Welfare Economics: Evaluating Market Efficiency and Market Failure

A set of flashcards covering the key concepts of welfare economics, market efficiency, market failure, and related definitions.

Positive Analysis

Describes what is happening, explaining why, or predicting what will happen.

Normative Analysis

Prescribes what should happen, which involves value judgments.

Economic Efficiency

An outcome is more economically efficient if it yields more economic surplus.

Consumer Surplus

The economic surplus you gain from buying something; calculated as marginal benefit minus price.

Producer Surplus

The economic surplus you gain from selling something; calculated as price minus marginal cost.

Voluntary Exchange

When buyers and sellers exchange money for goods only if they both want to, creating consumer and producer surplus.

Deadweight Loss

The loss of economic surplus when the allocation of resources is not efficient, leading to a reduction in total welfare.

Market Power

The ability of a firm or group to set prices above the competitive level, leading to reduced production.

Externalities

Side effects of an economic activity that affect third parties and are not reflected in market prices.

Irrationality (in economic decisions)

When individuals make choices that do not maximize their utility due to biases or errors in reasoning.

Economic Surplus

The sum of consumer surplus and producer surplus in a market.

Equity

A measure of fairness in the distribution of economic benefits.

Market Failure

When market forces lead to inefficient outcomes due to issues like market power, externalities, and information problems.

Capacity of Government Policies

The potential for government intervention to correct market failures but which can also lead to government failures.

Rational Rule for Buyers

Buy until the marginal benefit of the last unit equals the price of that unit.

Rational Rule for Sellers

Sell until the marginal cost of the last unit equals the price of that unit.