Econ review

MPB on a graph

• Downward‑sloping

• Labeled D or MPB

MPB used for

• to find market equilibrium (MPB = MPC)

• Compared to MSB to detect positive externalities

MPB definition

• The benefit to the individual consumer from consuming one more unit.

• This is just the regular demand curve.

• private DEMAND curve

MPC definition

• The cost to the producer of making one more unit.

• This is the regular supply curve.

• private SUPPLY curve

MPC on a graph

• Upward‑sloping

• Labeled S or MPC

MPC used for

• Used to find market equilibrium (MPB = MPC)

• Compared to MSC to detect negative externalities

MSB definition

• The benefit to society as a whole, not just the buyer.

• Includes:

  • Private benefit (MPB)

  • + external benefits (like education, vaccines)

  • social DEMAND curve

MSB on a graph

• Above MPB when there is a positive externality

• Slopes downward like demand

MSB used for

• MSB is used to find the socially optimal quantity

• Socially optimal quantity: where MSB = MSC

• Subsidy = MSB − MPB

MSC definition

The cost to society as a whole, not just the producer.

Includes:

• Private cost (MPC)

• + external costs (pollution, congestion, health costs)

• social SUPPLY curve

MSC on a graph

• Above MPC when there is a negative externality

• Slopes upward like supply

MSC used for

• Used to find the socially optimal quantity (MSB = MSC)

Market equilibrium

MPB=MPC / D market=MPC

Socially optimal equilibrium

MSB=MSC

Positive externality in graph/market/fix

• MSB > MPB

• Market underproduces

• Fix with a subsidy

Negative externality in graph/market/fix

• MSC > MPC

• Market overproduces

• Fix with a tax

calculate tax and subsidy size:

• Tax = MSC − MPC

• Subsidy = MSB − MPB

• vertical distance between the 2

Deadweight loss on a graph

The triangle between:

• The social curve (MSC or MSB)

• The private curve (MPC or MPB)

• Between Q\* and Q_market

Total surplus on a graph, with & without policy

Without policy:

• Area between MPB and MSC from 0 to Q_market

• Minus the DWL triangle

With optimal policy:

• Area between MSB and MSC from 0 to Q\*

• No DWL (maximum efficiency)

Slope of the budget constraint

-(ph/pv)

Indicate all affordable combinations on the budget constraint

solve for all poss combos at or below income amount

Marginal Utility formula

MU = change in TU (TU1-TU0 etc)

MU per dollar formula

divide each MU by the price per item — MU/P

binding vs non-binding in terms of eq price (PC PF)

binding: ceiling < eq price, floor > eq price

non-binding: ceiling > eq price, floor < eq price

Surplus vs shortage

Surplus: qs > qd, shortage: qs < qd

CS, PS, TS

CS = .5bh upper triangle (above ep & below D curve), PS = .5bh lower triangle (below ep & above s curve), TS=CS+PS

PS can also be considered TR-TC/profit

on a graph, # units sold

where the L-tax or R-subsidy wedge = the tax or subsidy amount

price to consumers

based on demand at units sold

price to producers

based on supply at units sold

govt. revenue on a graph

Q of tax, etc. * Q where wedge=amount of tax, etc.

optimal bundle/maximizing utility

• Calculate MU/P for each good.

• Rank units from highest to lowest MU/P across all goods

• “Spend” the consumer’s budget by choosing units in order of highest MU/P first.

• Stop when the budget is fully used (or cannot buy another unit).

• The last affordable combination you selected is the optimal bundle.

MSC formula

MPC+MEC

MSB formula

MPB+MEB

total revenue

p*q

DWL on SD graph with tax wedge

DWL = ½ × tax × reduction in quantity

general DWL formula

DWL=.5×(change in quantity)×(vertical wedge)

binding price floor (PF above equilibrium) creates a

surplus

binding price ceiling (above equilibrium) creates a

shortage

Tax Incidence

The side that is more inelastic bears more of the burden

Utility maximization rule

MUx/Px=MUy/Py

Budget constraint

Px+Py=Income

Why does DWL occur with externalities?

Because market quantity ≠ socially optimal quantity.

As consumption increases,

MU decreases

Inferior vs normal good

If income rises and a consumer buys less of Good A, what is A?

A: Inferior good.

Q: If income rises and a consumer buys more of Good B, what is B?

A: Normal good.

Income effect of a price increase?

Consume less of other goods.

Substitution effect of a price increase?

Consume more of other goods.

What does a binding minimum wage cause?

Unemployment

What counts as unemployment in this model?

People fired + new job seekers.

What does equilibrium maximize when there are no market failures?

Total surplus.

Who benefits from a subsidy?

Both consumers and producers.

Rival good

A good is rival if one person’s use reduces the amount available for others.

Think: If I use it, you can’t.

Examples of rival goods

• A slice of pizza

• A seat on a bus

• Fish in the ocean

• A parking spot

If I take the last parking spot, you can’t take it.
If I catch a fish, there’s one less fish for you.

Non-rival good

One person’s use does NOT reduce anyone else’s ability to use it.

Think: “If I use it, you still can too.”

1. Radio broadcast

If you listen to a radio station, it doesn’t stop anyone else from listening.

2. Fireworks show

You watching the fireworks doesn’t block someone else from watching the same show.

Excludable good

A good is excludable if you can prevent people from using it.

Think: You can block access.

Examples

• Netflix (password)

• Concert tickets

• A private swimming pool

Non-excludable good

A good is non‑excludable if you cannot stop people from using it, even if they don’t pay.

Think: You can’t block access.

Examples

• Public roads

• Fireworks displays

• Fish in the ocean

• Air

You can’t stop someone from breathing air or driving on a public road.

What are common resources?

Goods that are rival but non‑excludable.

Examples

• Fish in the ocean

• Public forests

• Public grazing land

• Traffic on a public road

Why do common resources cause overconsumption, and what does this lead to

Because everyone has an incentive to use the resource, but no one has an incentive to conserve it. Leads to Tragedy of the Commons.

Tragedy of the Commons

People overuse the resource until it becomes depleted or inefficiently used.

Why?
Each person gets the full benefit of using it, but the cost (depletion) is shared by everyone.

negative externality definition, key idea, examples

A negative externality happens when someone’s action imposes a cost on others that they don’t pay for.

NE—too much—tax

Key idea:

Social cost > private cost
(meaning: society pays more than the individual who caused it)

Examples

• Pollution

• Smoking near others

• Traffic congestion

• Loud parties at 2 AM

market outcome of a negative externality

The market overproduces the good because the producer/consumer isn’t paying the full cost.

fix for a negative externality

Pigovian tax: A tax equal to the external cost shifts MPC → MSC and reduces quantity to the socially optimal level.

positive externality

A positive externality happens when someone’s action creates a benefit for others that they don’t get paid for.

PE—too little—subsidy

Key idea:

Social benefit > private benefit
(meaning: society benefits more than the individual who created the benefit)

Examples

• Vaccinations

• Education

• Research & development

• Maintaining a beautiful garden others enjoy

positive externality market outcome

The market underproduces the good because the individual doesn’t receive the full benefit.

positive externality fix

Pigovian subsidy: A subsidy equal to the external benefit shifts MPB → MSB and increases quantity to the socially optimal level.

substitution effect

When a good becomes more expensive, you naturally switch to cheaper alternatives.

Think: “This got expensive — what can I replace it with?”

Direction

• If price ↑ → you buy less of the now‑expensive good

• And more of substitutes

This effect is always negative for the good whose price increased.

income effect

When the price of a good increases, your real purchasing power falls — even if your income didn’t change.

Think: “I feel poorer now.”

Direction

• If price ↑ → you buy less of other goods

• And often less of the good itself, because your budget is tighter

tax

Pushes the market upward, raises costs, shifts supply curve up

subsidy

pushes the market downward, lowers costs, shifts supply curve down

effects of taxes on consumers, producers, quantity, DWL, govt.

• Price consumers pay ↑

• Price producers receive ↓

• Quantity falls

• Creates deadweight loss

• Government collects revenue

who bears the burden of a tax

The side that is more inelastic.

• Inelastic demand → consumers pay more

• Inelastic supply → producers pay more

subsidy effects on consumers, producers, quantity, DWL, govt.

• Price consumers pay ↓

• Price producers receive ↑

• Quantity rises

• Creates deadweight loss

• Government SPENDS money (instead of collecting it)

who benefits from a subsidy

both consumers and producers

binding (higher) minimum wage effects on wage, QD QS of labor

• Quantity of labor demanded falls (firms hire fewer workers)

• Quantity of labor supplied rises (more people want jobs at the higher wage)

non binding minimum wage when

it is below eq wage

non binding minimum wage effects on change in un/employment, wage, DWL, SC

• No unemployment

• No change in wage

• No change in employment

• No deadweight loss

• No search costs

search costs

Search costs are the time, effort, and resources that buyers or sellers spend trying to find a trading partner in a market.

Think:
The cost of looking for a job, a worker, a product, or a buyer.

maximum willingness to pay

The exact amount a consumer would pay where they are indifferent between having their money or having a good

• Priced a penny higher->will not buy

• Priced a penny lower->will happily buy

• Market of 4 people who want to buy a record

minimum willingness to accept

The exact amount a producer would accept where they are indifferent between providing a good or service or accepting money (Marginal cost)

• Priced a penny higher->will happily sell/work

• Priced a penny lower->will not sell/work

• Market of 4 people willing to paint houses

what does “market clears” mean

qd=qs

Why economists like equilibrium

• Maximizes total (social) surplus.

• Any other quantity → deadweight loss.

• “Assures the most Total (Social) surplus that is possible… Any other quantity results in less surplus.”

DWL definition

• Lost surplus from producing too little or too much.

• Appears when markets are distorted (taxes, subsidies, price controls, externalities).

tax wedge

price buyers pay-price sellers receive=tax

public goods + problems + solutions

⭐Characteristics

• Non‑excludable

• Non‑rival

⭐ Market failure

• Free‑rider problem

• Underproduction

⭐ Fixes

• Government provision

• Taxation

• Voluntary contributions (rare)

Coase Theorem

If people can bargain easily and property rights are clearly assigned, then they can solve externality problems on their own, and they will reach an efficient outcome no matter who starts with the rights.

Free Rider problem

The free rider problem happens when people benefit from a good without paying for it, which leads to underproduction of that good.

This is directly tied to public goods, which are:

• Non‑excludable → you can’t stop people from using them

• Non‑rival → one person’s use doesn’t reduce others’ use

elastic labor demand

• Employers are very sensitive to wage increases.

• When minimum wage goes up, they cut a lot of jobs.

• Even a small wage increase → big drop in quantity of labor demanded.

inelastic labor demand

• Employers are not very sensitive to wage increases.

• They still need workers, even at higher wages.

• Minimum wage increase → small job losses.

price elastic goods

What this means:

• A small price increase → big drop in quantity demanded

• A small price decrease → big increase in quantity demanded

• Consumers have lots of substitutes

• They can “take it or leave it”

Examples:

• Restaurant meals

• Clothing

• Luxury items

Why it matters:

When demand is elastic, raising price reduces total revenue because quantity demanded falls sharply.

price inelastic goods

A good is price inelastic when consumers are not very responsive to price changes.

What this means:

• Price increases → small drop in quantity demanded

• Price decreases → small increase in quantity demanded

• Consumers have few substitutes

• They “need it” regardless of price

Examples:

• Gasoline

• Insulin

• Basic groceries

Why it matters:

When demand is inelastic, raising price increases total revenue because people keep buying almost the same amount.

DWL is to the right of equilibrium for:

overproduction, subsidies, and negative externalities

Subsidy program cost formula

cost/unit * # units (area on graph)

binding price ceiling is __ eq price

below

binding price floor is __ eq price

above

We would expect producers to bear more of the burden of a tax when…and why

Supply is relatively inelastic and demand is relatively elastic. bc the more inelastic side bears more of the burden

The distance between an individual’s minimum price they are willing to accept and the market price represents…and why

Producer Surplus, bc PS is the diff between the price a P receives and the min price they would have accepted

Consumers bear more of the tax burden when:

Supply is relatively elastic and demand is relatively inelastic.

Distance between maximum willingness to pay and market price and why

Consumer Surplus. bc The difference between what a buyer is willing to pay and what they actually pay.

the DWL triangle always points to what

the socially optimal point

private good

rival and excludable. example: a slice of pizza, a bus seat