4. The analysis of competitive markets

Question 1

What is consumer surplus?

Answer 1

Consumer surplus is the difference between what consumers are willing to pay and what they actually pay.

Question 2

What is producer surplus?

Answer 2

Producer surplus is the difference between what producers are paid and their costs of production.

Question 3

What is deadweight loss?

Answer 3

Deadweight loss is the loss of economic efficiency when the equilibrium outcome is not achieved, often due to taxes, price controls, or subsidies.

Question 4

What is a price support?

Answer 4

A price support is a government policy that sets a minimum price for a good, typically above the equilibrium price, to benefit producers.

Question 5

What is a production quota?

Answer 5

A production quota limits the amount of a good that can be produced, often used to maintain higher prices by restricting supply.

Question 6

What is the impact of a specific tax on market equilibrium?

Answer 6

A specific tax shifts the supply curve upward by the amount of the tax, raising prices for consumers and lowering the price received by producers.

Question 7

What is a subsidy?

Answer 7

A subsidy is a payment from the government to producers or consumers to encourage production or consumption of a good.

Question 8

What is the pass-through formula for a tax?

Answer 8

Pass-through fraction = Es / (Es - Ed), where Es is the elasticity of supply and Ed is the elasticity of demand.

Question 9

What is the formula for deadweight loss due to a tax?

Answer 9

Deadweight loss = B + C, where B and C represent areas of lost consumer and producer surplus.

Question 10

What is an import quota?

Answer 10

An import quota limits the quantity of a good that can be imported into a country, usually to protect domestic industries.

Question 11

What is a tariff?

Answer 11

A tariff is a tax on imported goods, typically used to protect domestic industries and generate government revenue.

Question 12

How do price supports affect government spending?

Answer 12

The government buys the surplus output to maintain the price, costing the government the price support times the quantity difference (PS * (Q2 - Q1)).

Question 13

What is the effect of a minimum price on a competitive market?

Answer 13

A minimum price set above equilibrium creates a surplus, as quantity supplied exceeds quantity demanded.

Question 14

What is the effect of a maximum price on a competitive market?

Answer 14

A maximum price set below equilibrium creates a shortage, as quantity demanded exceeds quantity supplied.

Question 15

What is market failure?

Answer 15

Market failure occurs when the allocation of goods and services is inefficient, often due to externalities, public goods, or monopolies.

Question 16

What is an externality?

Answer 16

An externality is a cost or benefit that affects a third party not directly involved in the economic transaction.

Question 17

How does a tax affect consumer and producer surplus?

Answer 17

A tax reduces both consumer and producer surplus, creating a deadweight loss due to the reduction in trade.

Question 18

How does a subsidy affect market equilibrium?

Answer 18

A subsidy lowers the cost for producers or price for consumers, increasing the equilibrium quantity and potentially leading to overproduction.

Question 19

What is the formula for annual tax revenue?

Answer 19

Annual tax revenue = t * Q, where t is the tax rate and Q is the quantity sold.

Question 20

What are price controls?

Answer 20

Price controls are government-imposed limits on how high or low a price can be, such as maximum or minimum prices.

Question 21

How do price supports affect consumer surplus?

Answer 21

Price supports reduce consumer surplus because the price consumers pay is higher than the market equilibrium price, decreasing the total benefit they receive from the good.

Question 22

How do tariffs influence domestic producers and consumers?

Answer 22

Tariffs benefit domestic producers by raising the price of imported goods, allowing them to compete, but they harm consumers by increasing prices and reducing the variety of goods available.

Question 23

How does a subsidy impact producer surplus?

Answer 23

A subsidy increases producer surplus by effectively lowering production costs, allowing producers to sell more at a lower price while maintaining or increasing profits.

Question 24

What role does elasticity play in the pass-through of a tax?

Answer 24

The pass-through of a tax depends on the relative elasticities of supply and demand; the more inelastic side bears a greater share of the tax burden.

Question 25

How do production quotas create inefficiency in the market?

Answer 25

Production quotas limit the quantity produced below the market equilibrium, leading to a higher price and a deadweight loss due to unmet consumer demand and underutilized resources.

Question 26

How does the imposition of a tax create deadweight loss in a competitive market?

Answer 26

A tax reduces the quantity traded, distorting the market equilibrium and causing a deadweight loss, which represents the lost transactions that would have generated consumer and producer surplus.

Question 27

How can price elasticity of demand and supply affect the size of deadweight loss from a tax?

Answer 27

When demand or supply is more elastic, a tax leads to a larger reduction in quantity traded, increasing the size of the deadweight loss compared to when demand or supply is inelastic.

Question 28

How does a minimum price above equilibrium lead to inefficiency?

Answer 28

A minimum price above equilibrium results in excess supply, as producers supply more than consumers demand at the higher price, leading to unsold goods and wasted resources.

Question 29

How do externalities lead to market failure?

Answer 29

Externalities cause market failure by creating a gap between private and social costs or benefits, leading to overproduction in the case of negative externalities or underproduction with positive externalities.

Question 30

How does a government’s purchase of surplus output with price supports impact overall welfare?

Answer 30

The government’s purchase of surplus output reduces overall welfare by creating inefficiency; consumer surplus decreases, producer surplus increases, and the cost to the government often outweighs the welfare benefits to producers.

Question 31

How would you evaluate the long-term impact of price supports on market efficiency?

Answer 31

Price supports reduce market efficiency in the long term by maintaining artificially high prices, leading to overproduction, government surplus purchases, and misallocation of resources that could have been used more effectively elsewhere.

Question 32

How can the pass-through fraction of a tax help in understanding the burden distribution between consumers and producers?

Answer 32

The pass-through fraction shows how much of the tax is borne by consumers versus producers. If supply is more elastic than demand, consumers bear a larger share of the tax burden, and vice versa.

Question 33

How would you analyze the welfare effects of an import quota on domestic markets?

Answer 33

An import quota benefits domestic producers by limiting foreign competition, but it harms consumers through higher prices and reduced choice. The resulting welfare loss includes deadweight loss from restricted trade and inefficiency in resource allocation.

Question 34

How does the elasticity of demand and supply influence the incidence of a specific tax?

Answer 34

The tax burden falls more on the side of the market (consumers or producers) that is less elastic. A relatively inelastic side bears a larger share of the tax because it is less responsive to price changes.

Question 35

How would you assess the impact of government subsidies on overall market welfare?

Answer 35

Government subsidies increase producer and consumer surplus by lowering prices and increasing output, but they may also lead to overproduction and inefficient resource allocation, potentially causing a deadweight loss if the subsidy is too large.

Question 36

What is the formula for deadweight loss with government intervention?

Answer 36

Deadweight loss = B + C, where B and C represent the areas of lost consumer and producer surplus due to inefficient market outcomes.

Question 37

How do you calculate the change in consumer surplus due to price supports?

Answer 37

ΔCS = -A - B, where A and B represent the areas of consumer surplus lost due to the price being set above equilibrium.

Question 38

How do you calculate the change in producer surplus with price supports?

Answer 38

ΔPS = A + B + D, where A, B, and D are the areas of increased producer surplus due to higher prices and government intervention.

Question 39

What is the formula for the cost to the government with price supports?

Answer 39

Cgovt = PS * (Q2 - Q1), where PS is the price support level, Q2 is the new quantity produced, and Q1 is the original quantity.

Question 40

How do you calculate the welfare change with price supports?

Answer 40

Welfare change = ΔCS + ΔPS - Cgovt = D - PS * (Q2 - Q1), where ΔCS and ΔPS represent changes in consumer and producer surplus, and Cgovt is the cost to the government.

Question 41

How do you calculate the pass-through fraction of a tax?

Answer 41

Pass-through fraction = Es / (Es - Ed), where Es is the elasticity of supply and Ed is the elasticity of demand.

Question 42

How do you determine the new market-clearing conditions after a tax?

Answer 42

After a tax: QD = QD(Pb), QS = QS(Ps), QD = QS, and Pb - Ps = t, where Pb is the price paid by buyers, Ps is the price received by sellers, and t is the tax.

Question 43

How do you calculate annual tax revenue?

Answer 43

Annual tax revenue = t * Q, where t is the tax rate and Q is the quantity sold in the market after the tax.

Question 44

How do you compute the price elasticity of market supply with government controls?

Answer 44

Ep = (ΔQ / ΔP) * (P / Q), where Ep is the price elasticity of supply, Q is the quantity supplied, and P is the price.

Question 45

How do you calculate profit maximization for a firm in a competitive market?

Answer 45

Profit maximization occurs where MR(q) = MC(q), meaning the firm maximizes profit when marginal revenue equals marginal cost at the optimal quantity.