Principles of Microeconomics: Welfare, Taxation, Trade, and Public Policy

Vocabulary practice flashcards covering market efficiency, deadweight loss, international trade, externalities, public goods, common resources, and the design of the tax system.

Welfare Economics

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

Willingness to Pay (WTP)

The maximum amount that a buyer will pay for a good.

Consumer Surplus (CS)

A measure of the economic benefit consumers receive from participating in a market, calculated as buyers' willingness to pay minus the price actually paid: $\text{CS} = \text{WTP} - \text{Price}$.

Marginal Buyer

The buyer who would leave the market first if the price were any higher.

Cost (Seller's Cost)

The value of everything a seller must give up to produce a good or service.

Producer Surplus (PS)

A measure of the economic benefit producers receive from participating in a market, calculated as the price received minus the seller's cost: $\text{PS} = \text{Price} - \text{Cost}$.

Marginal Seller

The seller who would leave the market first if the price were any lower.

Total Surplus

The total gains from trade in a market, equal to consumer surplus plus producer surplus: $\text{Total Surplus} = \text{CS} + \text{PS} = (\text{value to buyers}) - (\text{cost to sellers})$.

Efficiency (Market Efficiency)

The property of a resource allocation that maximizes total surplus, ensuring goods are consumed by buyers who value them most and produced by sellers with the lowest costs.

Deadweight Loss (DWL)

The fall in total surplus that results from a market distortion, such as a tax, which prevents mutually beneficial trades where the value to buyers exceeds the cost to sellers.

Laffer Curve

A curve showing the relationship between the size of a tax and total tax revenue collected, illustrating that as a tax rate rises, revenue increases up to a maximum and then declines.

Supply-Side Economics

An economic perspective associated with President Reagan proposing that lower taxes increase incentives to work, save, and invest, stimulating faster economic growth.

Comparative Advantage

The ability of an individual or country to produce a good at a lower opportunity cost than other producers.

World Price ($P_W$)

The price of a good that prevails in the world market for that good.

Domestic Price without Trade ($P_D$)

The price determined exclusively by domestic demand and supply in the absence of international trade.

Price Taker (Small Economy)

A small economy whose trading actions have no noticeable effect on the world price ($P_W$), meaning it must take the prevailing world price as given.

Tariff

A tax on goods produced abroad and sold domestically, causing domestic price to equal the world price plus the tariff ($\text{Domestic price} = P_W + \text{tariff}$).

Import Quota

A quantitative limit on the imports of a good, which raises the domestic price, creates a domestic shortage at the world price, and generates profits for foreign producers of the imported goods.

Infant Industry Argument

A trade restriction argument claiming that new domestic industries need temporary trade protection to help them get established before competing against mature foreign firms.

Externality

The uncompensated impact of one person's actions on the well-being of a bystander, which can be negative (adverse) or positive (beneficial).

Social Cost

The full cost to society of producing a good, calculated as private costs incurred by producers plus external costs borne by bystanders ($\text{Social Cost} = \text{Private Cost} + \text{External Cost}$).

Social Value

The total benefit to society from consuming a good, calculated as private value (willingness to pay) plus external benefits collected by bystanders ($\text{Social Value} = \text{Private Value} + \text{External Benefit}$).

Internalizing the Externality

Altering incentives so that private decision-makers (consumers or producers) take into account the external costs or benefits of their actions.

Corrective Tax

A tax designed to induce private decision-makers to take account of the social costs arising from a negative externality; an efficient corrective tax equals the external cost.

Corrective Subsidy

A per-unit payment by the government designed to induce private decision-makers to take account of the social benefits from a positive externality; an efficient subsidy equals the external benefit.

Command-and-Control Policy

Direct government regulations that require or prohibit specific actions to address externalities (e.g., technology mandates or outright bans on toxic substances).

Tradable Pollution Permits (Cap-and-Trade)

A market-based policy that sets a strict cap on total emissions and allows firms to buy and sell pollution allowances, reducing pollution at the lowest total cost.

Coase Theorem

The proposition that if private parties can bargain costlessly over resource allocation, they will solve the externality problem on their own and achieve the socially efficient outcome regardless of the initial distribution of rights.

Transaction Costs

The expenses and frictions incurred by parties in negotiating, agreeing upon, and carrying out a transaction, which can prevent private bargaining under the Coase Theorem.

Excludable Good

A characteristic of a good whereby individuals can be prevented from consuming or using it.

Rival in Consumption

A characteristic of a good whereby one person's consumption of it diminishes another person's ability or opportunity to consume it.

Private Good

A good that is both excludable and rival in consumption (e.g., an ice cream cone).

Public Good

A good that is neither excludable nor rival in consumption (e.g., national defense, basic research, fighting poverty).

Common Resource

A good that is rival in consumption but not excludable (e.g., clean air and water, congested roads, fish and wildlife).

Club Good

A good that is excludable but non-rival in consumption (e.g., subscription streaming services like Netflix).

Free Rider

A person who receives the benefit of a good but avoids paying for it, leading private markets to underprovide public goods.

Cost-Benefit Analysis

A study that compares the costs and benefits to society of providing a public good to determine whether the government should supply it.

Tragedy of the Commons

A parable illustrating why common resources get used more than is socially desirable because private incentives (using the resource for free) outweigh social incentives (using it carefully).

Marginal Tax Rate

The percentage of tax paid on the next dollar of income.

Average Tax Rate

Total taxes owed divided by total income ($\text{Average Tax Rate} = \frac{\text{Tax Liability}}{\text{Total Income}}$).

Lump-Sum Tax

A tax that is the same fixed dollar amount for every person, regardless of earnings or actions taken, making it the most efficient but least equitable tax.

Benefits Principle

A principle of tax equity suggesting that people should pay taxes based on the benefits they receive from government services.

Ability-to-Pay Principle

A principle of tax equity suggesting that taxes should be levied according to how well a person can shoulder the financial burden, requiring equal sacrifice across taxpayers.

Vertical Equity

The concept that taxpayers with a greater ability to pay should contribute a larger amount of taxes.

Horizontal Equity

The concept that taxpayers with similar abilities to pay should contribute the same amount of taxes.

Proportional Tax

A tax system in which high-income and low-income taxpayers pay the exact same fraction of their income.

Regressive Tax

A tax system in which high-income taxpayers pay a smaller fraction of their income than low-income taxpayers do.

Progressive Tax

A tax system in which high-income taxpayers pay a larger fraction of their income than low-income taxpayers do.

Tax Incidence

The study of who ultimately bears the true economic burden of a tax, which may differ from the party that receives the official tax bill.

Sixteenth Amendment

The U.S. constitutional amendment established in 1909 that gave Congress the right to impose a Federal Income Tax, with an initial top rate of $1\%$.