SL Economics - Unit 2

Where buyers and sellers carry out an independent exchange where no one individual has market power

Goods are tangible. Services are not tangible

Quantities consumer is willing/able to buy at different prices

higher price = lower demand (etc)

Aggregate = whole economy. Market = 1 industry

Income (normal goods↑↑/inferior goods↑↓), preferences and tastes↑↑, price of substitute goods↑↑, price of complementary goods↑↓, population↑↑

Increase quantity demand is a movement along demand curve (has to do with price). Increase demand is a shift.

Quantity producer willing/able to supply at different prices

Increase price = increase supply

Prices of related goods (joint supply↑↑/competitive supply↑↓), government intervention (tax↑↓/subsidy↑↑), cost of resource prices ↑↓, changes in technology↑↑, price of complementary goods↑↑, producer price expectations↑↓, number of suppliers↑↑, unpredictable events↑↓

The intersection between demand and supply

QD > QS. P > Pe. Price often drops with surplus

QD < QS. P < Pe. Price often increase with shortage

Measures how much QD responds to change in price

Demand is highly responsive to change in price (PED > 1)

Demand not very responsive to change in price (PED < 1)

| (Qf-Qi / Qi) / (Pf-Pi / Pi) | or | %ΔQD / %ΔP|

Number of substitutes, closeness of substitutes, necessities vs luxuries, length of time, proportion of income spent

TR = QS x QD

How much demand responds to change in income

(Df-Di / Di) / (Yf-Yi / Yi) or | %ΔQD / %ΔY|

Demand for normal good

Demand for inferior good

Income elastic demand (necessities)

income inelastic demand (luxuries)

As you get rich, changes in income don’t affect you as much. Graph looks like a spiral

How much quantity supplied responds to change in price

Supply is highly responsive to change in price (PES > 1)

Supply is not very responsive to change in price (PES < 1)

(Qf-Qi / Qi) / (Pf-Pi / Pi) or or %ΔQD / %ΔP

Length of time↑↑, mobility of factors of production ↑↑, spare capacity of firms↑↑, Access to inventory ↑↑, rate at which costs increase, ↑↓

Same as indirect tax

Resources not owned by anyone. Rivalrous (If I take some, less for you) and non-excludable. Examples: air, river, forest

Herders share field for cattle. As herd grows, grass decreases. Eventually there is no more grass.

Cost to producers of producing goods.

Marginal private cost (MPC): cost to private firm/producers

Marginal social cost (MSC): cost to society

Benefit to consumers for consuming goods

Marginal private benefit (MPB): benefits go to private individuals

Marginal societal benefit (MSB): benefits for society

Sum of consumer and consumer surplus

When actions of consumers/producers causes positive/negative side effects to third parties

Positive production externality: external benefit created by producers (research, new tech)

Positive consumption externality: external benefits created by consumers (education)

Negative production externality: external costs created by producers (pollution)

Negative consumption externality: external costs created by consumers (smoking)

Tax per unit of carbon emissions of fossil fuels

Permits to pollute issued by gov. which can be bought and traded

Solution to common pool resources where consumers choose to use sustainably

Overallocation/provision: QS > QD

Under-allocation/provision: QS > QD

Not always bad as it signals areas to be corrected

Indirect taxes, carbon taxes, tradable permits, gov. legislation/regulation, education and awareness creation, collective self-governance

• Can internalize externalities where costs are covered by producers and consumers

  • Taxation on emission = less pollution/cost

• May be impractical (calculating amount of emission is hard)

• Technical limitations

• Easier to implement

• Can avoid technical difficulties

• Highly effective

• More costly as no gov. revenue

• Can still face technical difficulties

• Cost involving monitoring regulations

• Sustainability without private or government ownership

• Unlikely

• Much communication needed

• Part of “natural” free market system

• May not be effective

• Difficult to measure

• External benefits created by producers

• MSC < MPC

• MPC – MSC = external benefit

• Positive production externality

• Direct government provision to producers to continue to continue to produce goods/services

• Can be capital or resources

• Positive production externality

• Subsidy to a firm per unit of the good provided = external benefit

• External benefits created by consumers

• Often caused by consumption of merit goods

• MSB > MPB

• MSB –MPB = external benefit

• Positive consumption externality

• Regulations to promote greater consumption of goods with positive externalities

• Influencing consumer taste and preference to directly influence consumption choices (increase the demand)

Is imposed on one person or group (like manufacturers), then shifted to a different payer, usually the consumer. (Taxes are put on goods, not consumers)

Excise taxes, Specific taxes, Ad Valorem taxes, General sales taxes

Are imposed on a particular goods and services

A fixed amount of tax per unit of goods/service sold

A fixed % of the price of the good/service (price up → tax up)

(Paid to the government by taxpayers. Suppliers →gov) income tax, business tax, property tax

reduces consumer spending on taxed goods (QD decreases), signal producers to produce less (QS decreases)

Economy with a high degree of allocative efficiency → allocative efficiency goes down, welfare loss goes up. Economy with a low degree of allocative efficiency → allocative efficiency goes up (potentially)

Indirect taxes → source of gov revenue. Indirect taxes are a method to discourage consumption of demerit goods. Indirect taxes can be used to redistribute income (by taking luxury goods) Indirect taxes are a method to improve the allocation of resources

A gov setting a legal maximum price for a good. These are usually set to make certain goods more affordable to people on low incomes. Price ceiling must be below equilibrium price. AFFORDABILITY IS IMPORTANT. Creates a shortage.

Non-price rationing (distribution of goods determined not solely by price). Underground (parallel) markets (black market) (unrecorded transaction involving markup on goods with price ceiling). Under-allocation of resources (allocative inefficiency), creates shortage. Negative welfare impacts (due to disequilibrium, max social surplus not reached; there is welfare loss)

price floor

Possible consequences of price floor

A payment made to the firm by the gov (opposite of tax), to lower production cost. Right supply shift.