Chapter 7 Flashcards
What is welfare economics?
The study of how resource allocation affects economic well-being.
What does market efficiency mean?
When total surplus (consumer + producer surplus) is maximized.
What is total surplus?
The sum of consumer surplus and producer surplus:
[\text{Total Surplus} = \text{Value to Buyers} - \text{Cost to Sellers}]
What is consumer surplus (CS)?
Willingness to pay (WTP) minus the actual price paid.
How is consumer surplus represented graphically?
The area below the demand curve and above the price level.
What happens to consumer surplus when price decreases?
Consumer surplus increases because:
1. Existing buyers pay less.
2. New buyers enter the market.
What is producer surplus (PS)?
The amount sellers receive minus the cost of production.
How is producer surplus represented graphically?
The area above the supply curve and below the price level.
What happens to producer surplus when price increases?
Producer surplus increases because:
1. Existing sellers receive a higher price.
2. New sellers enter the market.
What does the equilibrium price do in a competitive market?
Maximizes total surplus by balancing consumer and producer interests.
How do competitive markets allocate resources efficiently?
They ensure:
1. Goods go to buyers who value them most.
2. Goods are produced by sellers with the lowest costs.
3. The quantity produced maximizes total surplus.
What is Adam Smith’s ‘Invisible Hand’ concept?
Markets naturally allocate resources efficiently without central planning.
What are common causes of market failure?
- Market Power – A firm or group can influence prices.
- Externalities – Actions affect third parties (e.g., pollution).
What happens to efficiency when markets fail?
Market equilibrium is no longer efficient; intervention may be needed.
What is the relationship between consumer surplus and price?
Consumer surplus = WTP - Price.
What is the relationship between producer surplus and cost?
Producer surplus = Price - Cost.
What measures market efficiency?
Total surplus measures market efficiency.
What does the equilibrium price do in competitive markets?
Equilibrium price maximizes total surplus in competitive markets.
What reduces efficiency in markets?
Market failures (monopolies, externalities) reduce efficiency.
What leads to efficient outcomes in markets?
The invisible hand leads to efficient outcomes unless there are market failures.
