ECON 351 KEY CONCEPTS (Midterm 2)

What happens under a binding price ceiling?

Price falls, quantity demanded rises, quantity supplied falls, and a shortage occurs.

What quantity is exchanged under a binding price ceiling?

Quantity supplied, because sellers offer fewer units than consumers demand.

What are unintended consequences of a price ceiling?

Shortages, waiting lists, discrimination, reduced quality, black markets, and lower future supply.

What happens under a binding price floor?

Price rises, quantity supplied rises, quantity demanded falls, and a surplus occurs.

What quantity is exchanged under a binding price floor?

Quantity demanded, because buyers purchase fewer units than sellers offer.

How is a minimum wage a price floor?

It establishes a minimum price for labor and can create unemployment in a competitive labor market.

Who bears more of a tax?

The more inelastic side of the market because it has fewer alternatives.

Who captures more of a subsidy?

The more inelastic side of the market.

Does the legal incidence of a tax determine the economic burden?

No; the economic burden depends on the relative elasticities of supply and demand.

Why does a negative externality create market failure?

The market ignores external costs, so the perceived cost is too low and too much is produced.

Negative externality: market quantity versus socially optimal quantity

Qmarket is greater than Qsocially optimal.

How can the government correct a negative externality?

Impose a tax equal to MEC at the socially optimal quantity.

Why does a positive externality create market failure?

The market ignores external benefits, so the perceived benefit is too low and too little is produced.

Positive externality: market quantity versus socially optimal quantity

Qmarket is less than Qsocially optimal.

How can the government correct a positive externality?

Provide a subsidy equal to MEB at the socially optimal quantity.

Emissions fee versus emissions standard

A fee creates a price for pollution and allows flexibility; a standard directly limits pollution but may not minimize total cost.

Why can cap-and-trade reduce pollution efficiently?

Firms with low abatement costs reduce more pollution and sell permits to firms with high abatement costs.

What causes the public-good market failure?

Non-excludability allows people to benefit without paying, so private firms underprovide the good.

What causes the tragedy of the commons?

Non-excludability combined with rivalry causes people to overuse a shared resource.

Why is MR less than price for a monopolist?

Selling another unit requires lowering the price on the new unit and all units already being sold.

What is special about MR for linear demand?

MR has the same vertical intercept as demand but twice the slope.

How does a monopolist find its profit-maximizing price and quantity?

Set MR equal to MC, solve for quantity, and plug that quantity into demand to find price.

Where is total revenue maximized?

Where MR equals zero and demand is unit elastic.

Why will a monopolist not operate on the inelastic portion of demand?

MR is negative, so reducing output would increase revenue and decrease cost.

Monopoly compared with perfect competition

Monopoly charges a higher price, produces less, transfers surplus to the producer, and creates DWL.

What does a high Lerner Index indicate?

A large markup over marginal cost and a high degree of market power.

How does elasticity affect monopoly markup?

More inelastic demand allows a larger markup because consumers have fewer substitutes.

What creates a natural monopoly?

High fixed costs, low marginal costs, and decreasing average costs over the relevant output range.

What is the natural-monopoly regulatory dilemma?

P = MC is efficient, but it may cause a loss because MC is less than AC.

What is average-cost regulation?

The government sets P = AC, allowing the firm to break even while still producing more than an unregulated monopoly.

Why is marginal expenditure greater than wage for a monopsonist?

Hiring another worker requires raising the wage for the additional worker and existing workers.

How can a minimum wage affect a monopsony?

A moderate minimum wage can increase wages and employment, but one set too high can create unemployment.

What conditions are required for price discrimination?

Market power, knowledge of willingness to pay, and the ability to prevent resale.

First-degree price discrimination

Each consumer pays their maximum willingness to pay; the firm captures all surplus and DWL equals zero.

Second-degree price discrimination

Prices depend on quantity purchased, and consumers self-select into pricing tiers. Third-degree price discrimination

Which group pays more under third-degree price discrimination?

The group with more inelastic demand.

Intertemporal pricing versus peak-load pricing

Intertemporal pricing separates consumers by willingness to pay over time; peak-load pricing charges more when high demand or capacity constraints raise MC.

How does an ideal two-part tariff work?

Set the usage fee equal to MC and the access fee equal to the resulting consumer surplus.

When is bundling especially profitable?

When consumers’ valuations for the products are negatively correlated.

What is tying?

Requiring or encouraging buyers of a primary product to purchase a complementary product from the same firm.

Why does a monopolistically competitive firm face downward-sloping demand?

Its differentiated product gives the firm some control over price.

What happens when monopolistically competitive firms earn positive economic profit?

New firms enter, reducing each existing firm’s demand until economic profit reaches zero.

What happens when monopolistically competitive firms experience losses?

Firms exit, increasing demand for the remaining firms until economic profit reaches zero.

What characterizes long-run monopolistic competition?

MR = MC, P = AC, economic profit equals zero, P is greater than MC, and firms have excess capacity.

Why is monopolistic competition not allocatively efficient?

P is greater than MC.

Why is monopolistic competition not productively efficient?

Firms do not produce at the minimum point of average cost.

What is a benefit of monopolistic competition?

Product variety, innovation, and choices that match different consumer preferences.