Consumer and Producer Surplus, Market Efficiency, and Externalities

Flashcards covering consumer surplus, producer surplus, market efficiency, market failures, externalities (negative and positive), government interventions for externalities, and optimal pollution reduction.

What two conditions must hold for a competitive market to produce efficient outcomes?

The market demand curve must reflect the full willingness to pay of every person receiving benefits, and the market supply curve must reflect all production costs, including those that may fall onto third parties.

What is measured by the total surplus, or social surplus?

The net benefits accruing to society from the conversion of scarce resource inputs into various forms of output.

How is total surplus expressed in equation form?

Total surplus = Consumer surplus + Producer surplus.

What is defined as instances where markets fail to produce the right amount of a product that will maximize total surplus?

Market failures.

What is consumer surplus?

The difference between the maximum price a consumer is willing to pay for a product and the actual price they do pay.

To what is a consumer's maximum willingness to pay equal?

The marginal benefit that they receive.

How do demand curves relate to consumer's willingness to pay?

Demand curves are equivalent to maximum willingness to pay curves.

How does price affect consumer surplus?

Higher prices reduce consumer surplus, and lower prices increase consumer surplus.

What is producer surplus?

The difference between the price a producer receives and the minimum price that the producer would have to be paid to make a particular unit of output available.

To what will a producer's minimum acceptable price for a particular unit equal?

The producer's marginal cost of producing that unit.

How do supply curves relate to producer's minimum acceptable price?

The minimal acceptable prices that producers are willing to accept form points on the supply curve.

How does price affect producer surplus?

Lower prices reduce producer surplus, and higher prices increase producer surplus.

What two types of efficiency comprise economic efficiency?

Productive efficiency and allocative efficiency.

What is productive efficiency?

Achieved when competition forces firms to use the best technologies and resource combinations available to minimize the per-unit cost of output.

What is allocative efficiency?

Achieved when the correct quantity of a good is produced relative to other goods and services, meaning scarce resources are allocated as long as the marginal benefit exceeds the opportunity cost.

What happens to total surplus during underproduction or overproduction?

It causes reductions in the size of the total surplus, known as efficiency losses or deadweight losses.

Why does underproduction lead to deadweight loss?

For output levels between the underproduced quantity and the efficient quantity, consumers' maximum willingness to pay exceeds producers' minimum price, so society suffers a loss of net benefits by not producing these units.

Why does overproduction lead to deadweight loss?

For units produced beyond the efficient quantity, costs exceed benefits, generating a loss of total surplus.

What is an externality?

When some of the costs or benefits of a good or service are passed on to, or spill over to, someone other than the immediate buyer or seller (a third party).

What are negative externalities?

Occur when producers or suppliers impose costs on third parties not directly involved in a market transaction, such as breathing polluted air downwind of factories.

How do negative externalities affect the market supply curve and output?

They cause producers' marginal costs to be lower, making their supply curves understate the total cost of production and leading to overproduction (market output Qe is greater than optimal output Qo).

What are positive externalities?

Occur when people not directly involved in a market transaction receive benefits without having to pay for them, such as enjoying fireworks near Disneyland without paying admission.

How do positive externalities affect the market demand curve and output?

They cause market demand curves to fail to include the willingness to pay of those receiving external benefits, leading to market demand curves understating total benefits and resulting in underproduction (market output Qe is less than optimal output Qo).

What is a common government intervention for negative externalities related to pollution?

Direct controls, such as uniform emission standards or legislation limiting offending activities.

What are Pigovian taxes?

Targeted tax assessments levied by the government on goods or services that generate negative externalities, which raise the marginal cost of production and shift the supply curve leftward.

How can the government correct under allocation of resources due to positive externalities?

By subsidizing consumers (e.g., discount coupons) or producers (payments to decrease costs), which shifts demand or supply curves to achieve the optimal output.

What is the optimal amount to clean up when dealing with negative externalities like pollution?

The amount that equalizes the marginal cost of cleaning up with the marginal benefit of a cleaner environment.

Why is completely eliminating pollution typically not economically efficient?

Due to the law of increasing opportunity costs, the marginal cost of reducing pollution rises, and at some point, may exceed society's marginal benefit of further reduction.

When does the optimal reduction of an externality occur?

When society's marginal cost and marginal benefit of reducing that externality are equal.

What is a 'government failure'?

Economically inefficient outcomes caused by shortcomings in the public sector.