Thais Hernandez- ECO 111 Written Assignment 2

Written Assignment 2 1. Name two types of market failure. Explain why each may cause market outcomes to be inefficient. Market power and externalities are two types of market failure. Market power can cause inefficient outcomes because one company can influence prices and quantities demanded outside of what they could be under perfect competition and keeps total surplus from reaching its maximum potential. Since externalities are side effects and they are not considered by either producers or consumers, the market cannot reach maximum surplus. 2. What happens to consumer and producer surplus when the sale of a good is taxed? How does the change in consumer and producer surplus compare to the tax revenue? Consumer and producer surplus both decline when a good is taxed. It will shift the supply curve to the left and creates a deadweight loss because buyers and sellers cannot achieve the full gains from trade because they are forced to pay more for the same product because of taxes. Tax revenue increases with the size of the tax but if taxes were to rise, it reduces the size of the market and tax revenue begins to decline. 3. How do the elasticities of supply and demand affect the deadweight loss of a tax? Why does this effect occur? Deadweight loss is a term used to describe the decrease in total surplus when there is a market distortion, such as a policy or tax. A high elasticity decreases the quantity demanded of a good or service. Therefore, the more elastic a good/service is the greater the deadweight loss of tax is, this happens because tax changes consumers and producers behavior. Consumers buy less because taxes have increased the price of a good and producers make less profit, so they produce less. Because of this the market shrinks below its optimum potential. 4. What does the domestic price that prevails without international trade tell us about a nations comparative advantage? The world price is defined as the price of a good that prevails in the world market for that good. If a nations prevailing price is above the world price: the country does NOT have the comparative advantage and should trade with another nation for that product. On the other hand, if the price is below the world price: the nation has the comparative advantage and should export that product to other countrys/nations.

Thais Hernandez- ECO 111 Written Assignment 2

5. What is the difference between the unilateral and multilateral approaches to achieving free trade? Give an example of each. A country can take on two different approaches to achieving free trade, 1.) unilateral approach: when a country removes trade restrictions on its own accord and 2.) the multilateral approach: in which a country bargains with others to reduce trade restrictions. An example of unilateral approach is British trade policy in the 1800s , and example of the multilateral approach is the Doha Round.

6. Why do economists use real GDP rather than nominal GDP to gauge economic well-being? Define the GDP deflator. Economist use real GDP to measure the amount produced that is NOT affected by price changes- it only reflects changes of the amounts being produced. Nomiinal GDP on the other hand uses prices to place an actual value on the economys production of goods and services. If economist used Nominal GDP, they wouldnt be able to tell if an increase or decrease is caused by increased or decreased production or higher/lower prices. The GDP Deflator is defined by Mankiw as: a measure of the price level calculated as the ratio of nominal GDP to real GDP times 100. It is calculated: Nominal GDP/Real GDP X 100. 7. What is the CPI? Which do you think has a greater effect on the consumer price index: a 10 percent increase in the price of chicken, or a 10 percent increase in the price of caviar? Why? The CPI is the consumer price index and it measures the overall cost of the goods/services purchased by consumers. A 10 increase in the price of chicken would have a greater effect on the CPI rather than the same increase in caviar because caviar is a luxury food item and chicken is considered more important to providing daily nutritional needs than caviar by the average consumer. 8. Describe the three factors that make the consumer price index an imperfect measure of the cost of living. Then explain how the GDP deflator differs from the CPI. The three factors that make the CPI an imperfect measure of the cost of living are: 1.) Substitution bias the CPI cant calculate how consumers change their purchasing behavior when cheaper substitutes become available for a particular good/service. 2.) Introduction of new goods- since the CPI is a fixed basket it does not support calculating the introduction of new consumer choices. New choices, new producer competition reduces the cost of keeping the same standard of living with more options.

Thais Hernandez- ECO 111 Written Assignment 2

3.) Unmeasured quality change- The quality of goods change over time, even though the BLS adjusts the price of a good to account for the change in quality, quality is hard to measure. The GDP deflator only includes domestically produced goods/services and reflects what is actually being produced at any given time and the CPI includes both domestic and imported produced goods and falls into a FIXED basket. 9. List and describe the determinants of productivity. 1.) Physical Capital: The workforce needs the right tools to produce more effectively. The more tools/technology available to workers, the more productivity. 2.) Human Capital: The workforce needs to be trained and educated in order to be productive. The proper education and hands on training needs to be provided in order to increase efficiency and productivity. 3.) Natural Resources- These are scarce resources, which include Oil, a form of non-renewable resources or trees, which are considered renewable. Although they can be important (depending on other factors of productivity in the economy) having natural resources really does not define the success of an economy because a nation can always trade for the natural resources that they need if they dont have the comparative advantage in harvesting it. 4.) Technological Knowledge- Understanding what is the best way to produce a good. This is similar to investing in the workforce (Human Capital) but there is a major different- technological knowledge refers to how a society understands the way the world works and human capital is understood to be the understanding of the labor force. I would personally say this sounds similar to Street Smarts aka, knowing the way the world really works and book smart. 10. Explain how a higher savings rate can lead to a higher standard of living. What might deter a policymaker from trying to raise the rate of saving? A higher savings rate means fewer resources are available to be used for consumption and more is available to produce capital goods, thus the GDP would increase. Policy makers might be deterred from raising the rate of savings because it would decrease consumers consumption and it can take a much longer time to achieve a higher standard of living. More savings means that banks could lend out more money for investments.

References Mankiw, N. G. (2008). Principals of Macroeconomics (6th ed.). Mason, OH: Cenage Learning.