Welfare Economics: Market Efficiency, Failure, and Policy Analysis

Vocabulary flashcards summarizing key concepts from Chapter 7 on welfare economics, market efficiency, market failure, and policy critiques.

Positive Analysis

Objective, fact-based examination that describes, explains, or predicts economic outcomes without value judgments.

Normative Analysis

Subjective evaluation that prescribes what should happen, incorporating personal or societal value judgments.

Economic Efficiency

A situation that yields the largest possible economic surplus, maximizing total benefits minus total costs.

Economic Surplus

Total benefits minus total costs resulting from a decision; the size of the ‘economic pie.’

Consumer Surplus

The economic surplus buyers receive when their willingness to pay (marginal benefit) exceeds the market price.

Producer Surplus

The economic surplus sellers receive when the market price exceeds their marginal cost of production.

Voluntary Exchange

A win-win trade that occurs only when both buyer and seller choose to transact, creating consumer and producer surplus.

Marginal Benefit

The additional benefit gained from consuming one more unit of a good or service.

Marginal Cost

The additional cost incurred from producing one more unit of a good or service.

Willingness to Pay

The maximum amount a buyer is prepared to spend for an additional unit; equals marginal benefit.

Rational Rule for Buyers

Purchase until marginal benefit equals price to maximize consumer surplus.

Rational Rule for Sellers

Supply until marginal cost equals price to maximize producer surplus.

Efficient Production

Output produced at the lowest possible total and marginal cost across all firms.

Efficient Allocation

Distribution of goods to the buyers who value them most, creating the largest economic surplus.

Efficient Quantity

Market quantity where marginal benefit equals marginal cost, maximizing total surplus.

Market Efficiency

The ability of competitive markets to achieve efficient production, allocation, and quantity without central planning.

Equity

A fairness concept concerning how economic benefits are distributed, separate from efficiency.

Market Failure

When market forces lead to an inefficient outcome, causing economic surplus to fall below the maximum.

Deadweight Loss (DWL)

The reduction in total economic surplus compared with the efficient outcome; arises from over- or under-production.

Market Power

Seller or buyer ability to influence prices due to limited competition, often leading to underproduction.

Externality

A side effect of a transaction that affects third parties not involved in the trade, causing over- or under-production.

Information Problem (Private Information)

When one party to a transaction holds information the other lacks, undermining trust and efficient trades.

Irrationality

Decision-making that violates the rational rules, causing demand or supply to misalign with true costs or benefits.

Government Regulation (as Market Failure Source)

Taxes, price controls, or quantity limits that distort market outcomes and may lower total surplus.

Government Failure

When government intervention worsens economic outcomes or creates new inefficiencies.

Distributional Consequences

The ‘who gets what’ effects of a policy on different groups’ economic welfare.

Ability to Pay

A person’s financial capacity, which influences willingness to pay and can affect equity judgments.

Economic Pie

Metaphor for total economic surplus available in society; efficiency maximizes its size.

Underproduction

Market outcome where quantity is below the efficient level, typically when marginal benefit exceeds marginal cost.

Overproduction

Market outcome where quantity exceeds the efficient level, occurring when marginal cost exceeds marginal benefit.