AP Microeconomics – Unit 6 Market Failure and the Role of Government

These flashcards cover key concepts from AP Microeconomics Unit 6 on market failure and the role of government, helping students understand and memorize important economic terms and principles.

Social Efficiency

A market outcome is socially efficient when resources are allocated to maximize total surplus to society.

Marginal Social Benefit (MSB)

The additional benefit to society from the consumption of one more unit of a good.

Marginal Social Cost (MSC)

The additional cost to society from the production of one more unit of a good.

Allocative Efficiency

Achieved when MSB equals MSC, resulting in no deadweight loss.

Market Failure

Occurs when a free market fails to allocate resources efficiently, leading to different outcomes like overproduction or underproduction.

Deadweight Loss

A loss of economic efficiency that can occur when the equilibrium for goods or services is not achieved or is not achievable.

Market Power

The ability of firms to control price and supply, often leading to less output and higher prices.

Asymmetric Information

A situation where one party in a transaction has more or better information than the other party.

Externality

A cost or benefit that affects a third party who did not choose to incur that cost or benefit.

Public Goods

Goods that are both nonrivalrous and nonexcludable, such as national defense.

Free Rider Problem

Occurs when individuals can benefit from a resource without paying for it, leading to underproduction of public goods.

Rivalrous Goods

Goods where one person's consumption reduces the availability for others.

Nonrivalrous Goods

Goods where one person's consumption does not reduce availability for others.

Excludable Goods

Goods that can be withheld from those who do not pay for them.

Nonexcludable Goods

Goods that cannot easily be withheld from those who do not pay for them.

Negative Externalities

External costs imposed on third parties by a transaction.

Positive Externalities

External benefits received by third parties from a transaction.

Per-Unit Tax

A tax imposed on each unit of a good or service produced.

Subsidy

A government payment to producers to encourage increased production.

Price Ceiling

A government-imposed limit on how high a price can be charged for a product.

Price Floor

A government-imposed limit on how low a price can be charged for a product.

Gini Coefficient

A measure of income inequality within a population.

Progressive Tax

A tax system where higher incomes are taxed at higher rates.

Regressive Tax

A tax system where lower incomes are taxed at higher rates.

Socially Efficient Market Outcome

Occurs when resources are allocated in a way that maximizes total societal surplus, where Marginal Social Benefit (MSB) equals Marginal Social Cost (MSC).

Socially Inefficient Market Outcome

Occurs when resources are not allocated efficiently, leading to deadweight loss and either overproduction or underproduction of goods.

Market Failure

A situation where the allocation of goods and services by a free market is not efficient, often due to externalities, public goods, or market power.

Negative Externalities in Production

Costs that producers impose on third parties during the production of goods, resulting in a social cost higher than private cost.

Negative Externalities in Consumption

Costs that consumers impose on third parties when consuming goods, creating a social cost that exceeds the private cost.

Positive Externalities in Production

Benefits that producers confer on third parties during production, leading to a social benefit greater than private benefit.

Positive Externalities in Consumption

Benefits that consumers provide to third parties through consumption, resulting in a social benefit that exceeds private benefit.

Correcting Externalities with Taxes

Imposing tax on goods that generate negative externalities to reduce production and consumption to socially optimal levels.

Correcting Externalities with Subsidies

Providing financial incentives to encourage production or consumption of goods with positive externalities.

Free Rider Problem

Occurs when individuals benefit from resources, goods, or services without paying for them, often leading to the underprovision of public goods.

Government Intervention in Markets

Actions taken by government to influence economic activity, often to correct market failures or achieve social welfare objectives.

Per-Unit Tax

A tax applied to each unit produced, intended to reduce the quantity of negative externalities in the market.

Subsidies

Financial support provided by the government to encourage production or consumption of specific goods, often to promote positive externalities.

Income Distribution

The way in which total income is distributed among the members of an economy, often measured to assess equality.

Lorenz Curve

A graphical representation of income distribution, showing the proportion of total income earned by cumulative percentages of the population.

Gini Coefficient

A quantitative measure of income inequality, where 0 represents perfect equality and 1 represents maximum inequality.

Tax Revenue

The income generated from taxes imposed by the government, which can be used for public services and expenditures.

Subsidy Spending

Financial support provided by the government to encourage specific economic activities or sectors, often intended to increase production or consumption of certain goods.

Interpretation of Deadweight Loss Graph

The area of the deadweight loss triangle illustrates the lost economic welfare due to market inefficiency, typically resulting from overproduction or underproduction of goods.

What does the deadweight loss triangle on the supply and demand graph signify?

The deadweight loss triangle indicates economic inefficiency when the market is not at equilibrium. It represents lost welfare, as the quantity produced and consumed is less than the social optimum due to distortions like taxes or subsidies.

How is the area representing total tax revenue shown on a supply and demand graph, and what does it depend on?

Total tax revenue appears as a trapezoidal or rectangular area, determined by the per-unit tax and the quantity sold after the tax. The position of demand and supply curves affects the tax burden on consumers and producers.

What does the area between the demand curve and price line represent in a subsidy scenario?

This area reflects the total cost to the government for providing a subsidy. The amount varies based on demand and supply elasticity, showing how effectively the subsidy impacts the market quantity.

What causes the deadweight loss triangle to form, and why is its size important?

The triangle forms due to market inefficiencies, such as taxes or monopolistic practices, leading to quantity deviations from the equilibrium. Its size indicates the extent of resource misallocation and the associated loss in societal welfare.