Principles of Microeconomics: Price Controls, Taxes, Subsidies, and Elasticity

Vocabulary practice flashcards covering price controls (ceilings and floors), excise taxes, subsidies, welfare effects, and price elasticities of demand, supply, income, and related goods.

Price Control

A government-mandated price that imposes a legal maximum or minimum price in a market, such as rent control, the minimum wage, or anti-price gouging laws.

Price Ceiling

A legally established maximum price that sellers are allowed to charge for a good or service.

Binding Price Ceiling

A price ceiling set below the equilibrium price ($P^C < P^*$), preventing the market from reaching equilibrium and causing a persistent shortage where quantity demanded exceeds quantity supplied ($Q_D^C > Q_S^C$).

Non-Binding Price Ceiling

A price ceiling set above the equilibrium price ($P^C > P^*$), allowing market forces to push the price down to equilibrium ($P^*$), resulting in no effect on the market.

Shortage (Price Ceiling)

A market disequilibrium condition resulting from a binding price ceiling where quantity demanded exceeds quantity supplied, calculated as $\text{Shortage} = Q_D^C - Q_S^C$.

Deadweight Loss (DWL)

The cost to society created by economic inefficiency when a market produces or consumes at a level other than the competitive equilibrium, reducing total economic surplus.

Search Cost

The time, energy, and money allocated by buyers or sellers in a market to locate a trading partner to engage in a transaction, which increases under binding price ceilings like rent control.

Misallocation of Resources (Price Ceilings)

An unintended consequence of a price ceiling where below-equilibrium prices discourage suppliers and developers from constructing new supply or investing, causing capital to flow elsewhere and shrinking future market supply.

Price Floor

A legally established minimum price that sellers can charge for a good or service.

Binding Price Floor

A price floor set above the equilibrium price ($P^F > P^*$) that prevents market clearing and creates a persistent surplus where quantity supplied exceeds quantity demanded ($Q_S^F > Q_D^F$).

Non-Binding Price Floor

A price floor set below the equilibrium price ($P^F < P^*$) that has no impact on the market, as market forces push the price up to the equilibrium level ($P^*$).

Surplus (Price Floor)

A market disequilibrium condition caused by a binding price floor where quantity supplied exceeds quantity demanded, calculated as $\text{Surplus} = Q_S^F - Q_D^F$ (e.g., unemployment in low-wage labor markets under minimum wage laws).

Wasteful Increase in Quality

An unintended effect of a price floor where firms, unable to compete on price, make unnecessary or unwanted upgrades to products or services to justify higher government-mandated prices.

Taxes

Mandatory contributions levied on individuals or corporations by a government entity, primarily used to raise government revenue or discourage specific market behaviors.

Commodity (Excise) Tax

A tax levied specifically on the sale or purchase of individual goods and services.

Tax Wedge

The vertical gap driven between the price paid by the consumer and the price received by the seller, shifting the effective supply curve upward (or demand curve downward) by the exact amount of the per-unit tax.

Tax Burden (Tax Incidence)

The actual distribution of economic cost shared between buyers and sellers, which depends entirely on the relative price elasticities of supply and demand and is independent of whether the tax is legally levied on buyers or sellers.

Relative Elasticity Rule of Tax Burden

The economic principle stating that the market participant with the relatively more elastic curve bears a smaller share of the tax burden, while the participant with the relatively more inelastic curve bears a larger share.

Welfare Effects of Taxes

The market outcome where both consumer surplus and producer surplus decline, part of which is converted into government tax revenue ($Q_{\text{tax}} \times \text{Tax}$) and part of which becomes deadweight loss due to reduced quantity traded.

Subsidy

A payment made by the government to either a buyer or a seller when a good or service is purchased or sold, designed to incentivize consumption or production.

Welfare Effects of Subsidies

The market outcome where consumer surplus and producer surplus increase, but deadweight loss is created because the total government expenditure on the subsidy exceeds the combined consumer and producer surplus gains.

Price Elasticity of Demand ($\varepsilon_D$)

A measure of how sensitive consumer purchasing behavior is to changes in a product's price, calculated as $\varepsilon_D = \frac{\% \Delta Q_D}{\% \Delta P}$. Its value is always negative.

Midpoint Method

A method used to compute percentage changes that divides the absolute change by the average of the initial and new values, ensuring that the elasticity value is invariant to the direction of the price change: $\% \Delta Q_D = \frac{Q_{\text{new}} - Q_{\text{old}}}{(Q_{\text{new}} + Q_{\text{old}})/2} \times 100$.

Elastic Demand

A demand relationship where the absolute value of the price elasticity coefficient is strictly greater than one ($|\varepsilon_D| > 1$), indicating that consumers are relatively sensitive to price changes.

Inelastic Demand

A demand relationship where the absolute value of the price elasticity coefficient is strictly less than one ($|\varepsilon_D| < 1$), indicating that consumers are relatively insensitive to price changes.

Unit Elastic Demand

A condition where the absolute value of the price elasticity coefficient equals exactly one ($|\varepsilon_D| = 1$), meaning the percentage change in quantity demanded equals the percentage change in price.

Elasticity Along a Linear Demand Curve

The structural property that elasticity varies along a downward-sloping linear demand curve: the upper portion is elastic ($|\varepsilon_D| > 1$), the midpoint is unit elastic ($|\varepsilon_D| = 1$), and the lower portion is inelastic ($|\varepsilon_D| < 1$), even though the slope remains constant.

Total Revenue (TR)

The total amount of money a firm brings in from selling its output, defined by the formula $\text{TR} = P \times Q$.

Total Revenue Test (Elastic Demand)

When demand is elastic ($|\varepsilon_D| > 1$), an increase in price causes total revenue to decrease ($P \uparrow \implies \text{TR} \downarrow$) because the percentage drop in quantity demanded outweighs the percentage increase in price.

Total Revenue Test (Inelastic Demand)

When demand is inelastic ($|\varepsilon_D| < 1$), an increase in price causes total revenue to increase ($P \uparrow \implies \text{TR} \uparrow$) because the percentage drop in quantity demanded is smaller than the percentage increase in price.

Total Revenue Test (Unit Elastic Demand)

When demand is unit elastic ($|\varepsilon_D| = 1$), a price change leaves total revenue unchanged, meaning total revenue is maximized at the unit elastic point of a linear demand curve.

Determinants of Price Elasticity of Demand

Factors that govern consumer price responsiveness: availability of close substitutes, passage of time (short run vs. long run), market definition (broad category vs. specific good), necessity versus luxury status, and budget share.

Cross-Price Elasticity ($\varepsilon_{x/y}$)

A measure of how quantity demanded of one good ($x$) responds to a change in the price of another good ($y$), calculated as $\varepsilon_{x/y} = \frac{\% \Delta Q_{Dx}}{\% \Delta P_y}$.

Substitute Goods (Cross-Price Elasticity)

Goods that have a positive cross-price elasticity of demand ($\varepsilon_{x/y} > 0$), where an increase in the price of one good causes an increase in demand for the other (e.g., iPhones and Samsung phones).

Complement Goods (Cross-Price Elasticity)

Goods that have a negative cross-price elasticity of demand ($\varepsilon_{x/y} < 0$), where an increase in the price of one good causes a decrease in demand for the other (e.g., iPhones and Apple App Store apps).

Unrelated Goods (Cross-Price Elasticity)

Goods that have a cross-price elasticity of demand equal to zero ($\varepsilon_{x/y} = 0$), indicating that a price change in one good has no effect on the consumption of the other (e.g., iPhones and peanut butter).

Income Elasticity ($\varepsilon_I$)

A measure of the sensitivity of consumer quantity demanded to changes in consumer income, calculated as $\varepsilon_I = \frac{\% \Delta Q_D}{\% \Delta I}$.

Normal Good (Income Elasticity)

A good for which income elasticity is positive ($\varepsilon_I > 0$), indicating that demand increases as consumer income increases; higher values indicate greater luxury.

Inferior Good (Income Elasticity)

A good for which income elasticity is negative ($\varepsilon_I < 0$), indicating that demand falls as consumer income increases (e.g., ramen noodles, generic brands, public transportation).

Price Elasticity of Supply ($\varepsilon_S$)

A non-negative measure of how quantity supplied changes in response to a change in the product's price, calculated as $\varepsilon_S = \frac{\% \Delta Q_S}{\% \Delta P}$.

Determinants of Elasticity of Supply

Factors affecting producer responsiveness: cost to scale up production, conditions in input markets, geographic or market scope of supply (global vs. local), and the passage of time (short run vs. long run).