AP Microeconomics Unit 6 Notes: Government Actions, Efficiency, and Equity

Government intervention

Use of laws, taxes, spending, or regulations to change market outcomes (affecting equilibrium price/quantity, efficiency/total surplus, and equity/who gains or loses).

Incentives

The costs, benefits, restrictions, or rewards that influence buyers’ and sellers’ behavior; the first thing to analyze when a policy is introduced.

Price control

A legal minimum or maximum price set by the government (includes price ceilings and price floors).

Price ceiling

A maximum legal price, typically intended to make a good more affordable; if binding, it creates a shortage.

Binding price ceiling

A price ceiling set below the equilibrium price; it reduces quantity supplied, increases quantity demanded, and causes a shortage (traded quantity equals Qs).

Nonbinding price ceiling

A price ceiling set above the equilibrium price; it does not change the market outcome.

Shortage

A situation where quantity demanded exceeds quantity supplied at a given price; under a binding price ceiling: Shortage = Qd − Qs.

Non-price rationing

Methods of allocating goods when prices can’t clear the market (e.g., waiting in line, favoritism, lotteries, search costs).

Price floor

A minimum legal price, often intended to raise sellers’ incomes; if binding, it creates a surplus.

Binding price floor

A price floor set above the equilibrium price; it raises quantity supplied, lowers quantity demanded, and causes a surplus (traded quantity equals Qd).

Surplus

A situation where quantity supplied exceeds quantity demanded at a given price; under a binding price floor: Surplus = Qs − Qd.

Minimum wage

A price floor in the labor market (wage is the “price” of labor); if binding, it can create unemployment (a surplus of labor).

Per-unit tax

A fixed tax charged on each unit bought or sold; it creates a wedge between the price buyers pay and the price sellers receive and reduces quantity traded.

Tax wedge (Pb = Ps + t)

The gap created by a per-unit tax where the buyer price equals the seller price plus the tax (Pb is price paid by buyers, Ps is price received by sellers, t is the tax).

Tax incidence

Who actually bears the burden of a tax; determined by relative elasticity, not by who legally remits the tax to the government.

Elasticity (relative elasticity)

How responsive quantity demanded or supplied is to price; the more inelastic side of the market bears more of a tax burden.

Tax revenue

Government revenue from a tax, equal to t × Qtax (tax per unit times the quantity traded after the tax).

Deadweight loss (DWL) from a tax

The net loss in total surplus from mutually beneficial trades that no longer occur because the tax reduces quantity; on a standard graph it is a triangle.

Subsidy

A per-unit payment that encourages more buying or selling; like a negative tax wedge (Pb = Ps − s) and typically increases quantity traded.

Government outlay (subsidy spending)

Total government spending on a subsidy, equal to s × Qsubsidy (subsidy per unit times the quantity traded with the subsidy).

Quota

A legal limit on the quantity that can be bought, sold, or imported; if binding (below equilibrium quantity), it reduces trades and tends to raise market price.

Permit (tradable permit system)

A system that caps quantity and requires a permit for each unit (or for participation); if permits are tradable, a permit price emerges in a market.

Quota rent

Extra profit earned by holders of the right to sell (or import) when quantity is artificially scarce; with permits, this shows up as the permit price.

Lorenz curve

A graph of cumulative income share (vertical axis) earned by the bottom cumulative share of the population (horizontal axis), used to visualize income inequality.

Gini coefficient

A 0-to-1 summary measure of inequality based on the Lorenz curve: 0 = perfect equality, 1 = perfect inequality; equals the area between the line of equality and the Lorenz curve divided by the total area under the equality line.