ap economics: module 50 terms

total surplus

total net gain to consumers and producers from trading in a market

• = CS + PS

• there are gains from trade that exceed gains from self-sufficiency

• want to maximize this in an efficient market

what characterizes an efficient market?

a market that, once it produces its gains from trade, has no way of making someone better off without making someone else worse off

3 approaches to attempt to increase total surplus

1. reallocating consumption among consumers

2. reallocating sales among sellers

3. change quantity traded

*none of these approaches work! once a market is in equilibrium, there is no way to increase gains w/o decreasing total surplus

reallocation of consumption among consumers

total surplus decreases if goods are taken away from those who value it more and given to those who value it less

reallocation of sales among sellers

total surplus decreases if sales are reallocated, since it increases total cost

changing quantity traded

total surplus decreases if transactions are forced or prevented

t or f: once a market is in eq., you can’t increase gains w/o decreasing total surplus

t

4 functions of an efficient market

1. allocates consumption of a good to the buyers who value it most (highest WTP)

2. allocates sales of a good to sellers who value the right to sell it the most (lowest seller’s cost)

3. ensures that every consumer who makes a purchase values the good more than every seller who makes a sale (transactions are mutually beneficial)

4. ensures that every potential buyer who doesn’t make a purchase values the good less than every potential seller who doesn’t make a sale (no missed mutually beneficial transactions)

3 caveats to consider about markets

1. efficiency ≠ fairness/equity (often in conflict, there’s a trade-off)

2. markets can be inefficient and not maximize total surplus

3. even when total surplus is maximized (efficient market), this doesn’t mean this is the best outcome for individual buyers and sellers

   a. buyers will always want to pay a lower price

   b. sellers will always want to sell at a higher price

regressive tax

rises less than in proportion to income; people with higher income pay a smaller % of their income than people with lower income

proportional tax

rises in proportion to income; all taxpayers pay the same percentage of income

progressive tax

rises more than in proportion to income; those with higher incomes pay a larger percent of their income than those with lower income

• U.S. tax system

excise tax

tax on sales of a g/s; drives a wedge between price paid by consumers and price received by producers

• consumers pay more, producers receive less

• affects each group differently, but eq. outcome is the same regardless of who pays

  • on producers: they will increase S by wedge to receive more money → give tax to govt. and end up w/ original price

  • on consumers: they will decrease WTP by wedge, causing D to decrease

• leads to distorted incentives + missed mutually beneficial transactions

wedge

equal to the size of the excise tax

tax incidence

distribution of the tax burden

• depends on Es and Ed

when is an excise tax mainly paid by consumers?

demand is inelastic (low subs for consumers) and supply is elastic (many subs for producers)

• burden mainly falls on consumers

when is an excise tax mainly paid by producers?

demand is elastic (many subs for consumers) and supply is inelastic (low subs for producers)

• burden mainly falls on producers

revenue from an excise tax

area of rectangle with height = the tax wedge between supply and demand prices and width = quantity sold

costs of taxation

1. prevent mutually beneficial transactions from occuring

2. create inefficiency

deadweight loss from a tax

the value of forgone mutually beneficial transactions; inefficiency caused by an interference in a free market

• the decrease in total surplus resulting from the tax minus tax revenue generated

• triangle on graph (govt. revenue is the adjacent rectangle)

lump-sum tax

tax of a fixed amount paid by all taxpayers

• might be unfair, but increases efficiency (doesn’t distort incentives due to equality)

administrative costs

of a tax, the resources used by the govt. to collect the tax and by taxpayers to pay (or evade) the tax, over and above the amount collected

total inefficiency caused by a tax

deadweight loss + administrative costs

examples of interferences in a free market

price controls: ceilings and floors

quantity controls: tariffs and quotas

govt. policy: taxes and subsidies