Economics Core Concepts: Surplus, Taxes, Externalities, and Market Equilibriums

Key Rule

Efficient market → maximizes total surplus

Consumer Surplus (CS)

= willingness to pay − price

Producer Surplus (PS)

= price − cost

Total Surplus (TS)

= CS + PS

Deadweight Loss (DWL)

= lost gains from trade due to tax or control

Tax Wedge

= difference between price buyers pay and sellers receive

Tax Burden Rule

→ falls more on LESS elastic side

Deadweight Loss of Tax

= triangle from reduced quantity

Bigger DWL when

→ demand/supply more elastic

Tax Revenue

= tax × quantity

Corrective Tax (Pigovian)

→ fixes negative externality

Negative Externality

= cost to bystanders

Positive Externality

= benefit to bystanders

Market Outcome (Negative)

→ too much production

Market Outcome (Positive)

→ too little production

Solution

→ tax negatives, subsidize positives

Private Good

= excludable + rival

Public Good

= NOT excludable, NOT rival

Common Resource

= NOT excludable, BUT rival

Free Rider Problem

= people don't pay but benefit

Tragedy of Commons

= overuse of shared resource

Price Ceiling (binding)

→ shortage

Price Floor (binding)

→ surplus

Nonbinding

→ does nothing

Total Cost (TC)

= FC + VC

Fixed Cost (FC)

= doesn't change with Q

Variable Cost (VC)

= changes with Q

Marginal Cost (MC)

= change in TC / change in Q

Average Total Cost (ATC)

= TC / Q

ATC Rule

= ATC = AFC + AVC

MC < ATC

→ ATC falling

MC > ATC

→ ATC rising

MC = ATC

→ ATC minimum

Production Function

= inputs → output

Marginal Product (MP)

= extra output from one more input

Law of Diminishing Returns

→ MP eventually decreases

Economies of Scale

→ ATC decreases as Q increases

Diseconomies

→ ATC increases

Constant Returns

→ ATC stays same

Profit

= TR − TC

Total Revenue (TR)

= P × Q

Economic Profit

= TR − (explicit + implicit costs)

Accounting Profit

= TR − explicit costs

Price Taker

→ firm cannot control price

Key Rule (Competitive Markets)

MR = P

Profit Maximization

→ MR = MC

Shutdown (short run)

→ if P < AVC

Exit (long run)

→ if P < ATC

Zero Economic Profit

→ P = ATC

What happens if profit exists?

→ firms enter → price falls

If losses exist?

→ firms exit → price rises

Firm Supply Curve (SR)

= MC above AVC

Market Supply

= sum of all firms

Average Tax Rate

= total tax / income

Marginal Tax Rate

= tax on last dollar

Final Exam Traps

* Tax DOES NOT shift demand → creates wedge

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