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Terms in this set (145)
Demand is the quantity of a good or service that a consumer is willing and able to purchase at a certain price during a specific time period, ceteris paribus.
Draw a demand curve
What does the demand curve illustrate?
The demand curve illustrates an important relationshiip: as the price of the good falls, the quanitiy of the good demanded increases and vice versa.
Hence, a negative relationship or an indirect relationship
Law of demand
There is a negative causal relationship between the price of the good and the quantity demanded over a particular time; ceteris paribus. As the price increases the demand for the quantity falls and vice versa.
Difference between a shift and a movement of demand
Shift: caused by a non determinant factor
Movement: caused by a change in price
Non-price determinants of demand
- Tase and preferences
- Price of substitutes and complements
- Demographic changes
Shift of the demand curve and the movement along the demand curve - draw it
the quantity of a good or service that producers are willing and able to offer for sale at a given price during a specific period of time.
Law of supply
There is a positive causal relationship between the quantity of the good supplied over a period of time and its price; ceteris paribus. As the price of the good increases, the quanitity supplied also increases and vice versa
Non-price determinants of supply
- State of technology
- Price of a related product
- Indirect taxes and subsidies
- Number of firms in the market
Shift of the supply curve and movement along the supply curve - draw it.
Where the supply equals the demand.
At the equilibrium price, the quantity consumers are willing and able to buy is exactly equal to the quantity firms willing and able to sell. This price is also known as the market clearing price, or market price.
a situation of either shortage or surplus:
More is being supplied than demanded at P1. In order to eliminate this surplus, producers must lower the price.
When more is being demanded than supplied at P2. In order to eliminate this shortage, producer must raise the price.
A change in equilibrium due to a change in determinants of demand
look at your printed note !
A change in equilibrium due to a change in determinants of supply
look at your printed note !
What is Market Efficiency
Equilibrium price and quantity where supply = demand, with no externalities
the extra satisfaction gained by consumers from paying a price that is lower than which they are prepared to pay
The excess of actual earnings that a producer makes from a given quantity of output, over and above the amount the producer would be prepared to accept for that output.
This happens when a competitive market is in equilibrium, where resources are allocated in the most efficient way from society's point of view.
- Social surplus (consumer + producer surplus) is maximized
- Marginal social benefit=Marginal social cost
Automatic market forces:
- Allocation of scarce resources:
Depending on how much demand is or supply, the price will always decrease, this helps to allocate scarce resources by the government.
- Price signals:
Depending on whether demand is higher or low, signal produces early signals, making firms take action and it helps them know how they are supposed to price their products
- No central planning agency:
The invisible hand
( the consumers and producers can sort the disequilibrium - without government intervention)
explain price mechanism using digram (demand shifting right)
Before price mechanism:
- When demand shifts, it shifts at the same price. The price remains at P1.
- Clearly there is an excess demand (Qd- Q1).
- Hence, when there is a disequlibirum, the functions of the price mechanism take action. For example, a signal will be sent to producers that the price is too low (maybe because of competion of buyers to purcahse the good or long waiting lists to purchase the product).
- Hence, there is an incentive for producers to raise their price to produce more and satisfy the excess demand - to make profit.
- Hence, there will be a contraction along the demand curve and an extention of supply - at a new price at Q2 and P2 - The excess demand has been rationed away.
- We then have a new equilibrium where there is a perfect allocation of scarce resources because demand equals supply.
explain price mechanism using digram (supply shifting right)
- When supply shifts to the right there will be a lower price and a new equilibrium this is because when supply shifts to the right it does it at the same price.
- Therefore, there is a disequilibrium between QS and Q1
because quantity supplied is much higher than quantity demanded.
- A signal is sent to producers that the price is too high. Therefore, there is an incentive for producers to lower their prices in order to make more profit by selling more and liquidate their stocks.
- Hence, there will be a contraction along the new supply curve and an extension of demand.
- The new price is at P2 and Q2. At that price and quantity, there is no more excess supply. And now there is a perfect allocation of resources at the new equilibrium.
Hence no need government to ensure that there is a perfect allocation of resource (aka invisible hand)
Elasticity is a measure of the responsiveness of the quantity demanded or supplied of a good or service, to changes in any of the factors that determines it.
Price elasticity of demand
It is a measure if how much the quantity demanded of a good changes when there is a change in its own price.
Formula of PED
% change in quantity demanded / % change in price
Price elastic demand
A change in price leads to a proportionally greater change in the quantity demand (smaller than one)
Price Inelastic Demand
A change in price leads to a proportionally smaller change in the quantity demanded (greater than one)
Unitary Elastic Demand
A change in the price leads to a proportionally equal change in the quantity demanded (equal one)
Perfectly Inelastic Demand
A change in price leads to no change in quantity demanded (equal zero)
Perfectly elastic demand
A tiny change in price leads to an infinite change in the quantity demanded (equal to infinity)
What do the PED determinants influence ?
the determinants of PED influence how sensitive the quantity demanded of a good is to a change in its price
What are the determinants of PED
1) the number of closeness and substitutes
2) the degree of necessity and how widely it is defined
3) The time period considered
4) The proportion of income spent on the good
Give an example of an elastic product
give and example of an inelastic product
How does the time period affect the elasticity of a good
The time period under consideration affects the level of responsiveness consumers have to changes in the prices of goods and services.
- And, the demand for a good will be more inelastic in a short period of time rather than in the long period of time
How does the proportion of income affect the elasticity of a demand for a good
The higher the proportion of income spent on a good, the more elastic the demand it
What are primary commodities
They are goods that come directly from natural resources or 'land'. They tend to be unprocessed raw materials that are sold without needing to be processed further
What is the elasticity of primary commodities and why is that so ?
Primary commodities are inelastic demand. This is because they are necessities to those who consume them. And, there are no or few substitutes
What are manufactured goods
Manufactured goods are man-made goods that have been produced from raw materials, which have been transformed through a production process.
What is the elasticity of manufactured goods and why is that so ?
Manufactured goods are elastic demand. This is because they usually have more substitutes available to consumers, and take a long period of time
Draw a diagram to represent the inelastic demand for commodities
What is cross-price elasticity of demand?
it is a measure of the responsiveness of the quantity demanded of a good or service to changes in the price of another good.
For example, coca cola and pepsi. As the price of coca cola increases the quantity demanded of coca cola falls and people switch to pepsi where quanitiy demanded will increase - hence a right ward shift and VICE VERSA
Formula for XED
% change in quantity demanded for good X / % change in price of good Y
What does it mean if XED is negative or positive
Why type of goods do they mean when talking about XED
What does Y > 0 mean?
Positive value, hence, they are substitues
What does Y < 0 mean?
Negative value, hence, they are complements
What does Y=0 mean?
They are unrelated goods
What does a high positive value of XED mean
This means that they are close substitutes.
- A relatively small percentage increase in the price of one good will lead to a relatively larger increase in the quantity demanded of the other good.
What does a low positive value of XED mean
This means that they are remote substitutes.
- A relatively small percentage increase in the price of one good, will lead to a relatively small increase in the quantity demanded of the other good.
What does a low negative value of XED mean
This means that they are remote substitutes:
- A relatively small percentage increase in the price of one good, will lead to a relatively small decrease in the quantity demanded of the other good.
What does a low high value of XED mean
This means that they are close complements:
- A relatively small percentage increase in the price of one good, will lead to a relatively small decrease in the quantity demanded of the other good.
What is income elasticity of demand (YED)
YED measures how much the quantity demanded of a good will respond to a change in consumers income
What does it mean if you get a positive YED or negative YED?
Positive= normal goods
Negative= inferior goods
% change in quantity demanded / % change in income
What does Y > 0 mean
- the demand for the good increases as consumer income increases or demand for the good decreases as the income of consumers decreases.
What does Y < 0 mean
- The demand for the good increases as the income of the consumers income decreases and vice versa
What does Y > 1 mean
Income elastic demand (Normal luxury)
- A change in income leads to a proportionally greater change in the quantity demanded
What does 0 < Y < 1 or Y<1 mean?
Income inelastic demand (Normal necessity)
- A change in income leads to a proportionally smaller change in quantity demanded
YED = 0
A change in income leads to no change in the quantity demanded
YED = 1
A change in income leads to a proportionally equal change in the quantity demanded.
What happens during recession regarding the YED
Goods and services with the highest YED, YED > 1 (income elastic demand) will suffer the most. While products with lower YED, YED < 1 may avoid larger suffers and reduction in sales. And inferior goods (YED < 0 ) might even experience an increase
OPPOSITE DURING ECONOMIC GROWTH
A period of declining real GDP, accompanied by lower real income and higher unemployment.
Define economic growth
A period of positive growth in real GDP, accompanied by higher real income and lower unemployment.
Price elasticity of supply (PES)
Price elasticity of supply is a measure of the responsiveness of the quantity supplied of a good or service to changes in its own price.
PES= % ∆Qs
% ∆ Price
as the price of the good increases, the quantity supplied also increases, ceteris paribus and vice versa
- PES is always a positive number as the price and the quantity supplied always move in the same direction
Price elastic supply
PES > 1
- A change in price leads to a proportionally greater change in the quantity supplied
Price inelastic supply
0 < PES < 1
- A change in price leads to a proportionally smaller change in the quantity supplied
Unitary elastic supply
PES = 1
- A change in price leads to a proportionally equal change in the quantity supplied
Perfectly inelastic supply
PES = 0
- A change in price leads to no change in the quantity supplied
Perfectly elastic supply
PES = infinity
- A change in price leads to an infinite change in quantity supplied
What are the determinants of PES
- The time period considered
The longer the time the more the elastic the supply will be
- The mobility of the factors of production
The greater the mobility (easier/flexibility) the more elastic the supply will be
- The unused capacity
The greater the unused capacity the more elastic the supply will be
-The ability to store stock
The greater the ability to store stick, the more supply there will be
Primary commodities application with PES
Primary commodities tend to have lower PES (inelastic supply) then manufacture goods. This is because of the long period or high levels of investment needed to increase the production.
Inelastic supply of commodities
Elastic supply of manufactured goods
Define an indirect tax
An indirect tax is a tax imposed upon expenditure and is added to the selling price of the good. It is placed on producers or suppliers, raising the firms cost of production and therefore shifting the supply curve upwards by the amount of tax imposed.
What is a tax burden/incidence?
A tax burden or incidence relates to who bears the cost of the tax. And how the cost is divided between the producer and consumer depends on the price elasticity of the demand and supply.
Explain how the incidence of taxation on consumers and/or
producers will be influenced by the price elasticity of supply.
If supply is perfectly inelastic producers will bear the full burden (incidence) of the tax
AND equilibrium price and quantity will not change (so that consumers are not affected but producers bear the full burden/incidence
So, given PED, the more price inelastic supply is, the
smaller the incidence on consumers and the greater on
PED along a demand curve...
For the top part of the demand curve, the percentage changes in the quantity demanded are always going to be greater than the percentage changes in price. That is why elastic figures are on the top.
On the bottom half, the percentage changes in quantity demanded is are always going to be less than the percentage changes in price. That is why inelastic figures are at the bottom.
Do a few calculations in an essay answer.
In the second diagram:
Total revenue is going to be maximized when there is unit elasticity (the midpoint of the first diagram). This is because there is no longer elastic or inelastic demand taking place.
Whats another name for indirect tax
what are the two types of indirect taxes ?
Specific tax and ad valorem tax
What is specific tax
A specific tax is a fixed amount of tax imposed on a good or service per unit sold ( for example a tax or $2 per can of beer)
Before the tax was imposed the market was in equilibrium where D intersected with S1 at p
However, once the tax is imposed, the supply curve shifts upwards from S1 to S2 by the amount of tax. Supply extends and demand contracts until a new equilibrium at quantity Q+ and price PC is reached.
What is a ad valorem tax
An ad valorem tax is a fixed percentage of tax charged on the selling price of the good ( for eg: 20% on the price of cigarettes)
Before the tax was imposed the market was in equilibrium where D intersected with S1 at p
However, once the tax is imposed, the supply curve will diverge from the original S1 to S2 by the amount of tax. Supply extends and demand contracts until a new equilibrium at quantity Qt and price PC is reached
Effect of indirect tax on different stakeholders
Consumers: Consumer expenditure changes from Q
to Qt x Pc. Consumers are worse off after tax as they end up paying a higher price (pc) and consuming a lower amount (Qt)
Producers: Producers revenue falls from P
to Pp x Qt where Pp= Pc - tax per unit. They are worse off as they end up selling a small amount of the good and receive a lower final price after paying the tax to the government
Government: Their revenue = (Pc - Pp) x Qt. They are better off because it collects revenue from the tax, which can be used to spend on the provision of public goods and services or any other government expenditure.
Employment: The market becomes smaller as fewer units of output are consumed and produced after the tax (Qt < Q*).Workers are worse off because the firms will not need more workers due to the reduction of size, hence they would most probably get fired.
What happens to the society as a whole due to the indirect tax
Society as a whole is worse off because the imposition of this tax distorts the market, producing an under-allocation of resources.
Governments common objectives of setting an indirect tax
- To collect government revenue
- To discourage consumption of de-merit goods
- To redistribute incomes within the population
- To correct negative externalities and socially inefficient allocation of resources
What are subsidies
The amount of money paid by the government to the firm, per unit of output.
- It helps decrease the firm's cost of production and therefore shifts the supply curve downwards.
Draw a subsidy diagram
Before the subsidy, the market was in equilibrium at Q
where the demand curve intersects with the supply curve (S1).
After the subsidy is granted. The supply curve shifts downwards from S1 to S2 by the amount of subsidy. The equilibrium price falls from P
to Pc. Consumers will demand more of the good due to the lower prices, hence quantity increases from Q
Effect on the different stakeholders (Part one)
Consumers: they are better off after the subsidy as they are able to consume a larger amount (Qsb) for a lower price (Pc) in comparison to before the subsidy (Q
Producers: Producers are better off as they sell for a larger quantity (Qsb) and receive a higher final price (Pp) after receiving the subsidy from the government. Hence, they have a higher revenue of PpxQsb
Effect on the different stakeholders (Part two)
Government: the government is now worse off because it has a cost of the subsidy. The cost of the subsidy is (Pp - Pc) x Qsb. The government also has an opportunity cost as the funds granted in the subsidy cannot be used to provide public goods and services or any other government expenditure.
Employment: employment is better off as the market gets bigger (Qsb) , more units of output are sold. Hence, they need more workers to produce them. So more will be employed.
How is society as a whole after the subsidy?
A subsidy is negative for society as it distorts market equilibrium. However the final effect of a subsidy on society's welfare depends on the reason for granting the subsidy and its effectiveness in achieving its aim.
Explain the DWL due to the subsidy
Check ur written diagram flashcard:
Before - at free market
- Before, consumer surplus was A+B
- Before, producer surplus was C+D
- Before, government revenue was 0
- Total surplus was = A+B+C+D
After the subsidy:
- Consumer surplus is now A+B+F+G
- Producer surplus is now B+C+D+E
- Government revenue = -(B+C+E+F+G+H)
- Total surplus= A+B+C+D-H
Hence, we are loosing an area which is H. H is now a cost as a result of the subsidy being implemented that was not a cost before. Therefore, in total, we are loosing surplus in the market. Society has to pay an extra cost when before there was not that extra cost.
What are the reasons to grant subsidies?
- To increase the revenue for producers
- To make basic necessities and merit goods more affordable
- To encourage the consumption of merit goods
- To correct positive externalities, improving the allocation of resources.
What are Price Ceilings ?
Price ceilings are when the governments sets a maximum price below the equilibrium price preventing producers from selling their product above it. This is done in order to protect consumers and is usually applied to necessity and/or merit goods
What are the aims of price ceilings?
- To increase the consumption of the good or service
- To reduce the price of the good and service for low-income consumers
Draw a price ceiling
Initially, the equilibrium is at Pe and Qe where demand intersects with supply. When the maximum price is imposed, the demand is Q2, and the supply is Q1, meaning there is a excess of demand from Q3 - Q1
What are the consequences of a price ceiling?
- Creates a shortage
- Generates a rationing problem
- It promotes the creation of parallel (black) markets
- It eliminates allocative efficiency and generate welfare loss
- There are consequences for market stakeholders
Draw a price ceiling diagram showing its consequences
Check book too!!!!!
- With no price controls the market is at equilibrium at Qe and Pe. Consumer surplus is equal to area a + b+ c. And producer surplus is equal to area d + e + f.
When the price ceiling is set, consumers are only able to consume area a + b + d. And producers is now only at f. The total community surplus is are areas a + b + d + f and society suffer a deadweight loss at c + e
Price ceiling effect on different stakeholders (part one)
Consumers: consumers who got to buy the good at the lower price are better off than before. Those who dont get to consume it at any price due to the shortages, they are worse off. And it depends on the elasticity of supply and demand.
Producers: they now sell a smaller amount of good (Q1) and recieve a lower price for it. Their total revenue also falls after the maximum price. They are worse off
Price ceiling effect on different stakeholders (part two)
Government: they do not gain any of the lost welfare. However, you could argue that once food became more attainable society is better off. And they may gain political popularity
Workers: they are worse off as the market size reduced. hence, unemployment rates will increase because workers will most probably get fired.
Solutions to price ceilings
The major problem is the excess demand. Hence, the government can intervene further to increase the supply of the good until the equilibrium is reached at Pmax. THen, more will be produced and consumed at Q2 at (from Q2 to Q2) the price Pmax (from Pe to Pmax)
What or other ideas for PC solutions
- Granting subsidies, but thats expensive.
Opportunity cost because this money can be spent on other public goods and services such as education.
- Government can store some of the products before setting the price ceilings. Then increase the supply once needed.
What are Price Floors?
This is when the government sets a minimum price above the equilibrium price, prevent producers to sell their product below it. This is done in order to protect producers. And is usually done in the case of commodities in the labour market.
What are the aims of the price floor?
- To increase the income of producers of goods and services that the government considers important, such as agricultural products.
- To protect workers by setting a minimum wage to ensure that they earn enough money to have a reasonable standard of living.
Draw a price floor
The initial equilibrium will be at price Pe and quantity Qe where demand intersects with supply. When the government sets a minimum price above the equilibrium price, producers will be willing and able to supply at a higher amount (Q2) whereas, consumers will be willing and able to buy less (Q1) hence and excess supply between Q2 and Q1. This is because the prices increased for consumers (Pe to Pmin).
Consequences of price floors
- Produces a surplus
- Promotes the creation of black markets
- It might create firm inefficiency
- Eliminates allocative efficiency and produces a welfare loss
- Consequences for different stakeholders
Draw the consequences curve for Price Floor
Consumers' original surplus was the sum of areas a + b + c. They lose area c and area b due to the introduction of minimum price.
Producers original surplus was the sum of areas d + e + f .After the price floor it is the sum of b + d + f Producers now receive a higher price for their goods and services.
Deadweight loss area c + e.
You can score very highly when you shade the DWL and explain how its losss.
- the explanation of this is shown when you convey the loss of surplus for Consumers and Producers.
Draw the solution for PF
- The government can intervene by purchasing the excess supply, hence shifting the demand curve outwards from D1 to D2+government purchases. With a new equilibrium at Q2. This will generate a cost for the government. After the government purchases the excess supply, there will be an overallocation of resources from the society's point of view (from Q1 to Q2).
Welfare loss is shaded.
- But this option is expensive
SO THE SOLUTION IS GOVERNMENT PURCHASING THE EXCESS SUPPLY.
Other solutions from the government for price floors (excess supply)?
- They can burn the stock.
- But that's a massive waste of resources and money.
- Dumping it abroad. Selling it in foreign markets at a lower price.
- However, the foreigners know what's going on and they can realize that the price they are charging is less than the minimum in the home country. Hence, they will be un-happy because that means that domestic supply will not be able to compete.
- What ever they do will have substamtial opportunity cost. because the money spent could have been spent for education and other public services and goods.
Consequences of price floor on stakeholders
Consumers: Worse off because they end up consuming a smaller amount for a higher price
Producer: If the government purchases the surplus, they are better off as they will sell a larger amount and receive higher prices
Workers: Market increases so more employment
Government: if they buy the surplus it will incur a cost and have fewer funds to spend on other public goods. Gaining public popularity though.
What is market failure
Market failure results in allocative inefficiency, where too much or too little goods and services are produced and consumed from society's perspective.
It's consumption by one person reduces it's availability to someone else
This means that it is possible to exclude other firms from using the good once it has been provided.
What is the free rider problem
Tendency of individuals/organizations to fail to contribute to production of public goods BECAUSE they can still benefit without contributing
Define merit goods
Merit goods are goods whose consumption creates external benefits. - good for consumers but most likely are under-consumed and under-provided from society
What is A NEGATIVE EXTERNALITY OF PRODUCTION?
A negative externality of production is when the production process of the good or service generates a negative effect on third parties or on society as a whole.
Draw a negative externality of production
The marginal social cost (MSC) is greater than the marginal private cost of production (MPC) as the firms do not take into consideration these extra costs when deciding how much to supply. Therefore a greater amount is being produced than the socially optimum amount (Qopt < Qm) therefore, an over-allocation of resources. Hence, shifting the supply curve to MPC where the quantity supplied is equal to the quantity demanded at Qopt.
Therefore, both quantities Qopt and Qm have a higher cost for society than the benefit they bring. (MSC > MSB) - market failure
How to solve the negative externality of production?
1. Imposing a tax on polluting firms:
The government could impose a tax per unit of output produced, or tax per unit of pollutants emitted, in order to increase the private costs of production (MPC to MPC + Tax). This will generate a welfare loss, however, it will be much smaller and have minimal harm to society than before.
2. Laws and legislation:
The government could pass on laws relating to environmental standards that firms must comply with in the production process. To meet these the firms cost of production would increase and cause an upward shift of the supply curve.
- Hence, the MPC will be closer to MSC and it will reduce the size and effect of the welfare loss to society
3. Tradable emission permits:
- They are permits given from the government that give the firms a lisence to create pollution up to a certain extend. Once they are issued the firms can trade, buy and sell them in the markets.
What is A POSITIVE EXTERNALITY OF PRODUCTION?
A positive externality of production is when the production of a good or service generates a positive effect to the third parties and to the society as a whole
draw a positive externality of production
- When this happens the marginal social cost of production (MSP) is smaller than the marginal private cost of production (MPC) as firms are the ones who pay for training, R&D, or any other costs in the production process. Therefore a smaller amount is being produced than the socially optimum amount (Qm < Qopt) therefore, an under-allocation of resources. Hence, shifting the supply curve to MPC where the quantity supplied is equal to the quantity demanded at Qm.
Therefore, both quantities Qm and Qopt have a lower cost for society than the benefit they bring. (MSC < MSB) - market failure
How to solve the positive externality of production?
- obvious is to increase the quantity of the good to gain the welfare (Q1 to reach to Q*)
1. Susidise firms:
The government can grant subsidies for the firms that invest in training, R&D, and other costs during the production process, therefore shifting the supply curve from MPC to MPC - Subsidy, to the point of social efficiency (shaded area). Since the firms' cost of production reduced, firms will be more willing and able to produce more of the good at every price level. Hence reducing welfare loss as the society gain external benefits.
2. Direct government provision:
The government can directly provide training and other things for workers by setting up training centers for workers.
------------> similar effect as subsidies. The MPC would shift outwards to the MSC reducing externality.
What is A NEGATIVE EXTERNALITY OF CONSUMPTION
A negative externality of consumption is when the consumption of the good or service generate a negative (deleterious) effect to the third party and society as a whole.
Draw a negative externality of consumption
A negative externality of consumption causes the marginal social benefit (MSB) to be smaller than the marginal private benefit (MPB), as the third parties are the ones who suffer from this consumption. This results in a greater amount consumed from society (Q1) than the socially optimum amount (Q*) , hence, overallocation of resources. The welfare loss is shown in the green shaded area. - MARKET FAILURE
Solutions for negative externality of consumption
1) impose an indirect tax on the good:
The government can impose an indirect tax on the good, to increase the private costs of production and therefore the price for consumers. Shifting the supply curve from MSC to MSC+Tax, reducing the quantity from Q1 to Q* due to the increase in price from P1 to P2. Causing a smaller welfare loss. And governments gain revenue which can be spent on correct the negative effects caused by this consumption.
2) Ban or regulate the good:
The government can directly stop the consumption of this good by making them illegal. This would make the externality disappear completely as the good no longer exists in the market.
3) Negative advertisement:
The government can provide education regarding the risks and dangers of consuming these deleterious goods or they can fund negative advertising in order to reduce demand (MSB).
What is A POSITIVE EXTERNALITY OF CONSUMPTION?
A positive externality of consumption is when the consumption of this good generates a positive effect on the third parties or society as a whole.
Draw the positive externality of consumption
The marginal social benefit of consumption (MSB) is larger than the marginal private benefit (MPB), as the demand for the good benefits the individual who consumes it. This results a smaller amount consumed from society (Q1) than the socially optimum amount (Q*) causing an under-allocation of resources. Since MSB is larger than MPB, a welfare loss is generated (shaded area)
Solutions for positive externality of consumption
1) Subsidize firms:
The government can grant subsidies for firms for things like health care in order to increase the supply curve.
As seen from the diagram the subsidy causes a downward shift from MSC to MSC + Subsidy near the socially efficient point (shaded area). Because as firms cost of production reduced, they can produce more of the good (Q*) at any price level. Hence, the consumers benefit from the external benefit which reduces the externalities.
2) Positive Advertisements:
The government can educate the people about the benefits of consuming these goods. Or they can fund for positive advertising in order to increase the demand curve.
The government can pass laws to make the consumption of these goods compulsory to society. Shifting the demand curve outwards to MSB at Q*, eliminating the externality as society gains the potential welfare
Define Common Access Resources:
Common access resources are resources that are not owned by anyone, they do not have a price and are available to use without payment. They are rivalrous and non-excludable.
- Usually natural resources such as fish, clean air, lakes, rivers and etc...
- Common access resources are a case of market failure because the consumers benefit of consuming or using the resource are much greater than the private cost of doing so. Therefore, an overconsumption than what is optimal from society.
What are the governments responses to threats to sustainability?
- CARBON TAX:
this is a method used to reduce the levels of carbon dioxide emitted from burning fossil fuels. Fuels that contain more carbon get a higher amount of tax (it depends on the amount of carbon tax)
- CAP AND TRADE SCHEMES:
A cap imposes a maximum amount of carbon dioxide that can produce in the air. Permits are released to producers and these permits can be bought and sold in the markets.
Governments can also grant subsidies for clean technologies. (green= government spending) (red= consumer spending)
Define ASYMMETRIC INFORMATION (HL)
This is a case of market failure. This is when economic decisions are made based on incomplete information.
This happens when not all of the parties involved in the transactions have perfect knowledge or the full information to make economic decisions.
When one party in an economic transaction has more or better access to information than the other party, this is called asymmetric information. And when this happens, the market outcome will not be efficient from society's point of view. this means that consumers are not getting the maximum benefits they could be getting and producers are not making maximum profits.
In most cases, asymmetric information is also when the producers have more information than consumers, hence charging a higher price. Or, when consumers have more information than produces, hence purchasing at a lower price.
Producers have more information: overallocation
Consumers have more infomration: under allocation
What are possible government responses to asymmetric information (HL)
(increase amount of information for consumers so that producers don't manipulate them.)
- For example, adding health warning on cigarette packets.
- For example, adding rules that advertisements must comply with, as with UK's advertising standards.
PROVISION OF INFORMATION:
- For example, adding nutritional facts on packages
Define ABUSE OF MONOPOLY POWER:
A monopoly is when a single firm has full control over a particular market and has no competition from other firms. This lack of competition means that profit-maximizing monopolists - for the firms who hold the monopoly in their particular market will most likely supply less than the socially optimum amount and charge higher prices. Thus, there is a productive and allocative inefficiency resulting in a welfare loss.
Draw a imperfect competitive market
Monopolists and other firms of imperfect markets restrict their supply in order to raise the price of the product and maximize profit. Due to this the market is not producing at the socially optimum amount and therefore is a case of market failure.
Examples of abuse monopoly of power
The ability to exploit consumer surplus by using price discrimination.
Charging excessively high prices.
Collusion - an agreement between firms who hold market power to set higher prices.
Predatory pricing - setting prices many times below the costs of production to force rival firms out of the market.
What are possible government responses to monopoly?
Prohibit takeover and mergers
- governments can set up 'anti-monopoly commissions'
The government takes control of private industry in order to run it as a public sector
4) TRADE LIBERALISATION:
Free trade increases competitions, leading to increased efficiency and lower prices.
What is government failure?
When the costs of intervention outweigh the benefits of intervention. The end result is the worsening of the allocation of scarce resources - harming social welfare.
when writing about the policies of government intervention...is the problem so great that it required intervention? if they do intervene, is the risk of government failure significant or not?
if not - then intervention can be good. VICE VERSA
When can government failure occur? when can the costs of intervention outweigh the benefits?
1) Information failure
- lack of information from governments and politicians to make effective decisions
2) The costs of the policy directly might be extremely high (cost of administration and enforcement)
- For eg: regulation, subsidies, and price controls
3) Unintended consequences
- Black markets
- Impact on poor
- Increase in unemployment
4) Regulatory capture:
Happens when the interest of society are overlooked by the managers, CEO's and firms in the industry.
This set is often in folders with...
IB - MACROECONOMICS
IB - INTERNATIONAL TRADE
IB Economics: Microeconomics
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