for another
What is MRS also known as?
equal to the slope of the indifference curve, the rate at which the consumer will trade the good on the vertical axis for the good on the horizontal axis. MRS=-MUm/MUc
The cost of any purchase is the next best alternative use of that money, or the forgone opportunity.
What does the slope of the budget constraint state?
how much of one good you can buy if you give up one unit of the other, 𝑃𝑀/𝑃𝐶.
What does the MRS state?
says how much you like trading one good for another
What happens when the budget constraint slope is greater than the MRS?
you get more utility buying fewer of g1 than g2
What happens when the budget constraint slope is less than the MRS?
You get more utility buying more g1 than g2
How would one be able to maximize utility?
by setting the slope of the budget constraint equivalent to the MRS
The arena in which demanders and suppliers interact.
The combination of price and quantity that satisfies both demand and supply, determined by the interaction of the supply and demand curves.
The study of the determinants of well-being, or welfare, in society.
A curve showing the quantity of a good demanded by individuals at each price
Elasticity of demand
The percentage change in the quantity demanded of a good caused by each 1% change in the price of that good.
Mathematically: 𝜀𝜀=percentage change in quantity demandedpercentage change in price= (Δ𝑄/𝑄)/(Δ𝑃/𝑃)
Elasticity of Demand
What are the main things to know about the elasticity of demand?
Elasticities of demand are often negative: Quantity demanded falls as price rises.
Elasticities of demand are typically not constant along a demand curve.
Typically, a change in the price of one good will affect demand for other goods as well.
Cross Price Elasticity
The effect of one good's prices on the demand for another good
When the elasticity of demand is zero. the demand curve is vertical, and quantity demand does not change when price rises.
Perfectly inelastic demand
the elasticity of demand is infinite. the demand curve is horizontal, and quantity demanded changes infinitely for even a very small change in price
A curve showing the quantity of a good that firms are willing to produce (supply) at each price.
Supply curves are the outcome of profit maximization by firms. •Firms produce output using a production, such as 𝑞=𝐾×𝐿 (sqrt).
The impact of a unit change in any input, holding other inputs constant, on the firm's output.
The incremental cost to a firm of producing one more unit of a good.
How do firms choose quantities to supply?
Firms choose quantities to maximize profits, the difference between revenues and costs.
How is profit maximized?
when market price equals marginal cost.
represents the net gains to society from all trades that are made in a market
What are the two components of social efficiency?
Consumer and producer surplus
The benefit that consumers derive from consuming a good, above and beyond the price they paid for the good.
The benefit that producers derive from selling a good, above and beyond the cost of producing that good.
What is the first fundamental Law of Welfare Economics?
The competitive equilibrium, where supply equals demand, maximizes social efficiency.
The reduction in social efficiency from preventing trades for which benefits exceed costs.
The level of well-being in society.
Equity- Efficiency Trade Off
The choice society must make between the total size of the economic pie and its distribution among individuals.
What is the 2nd fundamental Law of Welfare Economics?
Society can attain any efficient outcome by suitably redistributing resources among individuals and then allowing them to freely trade
Social Welfare Function
A function that combines the utility functions of all individuals into an overall social utility function.
utilitarian social welfare function
maximizes the sum of individual utility
Rawlsian social welfare function
maximizes the utility of the worst-off member of society
The principle that society should ensure that individuals meet a set of basic needs, but that beyond that point income distribution is irrelevant.
Equality of Opportunity
The principle that society should ensure that all individuals have equal opportunities for success but not focus on the outcomes of choices made.
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