Economics Exam 2 Review: Welfare, Trade, Externalities, and Labor Markets

Comprehensive vocabulary flashcards covering microeconomic welfare, efficiency, comparative advantage, international trade policy, externalities, public goods, common resources, and labor markets.

Positive Analysis

An analytical approach that describes what is happening, explaining why it occurs or predicting what will happen; it is purely objective and empirical.

Normative Analysis

An analytical approach that prescribes what should happen, which involves value judgments, opinions, and personal values.

Economic Efficiency

A standard of performance achieved when total economic surplus is maximized across all market transactions.

Economic Equity

The goal of achieving a fair and equal distribution of economic benefits and costs among market participants.

Economic Surplus

The total benefits minus total costs generated by a decision or market transaction, calculated as $\text{Marginal benefit} - \text{Marginal cost}$ or $\text{Consumer surplus} + \text{Producer surplus}$.

Consumer Surplus (CS)

The economic surplus gained from buying a good, calculated as $\text{Marginal benefit} - \text{Price}$; graphically represented as the area below the demand curve and above the market price.

Producer Surplus (PS)

The economic surplus gained from selling a good, calculated as $\text{Price} - \text{Marginal cost}$; graphically represented as the area above the supply curve and below the market price.

Rational Rule for Markets

The principle stating that an economy should produce more of a good as long as marginal benefit is greater than or equal to marginal cost, maximizing economic surplus where $\text{Marginal benefit} = \text{Marginal cost}$.

Benevolent Social Planner

A hypothetical, all-knowing, all-powerful, and well-intentioned decision maker used in economics to evaluate how society can maximize total economic surplus.

Market Failure

A situation in which the unregulated forces of supply and demand lead to an inefficient allocation of resources, destroying economic surplus.

Deadweight Loss (DWL)

The reduction in total economic surplus resulting from an inefficient outcome or market distortion, equal to $\text{Economic surplus at efficient quantity} - \text{Actual economic surplus}$.

Government Failure

A situation occurring when government interventions or policies lead to worse economic outcomes and inefficiencies than the market failure they were intended to fix.

Gains from Trade

The net economic benefits generated when resources, goods, and services are reallocated to better uses through voluntary exchange.

Absolute Advantage

The ability of an individual, firm, or country to produce a unit of output using fewer inputs (such as labor hours) than another producer.

Comparative Advantage

The ability of an individual, firm, or country to produce a good or service at a lower opportunity cost than another producer.

Production Possibilities Frontier (PPF)

A curve showing the maximum possible combinations of two goods that an economy can produce when using all available resources efficiently.

Internal Markets

Markets created within a company or organization to buy and sell scarce internal resources, solving the knowledge problem without relying on a centralized manager.

Prediction Markets

Speculative markets whose payoffs are linked to the occurrence of an uncertain future event, designed to aggregate widely dispersed information into market prices.

Trade Costs

The additional costs incurred when buying or selling goods internationally rather than domestically, including shipping fees, tariffs, customs delays, and currency transaction costs.

World Price

The global equilibrium price at which a good or service is traded internationally, determined by the intersection of world supply and world demand.

Tariff

A government-imposed tax on imported goods that raises the domestic price of the good above the world price by the amount of the tax.

Import Quota

A legal limit placed by a government on the maximum quantity of a specific good that can be imported into a country during a specified time period.

Voluntary Export Restriction (VER)

A trade restriction in which an exporting country voluntarily agrees to reduce the quantity of goods it exports to a specific partner country.

Export Subsidy

A financial payment made by a government to domestic producers that allows them to sell their goods in international markets at reduced prices.

Dumping

The practice where a foreign firm sells a product abroad at an artificially low price, flooding the market to drive domestic competitors out of business.

Red Tape

Complex bureaucratic hurdles, excessive paperwork, and official approvals that raise trade costs and inhibit trade volumes.

Externality

A side effect of an economic activity that impacts bystanders whose welfare and interests are not taken into account by market decision makers.

Negative Externality

An activity whose uncompensated side effects harm bystanders, causing marginal social costs to exceed marginal private costs and resulting in overproduction.

Positive Externality

An activity whose uncompensated side effects benefit bystanders, causing marginal social benefits to exceed marginal private benefits and resulting in underproduction.

Marginal Social Cost (MSC)

The total marginal cost borne by all of society from producing an extra unit of a good, calculated as $\text{Marginal private cost} + \text{Marginal external cost}$.

Marginal Social Benefit (MSB)

The total marginal benefit enjoyed by all of society from consuming an extra unit of a good, calculated as $\text{Marginal private benefit} + \text{Marginal external benefit}$.

Socially Optimal Outcome

The most efficient market outcome for society as a whole, achieved at the quantity where $\text{Marginal social benefit} = \text{Marginal social cost}$.

Coase Theorem

The proposition that if property rights are clearly established and enforced, and bargaining is costless, private parties can resolve externalities efficiently on their own.

Corrective Tax

A tax levied on a market activity equal to the marginal external cost, designed to induce decision makers to internalize a negative externality.

Corrective Subsidy

A payment provided to market participants equal to the marginal external benefit, designed to induce decision makers to internalize a positive externality.

Cap and Trade

A policy mechanism that imposes a quantity cap on an externality by issuing a fixed number of permits that firms are allowed to trade among themselves.

Excludable Good

A characteristic of a good or service whereby it is possible to prevent or exclude non-payers from consuming it.

Rival Good

A characteristic of a good or service whereby one individual's consumption of it diminishes or precludes another individual's ability to consume it.

Private Goods

Goods that are both excludable and rival in consumption, such as consumer electronics, food, and clothing.

Public Goods

Goods that are non-excludable and non-rival in consumption, such as national defense and public broadcasting.

Common Resources

Goods that are rival in consumption but non-excludable, such as ocean fisheries and clean shared water resources.

Club Goods

Goods that are excludable but non-rival in consumption, such as subscription television, private toll roads, and satellite radio.

Free-Rider Problem

A market failure that occurs when individuals can enjoy the benefits of a non-excludable good without paying for it, leading to underprovision by private markets.

Tragedy of the Commons

The tendency of common resources to be overused and depleted because individual users gain all private benefits while spreading the costs across all of society.

Derived Demand

The demand for an input factor of production (such as labor) that stems directly from consumer demand for the final output that the input produces.

Marginal Product of Labor (MPL)

The additional physical output produced when one additional unit of labor is hired, given by $\text{MPL} = \frac{\Delta Q}{\Delta L}$.

Marginal Revenue Product (MRP)

The marginal revenue generated by hiring an additional unit of labor, calculated as output price multiplied by the marginal product of labor: $\text{MRP} = P \times \text{MPL}$.

Rational Rule for Employers

A profit-maximizing guideline directing an employer to hire additional workers as long as the marginal revenue product is greater than or equal to the wage ($\text{MRP} \ge W$).

Substitution Effect of a Wage Increase

The behavioral response whereby a higher wage increases the opportunity cost of leisure, providing a stronger incentive to substitute away from leisure and work more hours.

Income Effect of a Wage Increase

The behavioral response whereby a higher wage increases overall purchasing power, leading an individual to consume more leisure and reduce hours worked.

Extensive Margin of Labor Supply

The fundamental decision of whether or not to participate in the labor force at all.

Intensive Margin of Labor Supply

The decision regarding how many hours to work once an individual has already chosen to participate in the labor market.

Scale Effect

The mechanism whereby a decline in input costs (such as capital) lowers total production costs, prompting a firm to expand its scale of output and increase labor demand.