Questions about cause and effect

They are objective and can be tested by looking at evidence

They are subjective statements that carry value judgments

ex= pollution is most serious economic problem

unemployment is worse than inflation

Characteristics of a Perfectly Competitive Market

Price-taker = all firms sell the exact same product and therefore have to take the price that the market has set

Buyers know the market price

If a firm raised price above the market price, it would not be able to make any sales

Transaction costs = the expenses of finding a trading partner and making a trade for a good other than the good or service are low

Since transaction costs are low, it is easy for a consumer to purchase goods from a rival firm because buyers and sellers don't have to spend time finding each other to make a trade

Raise price= nobody would buy from them

No incentive to lower price because the demand curve is horizontal at market price, so there the firm can sell as much as it wants at market price

Agricultural and other commodity markets, stock exchanges, retail and wholesale markets

Perfect competition also has many ideal properties that economists use to be the ideal comparison

Increasing Returns to Scale (aka Economies of scale) means that

(Graphically)

You can look at a quantity - x, total cost- y graph and see a curve that

it is cheaper to be bigger

looks like the square root function. As quantiy increases total cost increases at a decreasing rate

Or as quantity increases, Average Total Cost decreases

Factory can get a large amount of items cheaper if they buy in bulk

As they get bigger, factories can specialize people more

make ppl do what they are trained to do

Increasing Returns to Scale

(equation-based)

If you double the inputs, you get more than double the output

Decreasing REturns to Scale

total cost (y) vs quantity (x)

It's more expensive to be bigger

total cost increases at exponential rate compared to quantity

And average total cost increases as quantity decreases

Double all inputs and get less than double output

because less efficient

(or if want to double outpur, need to put more than double input into it)

coodination problems, manegerial problems, unorganized, too big and inefficient

Constant Returns to Scale

(graphically)

Look at total cost (y) vs quantity (x-axis)

As quantity increases, the total cost increases at the same rate

total cost is linear and proportional to quantity

And Average Total Cost is constant with relations to quantity

Conditions of Perfect Competition

Effects of Perfect Competition

Conditions = large number of buyers and sellers

- all firms produce identical products

-all market participants have full information about price and product characteristics, so transaction costs are negligible

-easy entry and exit

Effects = Firms are price takers, and firms cannot influence market price

PED = dQ/dp * p/Q

> 1 = luxury good

< 1 = necessity good (b/c not many substitutes)

dQ/dI * I/Q

If income elasticity of demand is positive, the good is a normal good

if income elasticity of demand is negative, the good is an inferior good

dQx/dPy * Py/Qx

change in the quantity of x divided by change in the price of y * price of y divided by quantity of x

If Cross price elasticity of demand is positive, the two goods are substitutes

Price Ceilings and Consumer Welfare

Where are price ceilings in realtion to the equilibrium?

What does government, if anything, in result of price ceilings?

Price ceilings are actually below equilibrium even though they sound like they should not be

Ceilings do the opposite- instead of top, go to bottom

With price ceilings, what happens is that prices are actually cheaper than they were before, so the demand for them increases

However, suppliers cannot supply enough at the cheaper ceiling price to satisfy customers, so there is a shortage

The government does nothing to reduce the shortage, so you don't need to account for government expenditure when caculating Deadweight Loss

Price Floors and Consumer Welfare

Where is a price floor in relation to equilibrium ?

What does the government do as a result of a price floor?

A price floor is actually above equilibrium (opposite of what it sounds like)

A price floor raises the price of a good, so the consumers demand less of it

This also means that since the suppliers are not selling the good enough, there is a surplus

The government resolves teh surplus by purchasing all the surplus, and that's the area of:

(Qs - Qd) price ceiling price