Economics Key Concepts: Tax Incidence, Surpluses, Externalities, and Costs

Tax Incidence

who actually bears the economic burden of a tax, how much of the tax is paid by consumers (through higher prices) vs. producers (through lower revenue)

Consumer Surplus

The difference between what consumers are willing to pay for a good and what they actually pay; measures value buyers get beyond the market price.

Producer Surplus

The difference between the price producers receive and the minimum amount they would accept; measures the extra benefit producers get above their cost.

Deadweight Loss (DWL)

The loss of total welfare (beneficial trades) caused by something that prevents the market from reaching equilibrium — usually taxes, subsidies, price floors/ceilings.

Subsidy

A payment from the government to buyers or sellers per unit of a good, lowering the price for buyers and raising revenue for sellers; increases quantity but creates DWL unless correcting an externality.

Externality

A side-effect of a transaction that affects third parties. Negative externalities impose harm (pollution); positive externalities create benefits (education, vaccines).

Pigovian Tax

A tax equal to the marginal external cost of a negative externality that fixes market failure by forcing producers/consumers to internalize the external cost.

Public Good

A good that is nonrival (one person's use doesn't reduce another's) and nonexcludable (difficult to prevent anyone from using). Leads to free-riding and underprovision.

Opportunity Cost

The value of the next-best alternative that is given up when making a choice. Includes both monetary and non-monetary tradeoffs.

Accounting Profit

Revenue minus explicit costs (rent, wages, materials). Does not include opportunity costs.

Economic Profit

Total revenue minus both explicit and implicit costs (forgone wages, forgone return on capital, true economic depreciation). Determines whether a firm is truly better off.

Fixed Cost (FC)

A cost that does not vary with output. Must be paid even if the firm produces zero units (rent, insurance).

Variable Cost (VC)

A cost that changes with the level of output (labor, raw materials, fuel tied to production).

Total Cost (TC)

Fixed cost plus variable cost. The overall cost of producing a given quantity of output.

Average Fixed Cost (AFC)

Fixed cost divided by quantity. Always falls as output increases because the fixed cost is spread over more units.

Average Variable Cost (AVC)

Variable cost divided by quantity; represents variable cost per unit.

Average Total Cost (ATC)

Per-unit cost of production on average. Equals AFC + AVC. ATC falls when MC < ATC and rises when MC > ATC.

Marginal Cost (MC)

The additional cost of producing one more unit of output. Calculated as the change in total cost over the change in quantity.

Economies of Scale

When increasing production lowers average total cost in the long run, usually due to specialization, bulk buying, or efficient equipment use.

Diseconomies of Scale

When increasing production raises average total cost, often caused by coordination problems, bureaucracy, or overcrowding.