ECON Final Exam

a type of market failure that occurs when a person engages in an activity that influences the well being of a bystander
1) negative: impact on bystander is adverse
2) positive: impact on bystander is beneficial

private cost: the direct cost to sellers (also the supply curve)
external cost: the value of the negative impact on bystanders
social cost = private + external cost

private value: the direct value to buyers (also the demand curve)
external benefit: the value of the positive impact on bystanders
social value = private value + external benefit

1) command and control policies: regulate behavior directly by requiring/forbiding certain behaviors (ex: decide a maximum level of pollution)
2) market based policies: private decision makers choose to solve problem on their own (ex: tradeable pollution permits)
3) corrective taxes (Pigovian taxes): induce private decision makers to take into account social costs of a negative externality
-should equal external costs
-raise revenue for the government
-enhance economic efficiency

if private parties can bargain without cost over allocation of resources, they can solve externality problems on their own
-everyone is better off
-the outcome is efficient

people can be prevented from using a good
-excludable ex: fish in a private pond, tacos
-non-excludable ex: fish in the ocean, highway

one person's use of a unit of a good reduces another person's ability to use it
-rival ex: fish tacos, congested road
-non-rival: uncongested road, radio

1) private goods: excludable and rival in consumption (pizza)
2) public goods: not excludable and not rival in consumption (national defense)
3) common resources: not excludable and rival in consumption (deer in the forest)
4) club goods: excludable and not rival in consumption (cable TV)

person who receives the benefit of a good but avoids paying for it
-public goods are non excludable, so free riders arise
-prevents private market from supplying the goods
-market failure

parable that shows why common resources are used more than desirable
-ex) sheep on common land
-the private incentives (using land for free) outweigh the social incentive (using it carefully)

possible solutions:
-regulate the number of sheep per family
-internalize the externality by taxing sheep
-auction off a limited number of sheep grazing permits
-make land private property: divide land among town families

market fails to allocate resources efficiently:
-because property rights are not well established
-an item of value does not have owner with legal right to control it

government can solve it:
-help define property rights and unleash market forces
-regulate private behavior
-use tax revenue to supply a good that the market fails to supply

State and Local Gov: Property Taxes

Federal Gov: Income Taxes

marginal tax rate: change in tax payable divided by change in taxable income

average tax rate: total taxes paid divided by total income

same amount of tax for every person
-most efficient tax possible
-does not distort incentive (no DWL)
-minimal administrative burdern
-not equitable

policymakers have the role of balaning equity and efficiency in regards to taxation
-they often conflict with each other as equity is often judged based on progressivity
-economics can help by avoiding policies that sacrifice efficiency without enhancing equity

progressive tax: high-income taxpayers pay a larger fraction of their income than low-income taxpayers

regressive tax: high-income taxpayers pay a smaller fraction of their income than low-income taxpayers

proportional tax: high-income and low-income taxpayers pay the same fraction of their income

people should pay taxes based on the benefits they receive from government services
-tries to make public goods similar to private goods
-ex) wealthy citizens should pay higher taxes because they benefit more from public services (police, national defense, etc.)

taxes should be levied on a person based on how well that person can shoulder the burden
ex) a 10000 dollar tax bill is a bigger sacrifice for a poor person than a rich person - equal sacrifice should be made

vertical equity: taxpayers with a greater ability to pay taxes should pay larger amounts
-richer taxpayers should pay more than poorer tax payers

horizontal equity: taxpayers with similar abilities to pay taxes should pay the same amount
-difficult to agree on what factors would determine ability to pay outside of income

DWL: the fall in taxpayers' well-being exceeds the revenue the government collects

tax payment itself: taxes distort decisions that people make

administrative burden: includes the time and money people spend to comply with tax laws

the limit on the consumption bundles that a consumer can afford

budget constraint shift:
-a fall in income shifts the budget constraint inward to left
-an increase in income shifts the budget constraint outward to right

budget constraint pivot:
-an increase in the price of one good pivots the budget constraint inward
-a decrease in the price of one good pivots the budget constraint outward

curve that shows consumption bundles that give the consumer the same level of satisfaction
-MRS: rate at which a consumer is willing to trade one good for another (slope)

the best possible combination of the two goods
-combo on the highest possible indiffernce curve on or below the budget constraint

optimum: MRS = relative price
-the best bundle of the two goods that the consumer can afford
-the point on the budget constraint that touches the highest possible indifference curve

price of good A falls

substitution effect: a fall in price of good A makes it less expensive relative to good B; buy greater amt of good A and less good B

income effect: a fall in price of good A boosts purchasing power of income overall; buy more good A and good B

net effect on good A is ambiguous
-income effect is greater if you purchase more of good B
-substitution effect is greater if you purchase less of good B

the demand curve shows the quantity demanded of a good for any given price
-a summary of the optimal decisions that arise from budget constraint and indifference curves
-reflects consumption decisions

Ex) 9 on notes for reference

giffen goods: a good for which an increase in price raises the quantity demanded
-inferior good
-income effect > substitution effect

labor supply: hours of labor supply increase with the wage

savings:
-SE > IE, decrease consumption when young and higher savings
-SE < IE, increase consumption when young and lower savings