Microeconomics Midterm: Economic Thinking Through Taxes and Subsidies

Vocabulary flashcards covering core microeconomics principles, supply and demand shifts, elasticity, market welfare, and the effects of taxes and subsidies.

Cost-benefit

An economic decision rule where an action is chosen only if its benefits exceed its costs.

Opportunity cost

The value of the next-best alternative forgone, not the sum of every alternative.

Marginal analysis

The process of deciding whether to do one more unit of an activity if $MB \ge MC$, with the optimum typically occurring near $MB = MC$.

Sunk costs

Past, unrecoverable expenses that should be ignored when deciding what to do next.

Interdependence

The economic principle that individual decisions depend on others, other markets, and expectations.

Trade-offs

The reality arising from scarcity where choosing one option means foregoing another.

Law of demand

The principle that, other things equal, when own price increases, quantity demanded decreases ($\text{own price} \uparrow \rightarrow \text{quantity demanded} \downarrow$).

Normal good

A good for which an increase in income leads to an increase in demand, shifting the demand curve to the right ($\text{income} \uparrow \rightarrow D\text{ right}$).

Inferior good

A good for which an increase in income leads to a decrease in demand, shifting the demand curve to the left ($\text{income} \uparrow \rightarrow D\text{ left}$).

Substitutes

Related goods characterized by a relationship where a rise in the price of Good $A$ increases the demand for Good $B$ ($\text{price of } A \uparrow \rightarrow \text{demand for } B \uparrow$).

Complements

Related goods characterized by a relationship where a rise in the price of Good $A$ decreases the demand for Good $B$ ($\text{price of } A \uparrow \rightarrow \text{demand for } B \downarrow$).

Market demand

The total demand formed by summing individual quantities demanded horizontally at each price.

Law of supply

The principle that an increase in own price leads to an increase in quantity supplied ($\text{own price} \uparrow \rightarrow \text{quantity supplied} \uparrow$).

Market supply

The horizontal sum of individual supplies across sellers at each price.

Equilibrium

The point in a market where quantity demanded equals quantity supplied ($Q_d = Q_s$).

Shortage

A condition occurring below the equilibrium price ($P^*$) where quantity demanded exceeds quantity supplied ($Q_d > Q_s$), creating upward price pressure.

Surplus

A condition occurring above the equilibrium price ($P^*$) where quantity supplied exceeds quantity demanded ($Q_s > Q_d$), creating downward price pressure.

Consumer surplus (CS)

Willingness to pay minus price, summed over units; graphically represented as the area below the demand curve and above the price.

Producer surplus (PS)

Price received minus minimum willingness to sell, summed over units; graphically represented as the area above the supply curve and below the price.

Total surplus

The sum of consumer surplus and producer surplus ($CS + PS$), which is maximized at equilibrium in a standard competitive market without externalities.

Price elasticity of demand ($E_d$)

A measure of responsiveness calculated as $(\frac{\%\Delta Q_d}{\%\Delta P})$; classified in absolute value as elastic if $> 1$, inelastic if $< 1$, and unit elastic if $= 1$.

Total revenue ($TR$)

The product of price and quantity ($TR = P \times Q$); rises with a price increase when demand is inelastic, falls when demand is elastic, and remains unchanged for small price changes when demand is unit elastic.

Income elasticity

A measure calculated as $(\frac{\%\Delta Q}{\%\Delta \text{income}})$, which is positive for normal goods and negative for inferior goods.

Cross-price elasticity

A measure calculated as $(\frac{\%\Delta Q_x}{\%\Delta P_y})$, which is positive for substitutes and negative for complements.

Supply elasticity ($E_s$)

A measure of responsiveness calculated as $(\frac{\%\Delta Q_s}{\%\Delta P})$, which tends to become more elastic over time.

Per-unit tax wedge

The difference between the price paid by buyers and the price received by sellers ($t = P_b - P_s$).

Tax incidence

The distribution of the economic burden of a tax, which falls more heavily on whichever side of the market is more inelastic, regardless of who legally remits the tax.

Buyer burden

The portion of a per-unit tax paid by buyers relative to the pre-tax equilibrium price, defined as $P_b - P_0$.

Seller burden

The portion of a per-unit tax absorbed by sellers relative to the pre-tax equilibrium price, defined as $P_0 - P_s$.

Tax revenue

The total revenue collected from a per-unit tax, represented graphically as a rectangle equal to $t \times Q_t$.

Deadweight loss (DWL)

The lost gains from trade due to reduced quantity traded under a tax; represented by a triangle with area $\frac{1}{2} \times t \times (Q_0 - Q_t)$ for linear curves.

Subsidy

A policy intervention that creates an opposite price wedge ($P_s - P_b = \text{subsidy}$), leading to an increased traded quantity where buyers pay less, sellers receive more, and government expenditure equals $\text{subsidy} \times Q_{\text{subsidized}}$.