Microeconomics: Market Efficiency, Government Intervention, Externalities, and Consumer Choice

Comprehensive practice flashcards reviewing allocation methods, efficiency, market failures, government price/quantity interventions, tax incidence, positive and negative externalities, and marginal utility theory.

Under the market price allocation method, which individuals receive a scarce resource?

The people who are willing to pay the market price.

What are the specific resource allocation methods identified in the notes?

Market price, command system, majority rule, contest, first come first served, sharing equally, lottery, personal characteristics, and force.

How is allocative efficiency distinguished from production efficiency?

Allocative efficiency occurs when the quantities of goods and services produced are those that people value most highly, whereas production efficiency occurs on the production possibilities frontier (PPF).

How is marginal cost defined and measured on the production possibilities frontier (PPF)?

The opportunity cost of producing one or more units, measured by the slope of the PPF.

How is consumer surplus calculated?

Marginal benefit from a good or service minus the price paid for it.

What is the relationship between the supply curve and marginal cost, and how is producer surplus defined?

The supply curve is the marginal cost curve ($S = MC$), and producer surplus is the price of a good minus the opportunity cost of producing it.

What constitutes total surplus and total net benefit in a market?

Total surplus is the sum of consumer surplus and producer surplus ($CS + PS$), and total net benefit is total benefit minus total cost ($TB - TC$).

What is deadweight loss (DWL)?

The decrease in total surplus that results from underproduction or overproduction.

How do taxes and subsidies cause market inefficiency?

Taxes increase prices paid by buyers and lower prices received by sellers (causing underproduction), whereas subsidies lower prices paid by buyers and increase prices received by sellers (causing overproduction).

What is the 'big trade off' in market economics?

The tradeoff between efficiency and fairness that recognizes the cost of making income transfers.

What are transactions costs?

The opportunity costs of making trades in a market.

What occurs when a rent ceiling is set above versus below the equilibrium rent of $550\,\text{dollars}$ a month?

If set above $550\,\text{dollars}$, nothing will change; if set below (such as at $400\,\text{dollars}$), it creates a shortage.

What two developments can occur when a rent ceiling creates a housing shortage?

A black market (an illegal market that operates alongside a government-regulated market) and search activity (time spent looking for someone with whom to do business).

Why is an unregulated housing market at equilibrium efficient compared to one with a rent ceiling?

At equilibrium, producer surplus is as large as possible. Under a rent ceiling, marginal benefit exceeds marginal cost ($MB > MC$), consumer surplus and producer surplus shrink, resources are lost to search activity, and deadweight loss is created.

In the fast food server labor market example with an equilibrium wage rate of $7\,\text{dollars}$ and equilibrium quantity of $6{,}000$ servers, what is the result of a minimum wage law set at $10\,\text{dollars}$?

Quantity demanded falls to $3{,}000$ servers while quantity supplied rises to $8{,}000$ servers, resulting in $5{,}000$ unemployed people.

What is a production quota, and what are its market effects in the dairy products example?

A government regulation placing an upper limit on the quantity that may be supplied. A quota set at $40\,\text{billion pounds per year}$ shrinks consumer surplus, causes deadweight loss, and makes the market inefficient and unfair.

What is tax incidence and what formula defines the tax wedge between buyers and sellers?

Tax incidence is the division of the burden of a tax between the buyer and seller, defined by $P_{\text{buyers}} - P_{\text{sellers}} = \text{tax}$.

What is the excess burden of a tax?

The deadweight loss (DWL) from a tax, representing the cost of the tax beyond the revenue received by the government.

How does price elasticity of supply and demand affect tax incidence and excess burden?

The more inelastic side bears a greater share of the tax burden (inelastic demand means buyers pay more; inelastic supply means sellers pay more). Lower elasticity results in a smaller excess burden, with no deadweight loss when demand is perfectly inelastic.

What is a subsidy?

A payment, tax credit, or voucher where buyers or sellers get paid for the purchase or sale of a good or service (the opposite of a tax).

What is marginal social cost ($MSC$) and what is its equation?

The marginal cost incurred by the entire society (by the producer and everyone else), calculated as $MSC = MC + MEC$, where $MC$ is marginal private cost and $MEC$ is marginal external cost.

What does the Coase theorem ('COST THEROM') state regarding externalities?

If property rights exist, only a small number of parties are involved, and transaction costs are low, then private markets will correct an externality on their own.

What is abatement technology and what is its purpose?

Technology that cleans up the production process to reduce or prevent pollution, designed to reduce deadweight loss and shift quantities toward a more efficient (lower) level.

What are four regulatory approaches used to correct negative externalities?

Property rights, command-and-control regulation, pollution taxes, and cap-and-trade.

What is marginal social benefit ($MSB$) and what is its equation?

The marginal benefit enjoyed by society (anyone who benefits from it), calculated as $MSB = MB + \text{Marginal external benefit}$, where $MB$ is marginal private benefit.

What three government actions can be taken in the face of positive externalities (external benefits)?

Public provision (production by a government-funded authority), subsidies (payments to private producers to cover part of production costs), and vouchers (tokens provided to households to buy specified goods or services).

How is relative price calculated and what does it represent on a budget line?

Relative price equals $\frac{\text{price of 1 good}}{\text{price of another good}}$, which equals the slope of the budget line.

How do changes in budget and single-good price changes affect a consumer's budget line?

When a consumer's budget increases, consumption possibilities expand and the budget line shifts outward; when the price of only one good changes, the slope of the budget line changes.

What is marginal utility?

The change in total utility that results from a one-unit increase in the quantity of a good consumed.

What are the two conditions of the utility-maximizing rule for allocating a consumer's budget?

1. Allocate the entire budget. 2. Make marginal utility per dollar equal for all goods ($\frac{MU}{P}$ is equal across goods).

How is marginal utility per dollar calculated?

$\frac{\text{Marginal Utility}}{\text{Price}}$.

What do indifference curves represent?

Preferences over different combinations of goods.