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Econ - Midterm 3
Terms in this set (110)
Types of Good
when people who dont pay cant be easily prevented from using a good
ex) national defense
when one person's use of a good does not reduce the ability of another to use the good
ex) digital music
when people who do not pay for the good can be prevented from using it
when one person's use of a good reduces the ability of another to use the good
exludable and rival goods
What market are private goods provided in?
Why are private goods excludable?
there is a strong incentive to pay for and produce private goods
Why are private good rival?
excludability doesnt lead to inefficiency of private goods
non-excludable and non-rival
ex) national defense
Why are public goods non-excludable?
it is hard to get people to pay for public goods voluntarily
What happens since public goods are non-rival?
the production costs dont change if more users are added to it
What problem does public goods cause?
Free rider problem (benefit without the cost of paying)
If there are too many free riders, what happens to public goods?
They will be underprovided
What does failure to provide public goods at an optimal level create?
What do the benefits of public goods provide?
strong argument for taxation and government provision
Government provisions dont mean that everyone will be better off. What problem does this create?
Forced Rider problem
Free Rider Problem
someone who pays share of a good but doesnt want the good so they dont enjoy the benefits
Non-Rival Private Goods
excludable and non-rival
ex) cable tv, amusement park, movie theater
Can markets provide non-rival private goods?
yes, but at an inefficient level
How do entrepreneurs capitalize on non-rival private goods?
advertising on free tv stations
non-excludable but rival
ex) public park, fishing
What happens when someone consumes a common resource?
consumption doesnt exclude others but there is one less for everyone else
Common Resources lead to what?
The Tragedy of the Common
The Tragedy of the Common
tendency of any good which is unowned and non-excludable to be overused and undermaintained
Solutions to to The Tragedy of Commons
Private ownership, government regulation, taxes on use
Factors underlying government taxation and spending deccisions
Redistributing income via transfer payments
Correcting market failures and externalities
who bears the burden of a tax
What can redistribute the burden of a tax?
What does who pays a tax depend on?
Who pays a tax depends on relative elasticities of supply and demand
What does a tax create a wedge between?
the price paid by buyers and price received by sellers
(buyers pay a price greater than market price, seller receives price lower than market price)
Which side of the market pays the greater share of the tax?
the less elastic side (more horizontal = more elastic)
What are the two main types of regulation?
Direct regulation and price controls
attempts by the government to control AMOUNT of activity (command and control)
attempts by the government to control the PRICE of an activity (Price ceiling and price floor)
ex) quality control, education
a cap (max) on the price of a good
a lower limit on the price of a good
Who is happy with a price ceilings?
When does the price ceiling matter?
Only matters when it is below the equilibrium price
Price ceilings that involve maximum below the market price create 5 important effect:
2)reduction in product quality
3) wasteful lines
4) loss of gains from trade
5) missallocation of resources
Qd > Qs
Qd (at controlled price) - Qs (at controlled price) = S
lower the controlled price, greater the shortage
Reduction in Product Quality
at the controlled price, sellers have more customers than they have good
How do sellers respond to reduction in product quality problems and increase profits?
Sellers reduce quality and reduce service
price controls that create shortages lead to bribery and wasteful lines
When a buyer is willing to bribe seller in order to get good, what happens?
the max bribe is the difference between what the buyer is willing to pay and what they have to pay established by the price ceiling
What happens when a buyer is more willing to wait in line in order to get a good?
max wait time for buyer is difference between willingness to pay and controlled price established by price ceiling
Lost Gains From Trade
price ceilings set below market price cause quantity supplied to be less than market quantity demanded
When lost gains from trade happens, what happens when the output levels are below equilibrium?
the consumer values the good more than the cost of its production (SHORTAGE)
Missallocation of Resources
consumers of with high-value uses of a good are legally preventes from signaling their high value by offering sellers a price greater than the controlled price
With missallocation of resources, what happens to producers incentives?
no incentive to supply the good just to highest-value users; as a result controlled market goods are missallocated
Who is happy with price floors?
What do price floors lead to?
surplus, because suppliers want to supply more and consumers want less
When does the price floor matter?
When it is above the equilibrium price
In relation to price floors, government intervention in markets can cause?
1) dead weight loss
2) increased costs due to bureaucracy
4) black markets
the greater amount of regulations, the greater the number of government workers needed to enforce them (cost vs benefits)
misuse of public funds; can be a cost of government activity; not confined to government sector, can happen in private sector
Equity VS Efficiency
Equity: allocating resources fairly
Efficiency: increasing social surples
Consumer Sovereignty VS Paternalism
Consumer Sovereignty: consumer knows best
Paternalism: government knows best (can help guide consumer choice)
Why should consumers be allowed to make their own choices?
- government cant know whats best for consumer
- government cant be trusted to act in best interests of consumer
- if government intervenes there will be costs
Why should government help consumers make choices?
- some decisions are very complex and individuals dont have enough info
- if an individuals behavior benefits society, government should be able to encourage it
What do competitive forces do to price?
drive down price to the average cost of production
seller that can set price of a good
ability to set price
One seller of a good or service and no close substitutes
What is the main cause of monopolies?
barriers to entry (other firms cant enter market)
Barriers to Entry
circumstances that prevent potential competitors from entering market
What are the types of barriers to entry?
1) Legal market power
2) Natural market power
Legal Market Power
occurs when a firm obtain market power though barriers to entry created by the government
government permission to be the sole producer and seller of a good
ex) HIV medicine
government granted rights to the creator of a literary or artistic work
What does legal market power do to the price of a good?
makes it more expensive consumer
Natural Market Power
occurs when firm obtains market power through barriers to entry created by the market itself
Control of Key Resources
key resources are key for the production of a food or service
ex) DeBeer's control of diamond production
when products value increases as more consumers use it
ex) Facebook, eBay
What emerges from economies of scale over a very large range of output?
a market when one firm can provide a good or service at a lower cost than two or more firms
What demand curve do monopolies face?
market demand because they are the only one in the market; MR does not equal P; to sell larger quantity, they must reduce price
profit is maximized by producing where MR = MC
Where do MR and demand curve start?
at the choke price (no one wants to buy there)
Where does demand end?
at the give away point
Where does MR end?
at exactly half the distance to the give away point
Relationship between slope of demand curve and MR?
MR is twice as steep as demand curve ( MR will lie below demand curve)
How to find profit maximizing point?
where MR and MC cross, go up to demand curve, at that point find the price
Profit = quantity ( profit maximixing point - MC)
Does a monopoly have a supply curve?
since monopoly is the price maker, the supply relationship does not exist
How to get ride of DWL?
charging different consumers different prices for the same good or service when there are no price differences
Degrees of Price Discrimination
1st Degree (Perfect)
1st Degree (perfect) Price Discrimination
each customer is charged the max they are willing to pay
ex) buying a car, eBay
What is the consumer surplus in 1st Degree PD?
no consumer surplus; no loss of efficiency so technically no problem with monoply
2nd Degree Price Discrimination
consumers charged different prices based on characteristics of the purchased good
ex) last minutes hotel rooms, bundling of goods
3rd Degree Price Discrimination
consumers charged different prices based on the characteristics of the consumer of location
ex) senior and student discounts, theater matinee showing
What does price discrimination do?
creates different markets
What is the only way 2nd Degree PD will work?
as long as no one form the lower price group doesn't turn around and sell to the higher group
aims to regulate and prevent anti competitive pricing; based on Sherman Act (industries shouldnt be allowed to limit trade)
Game theory is an economic framework that does what?
describes optimal actions in such setting
the study of economic interactions
comprise a complete plan describing how a player will act
represents the pay-offs for each actions players can take
Simontaneous move games
players pick their actions at the same time and dont know how their opponet will act
strategy that gives a player the highest pay-off, taking the rival's strategy as given
is one best response to every possible strategy of the other players
strategy combination where each strategy is a best response to the strategies of others
A well defined game is compromised of what?
Players, strategies, and pay-offs
In order to know what strategy a rational person should choose in a game, what need to be known?
what the pay-offs are
What is created when each player has a single dominant strategy?
Dominate Strategy Equilibrium (DSE)
How do you find Nash Equilibrium?
find each player's best response strategies and then identify pairs of strategies that coincide
Extensive form games do what?
Specifies thew order of play
When the players would both benefit from picking the non-dominate strategy but they dont trust each other to pick it is called?
What does repetition create?
accountability in choices
What is backward induction?
the procedure of solving an extensive-form game by first considering the last mover's decision in order to deduce the decisions of all previous movers
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