Chapter 4 - Economic Efficiency, Government Price Setting, and Taxes Flashcards
Price ceiling
A legally determined maximum price
that sellers may charge
Price floors
A legally determined minimum price
that sellers may receive
What happens when government imposes a price ceiling or price floor?
The amount of economic surplus in a
market is reduced
Consumer surplus
The difference between the highest price a consumer is willing to pay for a good or service and the price the consumer actually pays.
Consumer surplus represents the benefit to consumers in excess of the price they paid to purchase the product
Marginal benefit
The additional benefit to a consumer from consuming one more unit of a good or service.
Consumers are willing to purchase a product up
to the point where the marginal benefit of
consuming a product is equal to its price
Consumer surplus in graphs
The total amount of consumer surplus in a market is equal to the area below the demand curve and above the market price
Producer surplus
The difference between the lowest price a firm would be willing to accept for a good or service and the price it actually receives.
Producer surplus represents the benefit to sellers in excess of the price they paid to produce the product
Marginal cost
The additional cost to a firm of producing one more unit of a good or service
Producer surplus in graphs
The total amount of producer surplus in a market is equal to the area above the market supply curve and below the market price
What happens if MB = MC?
At MB = MC, the supply curve and demand curve will both be at the same point in a graph which means an economically efficient level of output.
In this case, quantity supplied equals quantity delivered. Marginal benefit (MB) is represented by every point on the demand curve while marginal cost (MC) is represented by every point on the supply curve.
What happens if MB > MC?
When MB > MC, the cost increases, the demand decreases and supply increases. There is a surplus in quantity and lowering the price is recommended.
This output is inefficiently low.
What happens if MB < MC?
When MB < MC, the cost decreases, the demand increases and supply decreases. There is a shortage in quantity and increasing the price is recommended.
This output inefficiently high.
Economic surplus
The sum of consumer surplus and producer surplus
Economic efficiency
A market outcome in which the marginal benefit to consumers of the last unit produced is equal to its marginal cost of production and in which the sum of consumer surplus and producer surplus is at a maximum
Deadweight loss
The reduction in economic surplus resulting from a market not being in competitive equilibrium.
If a market is not in equilibrium, there is deadweight loss
What happens if there is a surplus due to the government raising the price floor?
Sometimes government buys surplus of a good to store and sell later
Ex. If the government raises the price of milk from $1 to $1.50 and it creates a surplus
Black market
A market in which buying and selling take place at prices that violate government price regulations
What 3 results occur when the government imposes price floors or price ceilings
- Some people win
- Some people lose
- There is a loss of economic efficiency
Excess burden
Deadweight loss from a tax
When is tax efficient?
A tax is efficient if it imposes a small excess burden relative to the tax revenue it raises
Tax incidence
The actual division of the burden of a tax between buyers and sellers in a market
“If the federal government raises the sales tax on gasoline by $0.25, then the price of gasoline will rise by $0.25. Consumers can’t get by without gasoline, so they have to pay the whole amount of any increase in the sales tax.”
Under what circumstances will the student’s statement be true?
This statement will only be true if the demand curve is a vertical line, meaning quantity doesn’t change. But that is not the case because the demand curve for gasoline is not vertical therefore the statement is incorrect.
When the price of gasoline goes up, demand will go down. Examples of vertical demand curves are parking spots in a parking lot or seats in a movie theatre.
Does It make a difference whether the government
collects a tax from buyers or sellers?
No! Because buyers and sellers will always share the burden of the tax.
