ECON 200: Welfare Economics – Flashcards
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efficiency argument of resource distribution
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Society will be better off if we are able to produce more goods and services. The more stuff we have, all else remaining equal, the better off we are. Efficiency is associated with the "size of the pie".
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equity argument of resource distribution
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There is a general sense that some ways of distributing the goods across members of society are more fair than others. Equity asks the question "what is fair?"
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Welfare economics can create inefficiencies
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Example: the government puts a 75% tax on those making 200K or more a year. The tax money will go to support individuals making less than 14K a year. This is done to improve society. However, many making more than 200K will reduce their work effort in order to avoid the tax. This means that the tax leads to people producing less overall.
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How do we quantify the inefficiencies policies designed to create equity?
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We compare the benefits to consumers, benefits to producers, and dead weight loss.
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Willingness to Pay
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A buyer's willingness to pay for a good is the maximum amount the buyer will pay for the good. It measures how much the buyer values this particular good. individual buyers' willingness to pay drives the demand curve when you combine them all together.
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Consumer Surplus
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Consumer surplus is the amount a buyer is willing to pay minus the price that the buyer actually pays.
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How do we calculate consumer surplus?
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Consumer Surplus = Willingness to Pay minus Price
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How do we identify Consumer Surplus on a graph?
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Consumer Surplus is the area under the demand curve but above the actual price paid from Quantity Zero to Quantity Q. At equilibrium, CS looks like a triangle. It looks like a weird polygon when there is a shortage or surplus.
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What do we mean when we say marginal buyer
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At any given price, the demand curve shows the willingness to pay of the marginal buyer. That is, the price at any given point on the demand curve shows the maximum price for that buyer. The marginal buyer is the person who would leave the market first if they price were any higher.
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Cost
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is the value of everything a seller must give up to produce a good (including opportunity cost).
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Seller will only produce and sell the good if...
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the price equals or exceeds his or her cost. The cost is a measure of willingness to sell.
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Producer Surplus
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is the amount a seller is paid for a good minus the seller's cost.
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How do we calculate Producer Surplus
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Producer Surplus = Price minus cost
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How do we find producer surplus on a graph?
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Producer surplus is the area above the supply curve, under the price from quantity zero to quantity Q. When sellers receive the equilibrium price, the producer surplus looks like a triangle. When there is a shortage or surplus, it looks like a strange polygon
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Total Surplus equals
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Consumer Surplus plus Producer Surplus. Total surplus measure the total gains from a trade in a market
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In the efficiency standard, what do we use to measure well-being?
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Total surplus. A particular outcome is said to be efficient if it maximizes total surplus
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market failures
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refer to the inability of unregulated markets to allocate resource efficiently. Rather than producing the equilibrium amount, the "wrong" amount of a good is produced at a non-ideal price.
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Total surplus measures
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efficiency. it does NOT measure equity.
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When there is efficiency, the following conditions are true:
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1. raising or lowering the quantity of a good would not increase total surplus 2. the goods are being produced by the producers at the lowest cost 3. The goods are being consumed by the buyers who value them most highly.
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Adam Smith
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British economist who believed that limited government enhances society and that economic well-being should be driven by the "invisible hand" ie the self-interest of producers.
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market power
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is the ability of an individual, group of individuals or a firm to influence the price of a good.
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Monopolies are...
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single sellers and so have all the market power.
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Oligopolies are
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a small group of sellers that act together in order to gain market power. Think OPEC
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Externalities
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are when market activity produces side effects - cost or benefits who are not buyers or sellers. EXAMPLE: Pollution (negative externality), vaccines (positive externality)
