unit 2 exam, micro

Consumer Surplus (CS)

The amount a buyer is willing to pay minus the amount the buyer actually pays.

Producer Surplus (PS)

The amount a seller receives minus the seller's cost of producing the good.

Total Surplus

The sum of consumer surplus and producer surplus; measures the total benefit to buyers and sellers.

Willingness to Pay

The maximum price a buyer is willing to pay for a good.

Cost of Production

The minimum amount a seller must receive to be willing to produce a good.

Market Price

The price buyers pay and sellers receive in a competitive market.

Consumer Surplus Formula

Consumer surplus = willingness to pay − price paid.

Producer Surplus Formula

Producer surplus = price received − cost of production.

Total Surplus Formula

Total surplus = consumer surplus + producer surplus.

Consumer Surplus on a Graph

The area below the demand curve and above the market price, up to the quantity purchased.

Producer Surplus on a Graph

The area above the supply curve and below the market price, up to the quantity sold.

Total Surplus on a Graph

The area between the demand and supply curves, up to the quantity traded.

Demand Curve and Willingness to Pay

The demand curve shows buyers' willingness to pay for each unit.

Supply Curve and Cost

The supply curve reflects sellers' costs of producing each unit.

How to Calculate Consumer Surplus for One Buyer

Subtract the market price from the buyer's willingness to pay.

How to Calculate Producer Surplus for One Seller

Subtract the seller's cost from the market price.

Consumer Surplus Example

A buyer values a product at $50 and pays $35. Consumer surplus = $15.

Producer Surplus Example

A seller's cost is $20 and the selling price is $32. Producer surplus = $12.

Total Surplus Example

Consumer surplus is $15 and producer surplus is $12. Total surplus = $27.

Consumer Surplus with Multiple Buyers

Add the consumer surplus of every buyer who purchases the good.

Producer Surplus with Multiple Sellers

Add the producer surplus of every seller who sells the good.

Surplus from a Demand and Supply Table

For each unit traded, subtract the buyer's willingness to pay and seller's cost to find the potential gains from trade.

Efficient Quantity

The quantity that maximizes total surplus.

Market Equilibrium

The point where quantity demanded equals quantity supplied.

Competitive Equilibrium

A market equilibrium in which buyers and sellers take the market price as given.

Invisible Hand

The idea that prices and self-interest can guide markets toward efficient outcomes.

First Welfare Theorem

Under certain conditions, competitive markets allocate resources efficiently.

Second Welfare Theorem

Under certain conditions, any efficient allocation can be achieved through redistribution followed by competitive markets.

Why Competitive Equilibrium Can Be Efficient

It maximizes total surplus when the standard assumptions of competitive markets hold.

Marginal Buyer

The buyer who would leave the market if the price increased slightly.

Marginal Seller

The seller who would leave the market if the price decreased slightly.

Efficient Trade

A trade where the buyer's willingness to pay is at least as high as the seller's cost.

Inefficient Trade

A trade that reduces total surplus, such as producing a good when its cost exceeds the buyer's value.

Underproduction

Producing less than the efficient quantity means some beneficial trades do not occur.

Overproduction

Producing more than the efficient quantity can create costs greater than the benefits of extra units.

Deadweight Loss (DWL)

The reduction in total surplus caused by a market distortion or inefficient quantity.

Deadweight Loss on a Graph

The area of lost gains from trade, commonly a triangle between supply and demand over units not traded.

Causes of Deadweight Loss

Taxes, tariffs, price controls, and externalities can cause deadweight loss.

Tax

The government requires buyers or sellers to pay money per unit or through another tax structure.

Tax Revenue

Tax revenue = tax per unit × quantity sold, for a per-unit tax.

Tax Wedge

The difference between the price buyers pay and the price sellers receive because of a tax.

Tax Incidence

How the burden of a tax is divided between buyers and sellers.

Tax Burden and Elasticity

The less elastic side of the market bears more of the tax burden.

Deadweight Loss from a Tax

A tax reduces the quantity traded and eliminates some mutually beneficial trades.

Elastic Demand

Demand is elastic when quantity demanded responds strongly to a price change.

Inelastic Demand

Demand is inelastic when quantity demanded responds weakly to a price change.

Elastic Supply

Supply is elastic when quantity supplied responds strongly to a price change.

Inelastic Supply

Supply is inelastic when quantity supplied responds weakly to a price change.

International Trade

The exchange of goods and services between countries.

World Price

The price of a good in the international market.

Autarky

An economy that does not trade internationally.

Domestic Price without Trade

The price determined by domestic supply and demand when international trade is absent.

Price Taker

A buyer or seller who cannot individually influence the market price.

How to Determine Whether a Country Imports or Exports

Compare the world price with the domestic price before trade.

Country Becomes an Exporter

When the world price is higher than the domestic no-trade price, the country exports the good.

Country Becomes an Importer

When the world price is lower than the domestic no-trade price, the country imports the good.

Exports

Goods produced domestically and sold to other countries.

Imports

Goods produced in other countries and purchased domestically.

Effect of Exports on Domestic Price

The domestic price rises toward the world price.

Effect of Imports on Domestic Price

The domestic price falls toward the world price.

Effect of Exports on Domestic Producers

Domestic producers benefit because they can sell at a higher price.

Effect of Exports on Domestic Consumers

Domestic consumers lose surplus because the domestic price rises.

Effect of Imports on Domestic Consumers

Domestic consumers benefit because they can buy at a lower price.

Effect of Imports on Domestic Producers

Domestic producers lose surplus because they face a lower price and greater competition.

Gains from International Trade

Trade can increase total surplus by allowing countries to specialize and exchange goods.

Who Benefits from Free Trade?

The gains are often large enough to benefit the country overall, but some groups gain while others lose.

Tariff

A tax on imported goods.

Effect of a Tariff on Imports

A tariff raises the domestic price and reduces the quantity of imports.

Effect of a Tariff on Domestic Producers

Domestic producers generally benefit from the higher price.

Effect of a Tariff on Domestic Consumers

Domestic consumers generally lose because they pay a higher price.

Tariff Revenue

The government collects revenue on imported units subject to the tariff.

Deadweight Loss from a Tariff

The loss in total surplus caused by reduced consumption and inefficient extra domestic production.

Import Quota

A legal limit on the quantity of a good that can be imported.

Free Trade

International trade without tariffs, quotas, or similar trade restrictions.

Arguments for Trade Restrictions

Protecting jobs or infant industries, national security, and responding to unfair foreign trade practices.

Arguments Against Trade Restrictions

Restrictions raise prices, reduce competition, and can reduce total surplus.

Externality

A cost or benefit of an economic activity that affects a third party not directly involved in the transaction.

Negative Externality

An external cost imposed on third parties.

Positive Externality

An external benefit received by third parties.

Private Cost

The cost directly paid by the producer or consumer making the decision.

External Cost

The cost imposed on people outside the transaction.

Social Cost

Private cost + external cost.

Private Benefit

The benefit received directly by the buyer or seller involved in the transaction.

External Benefit

A benefit received by third parties who are not directly involved.

Social Benefit

Private benefit + external benefit.

Marginal Private Cost (MPC)

The cost to the producer of making one additional unit.

Marginal Social Cost (MSC)

The total cost to society of making one additional unit, including external costs.

Marginal Private Benefit (MPB)

The benefit received by the direct consumer from one additional unit.

Marginal Social Benefit (MSB)

The total benefit to society from one additional unit, including external benefits.

Negative Production Externality

Production imposes external costs, so the market produces more than the socially efficient quantity.

Positive Production Externality

Production creates external benefits, so the market may produce less than the socially efficient quantity.

Negative Consumption Externality

Consumption imposes external costs, so the market consumes more than the socially efficient quantity.

Positive Consumption Externality

Consumption creates external benefits, so the market consumes less than the socially efficient quantity.

Market Failure

A situation where the market fails to allocate resources efficiently.

Efficient Quantity with a Negative Externality

The quantity where marginal social cost equals marginal social benefit; it is usually below the market quantity.

Efficient Quantity with a Positive Externality

The quantity where marginal social benefit equals marginal social cost; it is usually above the market quantity.

Corrective Tax

A tax designed to make decision-makers account for the external costs they create.

Pigovian Tax

A corrective tax intended to bring private incentives in line with social costs.

Corrective Subsidy

A payment designed to encourage an activity that creates external benefits.