EC 205 Exam 3
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239 Terms
what is economic efficiency in a market context?
an outcome is economically efficient if it yields the largest possible economic surplus
economic efficiency assumes trade represents…
preferences and leads to higher utility
what is the formula for economic surplus of a single transcation
economic surplus = marginal benefit (MB) - marginal cost (MC)
consumer surplus
the difference between what a consumer is willing to pay (MB) and the price they actually pay
producer surplus
the difference between the price a seller receives and their marginal cost of production
what is deadweight loss
the reduction in total economic surplus that occurs when the market is not at the efficient equilibrium (Q*)
what does deadweight loss represent
it represents “missing” gains from trade
what are the consequences (4) of a price floor that is set above equilibrium
creates a surplus
reduces quantity traded to Qd
creates deadweight loss
usually reduces consumer surplus and MIGHT increase producer surplus for some
surplus
excess supply
what is a price ceiling that is set below equilibrium
a law that keeps a price from rising above a maximum level
what does a price ceiling set below equilibrium create
it creates a shortage, reduces quantity traded, and results in deadweight loss
what is a tariff
a tax on imported goods that raises the domestic price to world price + tariff
how does a tariff affect the domestic market
it reduces imports, increases domestic production, generates government revenue, but it creates a deadweight loss
what is Autarky
a state of “no international trade” where the domestic market must rely solely on its own supply and demand to find equilibrium
when should a country import a good
when the foreign price + trade costs < domestic price
what are the effects (4) of exports on the domestic market
domestic price rises to the world price
domestic producers gain significant surplus
domestic consumers lose some surplus
overal economic surplus increases
name the four categories of goods based on rivalry and excludability
private goods: rival & excludable
public goods: non-rival & non-excludable
common resources: rival & non-excludable
club goods: non-rival & excludable
what is a negative externality
when the social cost of production is greater than the private cost. the market tends to overproduce these goods because participants dont pay for extrnal harm
what is positive externality
when the social benefit is greater than the private benefit. the market tends to under-produce these goods because participants dont capture the full value of the benefit
what is the tragedy of the commons
a market failure associated with common resources. because they are non-excludable but rival, rational individuals tend to “use them up” or deplete them
what is positive analysis
an object analysis that desribes or predicts what will happen as a result of a policy
what is normative analysis
an analysis that evaluates what should happen based on value judgements
what question does positive analysis answer
“what will happen?”
what question does normative analysis answer
“what should happen?”
what is economic efficiency
a situation that maximizes total economic surplus
what is economic surplus
the total benefits minus total cost
total costs
consumer surplus + producer surplus
what is equity
the fairness of how economic benefits are distributed
how do you calculate economic surplus for a transaction
marginal benefit - marginal cost
what does the demand curve represent
marginal benefit
what does the supply curve represent
marginal cost
where is total consumer surplus on a graph
area below the demand curve and above the price
where is total producer surplus on a graph
area above the supply curve and below the price
what are gains from tarde
the benefits both buyers and sellers receive from voluntary exchange
what is the efficient quantity
the quantity where marginal benefit equals marginal cost
what rule determines the efficient quantity
the rational rule for markets: produce until marginal benefit - marginal cost
what is efficient allocation
goods fo to those who value them most (highest willingness to pay)
what is efficient production
goods are produced at the lowest possible cost
what is market failure
when markets do not produce efficient outcomes
what happens when there is underproduction
deadweight occurs because beneficial trades dont happen
what happens when there is overproduction
deadweight loss occurs because costs exceed benefits for extra units
name the 5 sources of market failure
market power
externalities
private information
irrational behavior
government intervention
what are externalities
side effects of economic activity that affect third parties
what is government failure
when government actions make outcomes worse instead of better
why dont efficient outcomes make everyone happy
because some people gain while others lose
what is one argument in favor of efficiency
it maximizes the size of the economic “pie”
what is a key criticism of efficiency
it ignores fairness and distribution (equity)
why is willingness to pay imperfect
it reflects both value and ability to pay (income)
what is the “invisible hand”
the idea that self-interested behavior leads to efficient market outcomes
what does voluntary exchange guarntee
both buyer and seller expect to benefit
what is a soda tax designed to do
increase prices of sugary drinks to reduce consumption
what happens to quantity when a tax is imposed
quantity demanded and supplied both decrease
why do buyers pay more and sellers receive less after a tax
because the government takes a portion (the tax), creating a price gap
what curve shifts when a tax is placed on sellers
the supply curve shifts left (or up)
why does the supply curve shift with a tax on sellers
the tax increases marginal cost
what happens to price and quantity after a tax on sellers
buys pay more, sellers receive less, and quantity decreases
what curve shifts when a tax is placed on buyers
the demand curve shifts left (or down)
why does the demand shift with a tax on buyers
the tax reduces marginal benefit
what happens to price and quantity afte a tax on buyers
higher buyer price, lower seller price, lower quantity
what is statutory burden
who the law says must pay the tax
what is economic burden
who actually nears the cost through higher/lower prices
does statutory burden affect economic outcomes
no, the outcome is the same whether buyers or sellers are taxed
what is a tax incidence
the division of the tax burden between buyers and sellers
who bears more tax burden when demand is inelastic
buyer
who bears more tax burden when supply is inelastic
sellers
general rule for tax burden
the less elastic side if the market bears more of the burden
what are the 4 steps for tax analysis
identify which curve shifts
determine direction of shift
compare old vs new equilibrium
use elasticity to determine burden
what is subsidy
a givernment payment for engaging in an activity
what happens to quantity with a subsidy
quanttiy increases
how di subsidies affect prices
buyer pay less, seller receive more
who benefits more from a subsidy
the less elastic side of the market
what is a price ceiling
a maximum legal price
when is a price ceiling binding
when set below equilibrium price
what does a binding price ceiling cause
shortage
give examples of consequences of proce ceilings
shortage, black markets, lower qualit, long wait times
what is a price floor
a minimum legal price
when is a price floor binding
when set above equilibrium price
what dies a binding price floor cause
surplus
example of a price floor
minimum wage
what is a quota
a maximum quantity that can be sold
what effect do quotas have on price
prices rise
what efect do quotas have in quantity
quantity decreases
who benefits from quotas
sellers (higher prices)
do taxes reduce market activity
yes, less buying and selling
does it matter who the tax is assigned to
no, the economic outcome is the same
what determines who really pays a tax
elasticity of supply and demand
what determines who benefits from subsidies
elasticity of supply and demand
what is an externality
a side of action that affects bystanders whose interests arent fully considered
what is a negative externality
a side effect that harms others
what is a positive externality
a side effect that benefits others
why do externalities cause market failure
because decision-makers ignore costs or benefits to others, leading to inefficient outcomes
what is marginal private cost
the cost a producer directly pays to produce one more unit
what is marginal external cost
the cost imposed on bystanders from producing one more unit
what is marginal social cost
marginal private cost + marginal external cost
what is marginal private benefit
the benefit a consumer personally receives from one more unit
what is marginal external benefit
the benefit to bystander from one more unit
what is marginal social benefit
marginal private benefit + marginal external benefit
what is the socially optimal quantity
the quantity where marginal social benefit = marginal social cost
what is the rational rule for society
produce more as long as marginal social benefit is greater than or equal to marginal social cost, stop when they are equal
how do negative externalities affect production
they lead to overproduction