AP Micro Unit 6

Negative Externality

A cost imposed on a third party not in the transaction. Producers don't pay the full social cost → overproduction. Fix: per-unit tax to shift supply left.

Positive Externality

A benefit received by a third party. Consumers don't capture all social benefits → underproduction. Fix: subsidy to shift demand or supply right.

Socially Optimal Quantity

Where MSB = MSC (Marginal Social Benefit = Marginal Social Cost). This maximizes total value to society.

2 Characteristics of a Public Good

Non-rival and Non-excludable Examples: national defense, street lights.

Free Rider Problem

People can benefit from a good without paying for it (because it's non-excludable). This leads private firms to underproduce or not produce public goods at all → government must provide.

Tragedy of the commons

Common resources are rival but non-excludable. Each user rationally overuses since they don't bear the full social cost → resource depletes. Examples: overfishing, groundwater depletion.

What does a per-unit tax do to a supply curve?

Shifts supply LEFT (up) by the amount of the tax. Raises the price consumers pay, lowers the price producers receive. Creates deadweight loss. Tax revenue = tax × Qtax.

What does a lump-sum tax do?

Changes fixed costs only. Does NOT shift the supply curve. Does NOT change equilibrium P or Q. Does NOT create deadweight loss. Only reduces profit.

Who bears more of the tax burden?

MORE INELASTIC side bears more of the burden.

Inelastic demand → consumers pay more. Inelastic supply → producers pay more.

3 Monopoly Regualtions Prices

1) Pm (MR=MC): profit max, highest price, lots of DWL. 2) Pfr (P=ATC): fair return, zero profit, some DWL. 3) Pso (P=MC): socially optimal, no DWL but monopoly earns a loss — needs lump-sum subsidy.

Should the government use a per-unit subsidy or per-unit tax to get a natural monopoly to produce the socially optimal quantity?

It lowers the monopoly's marginal cost, moving MR=MC intersection to higher output closer to Qso. A per-unit tax raises MC and makes it worse.

Lorenze Curve

A graph plotting cumulative % of income against cumulative % of households. The 45° diagonal = perfect equality. The further the curve bows away from the diagonal, the MORE unequal the distribution.

Gini Coefficient

Area A ÷ (Area A + Area B) on the Lorenz curve. 0 = perfect equality, 1 = perfect inequality. A progressive tax shifts the Lorenz curve toward the diagonal.

Progressive Tax

Average tax rate INCREASES as income increases. Reduces after-tax income inequality. Shifts Lorenz curve toward the equality line. Example: U.S. federal income tax.

Regressive Tax

Average tax rate DECREASES as income increases. Lower-income earners pay a higher % of income. Worsens inequality. Example: sales tax, payroll tax with an income cap.

Coase Theorem

If property rights are well-defined and transaction costs are low, private parties will bargain to the efficient outcome WITHOUT government intervention. Fails when many parties are involved or transaction costs are high.