Microeconomics: Elasticity, Externalities, Price Controls, Taxes, and Welfare Economics

Comprehensive vocabulary flashcards covering key microeconomic concepts including price elasticity of demand and supply, negative and positive externalities, public goods, price controls, tax incidence, subsidies, and welfare economics.

Elasticity

A measure of the responsiveness of one variable to changes in another variable.

Price Elasticity of Demand

A measure of the responsiveness of quantity demanded ($Q^d$) to a change in price ($P$), defined as the percentage change in quantity demanded divided by the percentage change in price: $\text{Price Elasticity of Demand} = \frac{\% \text{ change in } Q^d}{\% \text{ change in } P}$.

Midpoint Formula for Elasticity

A formula used to compute price elasticity between two points without depending on direction, calculated as: $\frac{(Q_2 - Q_1) / [(Q_2 + Q_1)/2] \times 100}{(P_2 - P_1) / [(P_2 + P_1)/2] \times 100}$.

Elastic Demand

A situation in which the absolute value of the price elasticity of demand is greater than one ($|E_d| > 1$), indicating a high responsiveness of quantity demanded to price changes.

Inelastic Demand

A situation in which the absolute value of the price elasticity of demand is less than one ($|E_d| < 1$), indicating a low responsiveness of quantity demanded to price changes.

Unitary Elastic Demand

A situation in which the absolute value of the price elasticity of demand equals exactly one ($|E_d| = 1$), indicating a proportional responsiveness of quantity demanded to price changes.

Perfectly Inelastic Demand

A polar case where the price elasticity of demand equals zero ($E_d = 0$), meaning an increase in price leaves quantity demanded completely unchanged.

Perfectly Elastic Demand

A polar case where the price elasticity of demand equals infinity ($E_d = \infty$); consumers purchase any quantity at a specific price, but quantity demanded falls to zero at any higher price.

Total Revenue ($TR$)

The amount paid by buyers and received by sellers of a good, calculated as $\text{Total Revenue} = P \times Q$. When demand is elastic, $TR$ and $P$ move in opposite directions; when demand is inelastic, $TR$ and $P$ move together.

Price Elasticity of Supply

A measure of how responsive the quantity supplied ($Q^s$) is to a change in price ($P$), computed as $\text{Price Elasticity of Supply} = \frac{\% \text{ change in } Q^s}{\% \text{ change in } P}$.

Cross-Price Elasticity of Demand

A metric that measures the responsiveness of the quantity demanded of good A to changes in the price of good B, calculated as $\frac{\% \text{ change in } Q^d \text{ for good A}}{\% \text{ change in } P \text{ of good B}}$; it is positive ($> 0$) for substitute goods and negative ($< 0$) for complementary goods.

Income Elasticity of Demand

A metric that measures the responsiveness of quantity demanded to changes in consumer income, calculated as $\frac{\% \text{ change in } Q^d}{\% \text{ change in income}}$; it is positive ($> 0$) for normal goods and negative ($< 0$) for inferior goods.

Externality

The uncompensated costs or benefits that fall on bystanders as a consequence of economic activities.

Negative Externality

An externality where the impact on bystanders is adverse, leading the competitive market to produce a quantity larger than what is socially desirable.

Positive Externality

An externality where the impact on bystanders is beneficial, resulting in a competitive market producing a quantity smaller than what is socially desirable.

Private Cost

A direct economic cost paid by the consumer or the producer of a good or service.

External Cost

A cost imposed on people other than the direct consumer or producer of a good or service.

Social Cost

The total cost to everyone in society, defined as the sum of private cost and external cost.

Internalizing the Externality

Altering incentives so that market participants take into account the external effects of their actions, such as via taxes or subsidies.

Corrective Tax (Pigouvian Tax)

A tax designed to induce private decision-makers to account for the social costs resulting from a negative externality; named after Arthur Pigou and ideally set equal to the external cost.

Command-and-Control Policies

Public policies that regulate behavior directly through mandates, such as setting maximum emission limits or requiring firms to adopt specific pollution-reduction technologies.

Market-Based Policies

Public policies that provide economic incentives to lead private decision-makers to resolve externalities independently, such as corrective taxes, subsidies, and tradable emissions permits.

Coase Theorem

The economic proposition that if private parties can costlessly bargain over resource allocation, they can resolve the problem of externalities on their own without government intervention.

Transaction Costs

The expenses parties incur during the process of negotiating, agreeing to, and enforcing a bargain.

Public Goods

Goods that are available to everyone and whose consumption by one individual does not restrict or diminish consumption by others, being both nonexcludable and nonrival.

Nonexcludable

A property of a good meaning it is costly or practically impossible to prevent someone from using or consuming it.

Nonrival

A property of a good meaning that one person's consumption or use does not diminish its availability, quality, or quantity for other users.

Free-Rider Problem

A market failure occurring when an individual receives the benefits of a good without paying for it, leading private markets to underprovide public goods.

Price Controls

Government regulations that set legal restrictions on how high or low a market price may go, consisting of price ceilings and price floors.

Price Ceiling

A legal maximum on the price at which a good or service can be sold in a market, such as rent control.

Binding Price Ceiling

A price ceiling established below the market equilibrium price, serving as an active constraint that creates a shortage because quantity demanded exceeds quantity supplied.

Price Floor

A legal minimum on the price at which a good or service can be sold, such as the minimum wage.

Binding Price Floor

A price floor established above the market equilibrium price, serving as an active constraint that causes a surplus because quantity supplied exceeds quantity demanded.

Command Economy

An economic system characterized by permanent, universal government price controls and central administrative allocation of goods.

Tax Wedge

The difference between the higher price paid by buyers ($P_B$) and the lower price received by sellers ($P_S$) generated by a per-unit tax.

Tax Incidence

The distribution of a tax burden between buyers and sellers, which depends on the relative price elasticities of supply and demand rather than on who legally pays the tax.

Subsidy

A government payment that functions as a reverse tax, driving a wedge that reduces the buyer's effective price and increases the seller's received price, which can lead to inefficient overproduction.

Welfare Economics

The study of how the allocation of economic resources affects the overall economic well-being of society.

Willingness to Pay ($WTP$)

The maximum price a consumer is willing and able to pay for a good or service, reflecting their private valuation.

Consumer Surplus ($CS$)

The difference between what a consumer is willing to pay and the market price actually paid ($CS = WTP - P$); represented graphically by the area below the demand curve and above the market price.

Willingness to Sell ($WTS$)

The minimum price a producer is willing to accept to supply a good or service, representing the producer's cost of production.

Producer Surplus ($PS$)

The difference between the market price a producer receives and their willingness to sell ($PS = P - WTS$); represented graphically by the area above the supply curve and below the market price.

Total Surplus

The total gains from trade in a market, calculated as the sum of consumer surplus and producer surplus ($\text{Total Surplus} = CS + PS = WTP - WTS$).

Market Efficiency

The condition in which resource allocation maximizes total surplus received by all members of society.

Equity

The fairness or justice in the distribution of economic well-being and resources among the various members of society.

Laissez-Faire

A French term meaning 'allow them to do,' representing the economic philosophy that government should avoid interfering with market mechanisms.

Deadweight Loss ($DWL$)

The loss in total surplus that occurs when a market distortion—such as a tax, monopoly, price ceiling, or price floor—prevents mutually beneficial trades from taking place.