Unit 2 - Chapter Notes - Summary Principles of Microeconomics PDF

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Chapter 6 - Taxes and Subsidies ● Commodity taxes - taxes on goods ○ Include; fuel, liquor, and cigarettes ○ Following truths about commodity taxation ■ Who ultimately pays the tax does not depend on who writes the check to the government ■ Who ultimately pays the tax does depend on the relative elasticities of demand and supply ■ Commodity taxation raises revenue and creates deadweight loss ● Tax = price paid by buyers - price received by sellers ● Tax wedge ○ Whether buyers or sellers pay a tax is determined by the relative elasticities of demand and supply ○ When demand is more elastic than supply, demanders pay less of the tax than sellers ○ When supply is more elastic than demand, suppliers pay less of the tax than buyers ● Deadweight loss - is a loss of economic efficiency that can occur when equilibrium for a good or service is not achieved or is not achievable ● Broad-based taxes will tend to create less deadweight loss than more narrowly based taxes ● Even though taxes create a deadweight loss, they also pay for beneficial goods and services ● Subsidies - reverse tax ○ Instead of taking money away from consumers (or producers), the government gives money to consumers (or producers) ○ Facts about commodity subsidies ■ Who gets the subsidy does not depend on who gets the check from the government ■ Who benefits from a subsidy does depend on the relative elasticities of demand and supply ■ Subsidies must be paid for by taxpayers and they create inefficient increases in trade (deadweight loss) ○ Subsidy = price received by sellers - price paid by buyers ○ Sellers are receiving more than buyers are paying - who makes up the difference? Taxpayers Chapter 8 - Price Ceilings and Floors ● Price ceilings - maximum price allowed by law ○ Create 5 important effects ■ Shortages ● Hed below the market price ● Quantity demanded exceeds the quantity supplied ■ Reductions in product quality

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Demanders find that there is a shortage of goods - they cannot buy as much of the good as they would like ● Sellers have more customers than they have goods ■ Wasteful lines and other search costs ■ A loss of gains from trade ● Price controls also reduce the gains from trade ● Deadweight loss - total of lost consumer and producer surplus when not all mutually profitable gains from trade are exploited ● Price ceilings create a deadweight loss ■ A misallocation of resources Rent control - price ceiling on rental housing, such as apartments ○ Rent freeze - prohibits landlords from raising rents ○ Reduces housing quality ■ When the price of apartments is forced down, owners attempt to stave off losses by cutting their costs Price floors - minimum price allowed by law ○ Four important effects ■ Surpluses ● Quantity of labor supplied exceeds the quantity demanded ● Unemployment ■ Lost gains from trade ■ Wasteful increases in quality ■ A misallocation of resources

Chapter 9 - International Trade ● Analyzing trade with supply and demand ○ Protectionism - economic policy of restraining trade through quotas, tariffs, or other regulations that burden foreign producers but not domestic producers ○ Tariff - tax on imports ○ Trade quotas - restriction on the quantity of goods that can be imported ■ Imports greater than the quota amount are forbidden or heavily taxes ○ Tariff increases domestic production and reduces domestic consumption ○ Tariff or quota that restricts consumers from trading with foreign producers means that the market is not free ● Arguments against international trade ○ Trade reduces the number of jobs in the United States ○ It’s wrong to trade with countries that use child labor ■ Real cause is poverty and not trade ○ We need to keep certain industries at home for reasons of national security ○ We need to keep certain “key” industries at home because of beneficial spillovers onto other sectors of the economy ○ We can increase US well-being with strategic trade protectionism Chapter 10 - Externalities: When the price is not right ● Private cost - cost paid by the consumer or the producer

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External cost - cost paid by people other than the consumer or the producer trading in the market Social cost - cost to everyone: the private cost plus the external cost External costs, external benefits, and efficiency ○ Externalities - external costs or external benefits, that is, costs or benefits respectively, that fall on bystanders ○ Social surplus - consumer surplus plus producer surplus plus everyone else’s surplus ○ Efficient equilibrium - price and quantity that maximizes social surplus ○ External costs ■ Efficient quantity - quantity that maximizes social surplus ■ Pigouvian tax - tax on a good with external costs ○ External benefits ■ External benefit - benefit to people other than the consumers or the producers trading in the market ● Vaccines - when you are vaccinated, you will not spread viruses ■ Pigouvian subsidy - subsidy on a good with external benefits Private solutions to externality problems ○ Internalizing an externality - adjusting incentives so that decision makers take into account all the benefits and costs of their actions, private and social ○ Transaction costs - costs necessary to reach an agreement ○ Coase theorem - posits that if transaction costs are low and property rights are clearly defined, private bargains will ensure that the market equilibrium is efficient even when there are externalities Government solutions to externality problems ○ Command and control and tradable allowances for the activity in question ○ Command and control ■ When external costs are significant, we know that QMarket > QEfficient - best way to reduce the external cost of electricity generation is for the government to order firms to use less electricity ■ Many methods to achieve a goal and the government may not have enough information to choose the least costly method ○ Tradable allowances ■ Require that firms reduce pollutants by a specific quantity

Chapter 24 - Asymmetric Information: Moral Hazard and Adverse Selection ● Asymmetric information - when one party to an exchange has more or better information than the other party ● Principal-agent problem - how can a principal incentivize an agent to work in the principal’s interest even when the agent has information that the principal does not? ● Moral Hazard - when an agent tries to exploit an information advantage in a dishonest or undesirable way

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Taxi drivers who take longer routes to benefit themselves or dentists who recommend unnecessary services ○ Better informed buyers are one solution to asymmetric information problems ○ For major medical procedures - second opinions are usually the best Free rider - consumes but does not pay Adverse selection - occurs when an offer conveys negative information about the product being offered ○ Credible promise - one that the promisor has an incentive to keep Signaling as a response to asymmetric information ○ Signal - expensive action that is taken to reveal information...