Exam: Market Efficiency

Question 1

What is market efficiency?

Answer 1

Producing the goods and services that society wants at the lowest possible cost

Question 2

What is an efficient outcome?

Answer 2

It is not possible to make someone better off without making someone else worse off

Question 3

What do economists believe about efficiency?

Answer 3

Economists relate the term efficiency to making the best use of scare resources.

Economists believe that markets are the ‘best’ way to allocate goods and services

Question 4

Why are markets the ‘best’ way to allocate g/s?

Answer 4

Because markets maximise the net benefits to both consumers and producers after allowing for the cost of resources.

No other method can achieve a similar result.

Question 5

Define consumer surplus

Answer 5

Consumer surplus is the difference between what a consumer is willing to pay and what they actually pay.

Question 6

What is the effect of price changes on consumer surplus?

Answer 6

If price falls there will be an increase in consumer surplus because consumers will buy more at a lower price.

Question 7

How is an increase in consumer surplus beneficial?

Answer 7

An increase in consumer surplus means the consumer is ‘better off’, in other words their economic welfare has increased.

Question 8

Define producer surplus

Answer 8

Producer surplus is the difference between what a producer is willing to accept and what they actually receive.

Question 9

How do price changes effect consumer surplus?

Answer 9

If price rises there will be an increase in producer surplus because producers will sell more at a higher price.

Question 10

How is an increase in producer surplus beneficial?

Answer 10

An increase in producer surplus means the producer is ‘better off’, in other words their economic welfare has increased.

Question 11

What is total surplus?

Answer 11

The sum of consumer and producer surplus.
It is the difference between the total benefits and total costs

Question 12

What does total surplus measure?

Answer 12

• The economic welfare that a market creates for consumers and producers.
• The net benefits society receives after taking into account the cost of resources.
• Economic efficiency which occurs when total surplus is maximised

Question 13

Define deadweight loss (DWL):

Answer 13

A loss of total economic welfare that happens when the market is not operating at its most efficient level

Question 14

Why causes the market to not operate efficiently?

Answer 14

This is usually due to government intervention through a tax, subsidy, price ceiling or price floor

Question 15

What happens when the market is in equilibrium?

Answer 15

The amount of goods produced and consumed maximises total surplus.

Question 16

What is the effect of a tax on the market?

Answer 16

When a tax is introduced, it creates a difference between the price consumers pay and the price producers receive. Because of the tax, some mutually beneficial trades no longer happen

Question 17

What does deadweight loss represent?

Answer 17

The loss of potential economic value because the tax prevents the mutually beneficial exchange.

Question 18

Why are competitive markets said to be ‘ideal’?

Answer 18

Total surplus equals consumer surplus plus producer surplus. It is a maximum only at the equilibrium output.

Question 19

What happens if the market is prevented from equilibrium?

Answer 19

It will create a deadweight loss (a decrease in total surplus)

Question 20

How does market equilibrium maximise total surplus?

Answer 20

By ensuring that resources are allocated in a way that benefits to both consumers and producers

Ensures that both the quantity of goods produced and consumed, and the price at which they are traded, are the most efficient in terms of maximising total surplus.

Question 21

What happens to total surplus when the market is at equilibrium?

Answer 21

Consumer surplus and producer surplus are both maximised.

Ensures goods are allocated efficiently with no over/underproduction, leading to the highest possible total benefit for both consumers and producers.

The market price matches the value consumers place on a product and the cost of production.

Allows consumers to gain maximum value (consumer surplus), while producers earn the most benefit (producer surplus) by selling at a price that covers cost and provides a profit.

Question 22

How does overproduction happen?

Answer 22

When goods or services are produced beyond the efficient quantity, which occurs at the point where marginal cost equals the marginal benefit.

Question 23

What is the efficient quantity of production?

Answer 23

The point where marginal cost equals marginal benefit.

Question 24

What commonly causes overproduction?

Answer 24

Subsidies or price controls that encourage companies to produce more than is ideal for society.

Question 25

Why does overproduction lead to inefficiency?

Answer 25

Because it wastes resources on goods valued less than their cost to produce.

Question 26

How does price play a role in overproduction?

Answer 26

If the price is too low, producers may produce more than consumers are willing to buy

Question 27

What is the result of overproduction in terms of market supply?

Answer 27

It leads to excess supply.

Question 28

What happens when the marginal cost of production exceeds the marginal benefit to consumers?

Answer 28

Overproduction occurs, leading to resource waste and inefficiency.

Question 29

What is underproduction?

Answer 29

It’s when fewer goods or services are produced than the efficient or ideal amount.

Question 30

What often causes underproduction in markets?

Answer 30

Price controls like price ceilings or the market ignoring external factors.

Question 31

In underproduction, how do marginal benefit and marginal cost compare?

Answer 31

Marginal benefit exceeds marginal cost.

Question 32

What does it mean when the marginal benefit exceeds the marginal cost?

Answer 32

Consumers value the good more than it costs to produce, but not enough is being produced.

Question 33

What are the effects of underproduction on prices and consumers?

Answer 33

Prices may be too high for most consumers, and not enough goods are produced to meet demand.

Question 34

Why does underproduction result in inefficiency?

Answer 34

Because resources aren’t fully used to produce goods that consumers want, wasting economic potential.

Question 35

What type of economic loss is caused by underproduction?

Answer 35

Deadweight loss

Question 36

What is the result of underproduction in terms of market demand?

Answer 36

Leads to an excess demand, where consumers who value the good more than its cost cannot access it.

Question 37

Why do governments levy taxes on goods and services?

Answer 37

To raise revenue for government spending programs

Question 38

What is the effect of tax on prices?

Answer 38

When demand is inelastic, consumers bear more of the tax burden. However, when demand is elastic the burden of tax falls on producers.

Question 39

What is the effect of tax on the quantity demanded by consumers?

Answer 39

Tax increases the price that consumers pay. As the price increases, the quantity demanded usually decrease (law of demand). Consumers may buy less of the taxed good or switch to untaxed alternatives (depending on elasticity of demand)

Question 40

What is the effect of tax on the quantity sold by producers?

Answer 40

Tax also reduces the price sellers receive. This makes selling the good less profitable, so sellers are willing to supply less at each price (law of supply).

Question 41

What is the effect of tax on the equilibrium?

Answer 41

The new equilibrium happens at a lower quantity and usually a higher price for consumers. The exact change in price depends on the elasticities of supply and demand.

Question 42

What is the effect of tax on surpluses?

Answer 42

Buyers pay more and consumer less, reducing consumer surplus. Sellers receive less and sell less, also reducing producer surplus.

Question 43

How does tax create a deadweight loss?

Answer 43

Tax revenue becomes less than the lost consumer and producer surplus, meaning tax is inefficient because consumption and production is lower.

Question 44

Why should tax be imposed?

Answer 44

Tax should be imposed to try minimising the deadweight loss

Question 45

How can deadweight loss caused by tax be minimised?

Answer 45

By placing taxes on goods with relatively inelastic demand minimising the impact on quantity.

Question 46

What is a subsidy?

Answer 46

Subsidies are a grant paid by the government to a producer with the purpose of reducing costs and increasing output; also known as a negative tax.

Question 47

What is the effect of a subsidy on price?

Answer 47

A subsidy lowers the price that consumers pay, making the product more affordable, so demand may increase. It also increases the price producers receive, encouraging more supply.

Question 48

What is the effect of a subsidy on the equilibrium price?

Answer 48

A subsidy causes the equilibrium price to fall, consumers pay less, producers supply more, and the government pays the difference

Question 49

What is the effect of a subsidy on elastic demand?

Answer 49

If demand is elastic, the subsidy cause a substantial increase in quantity sold, leading to a higher total subsidy expenditure by the government.

Question 50

What is the effect of a subsidy on surpluses?

Answer 50

Buyers pay less and consume more, leading to an increase consumer surplus. Sellers receive more and sell more, also leading to an increase in producer surplus.

Question 51

How do subsidies create a deadweight loss?

Answer 51

Subsidy costs becomes greater than the combined increase in consumer and producer surplus

Question 52

What is a price ceiling?

Answer 52

A legislated maximum price that sellers are allowed to change in a market.

Question 53

Who benefits from a price ceiling?

Answer 53

They are designed to benefit consumers by keeping the price below the market clearing or equilibrium price - Often done to help low-income earners

Question 54

What role do consumers play in the implementation of price ceilings?

Answer 54

Consumers may have pressured the government to reduce the market price for an important good or service.

Question 55

How do price ceilings effect quantity?

Answer 55

A price ceiling results in a shortage At the lower price ceiling, consumers want to buy more because the good is cheaper than usual. Producers want to supply less because they're earning less per unit

Question 56

How do price ceilings effect surpluses?

Answer 56

Some consumers will benefit from a price celling if they can buy the limited quantity at the lower price. Some will lose because the quantity supplied is reduced. Producers will also lose because they sell less at a lower price.

Question 57

How do price ceilings create a deadweight loss?

Answer 57

The total surplus is decreased because quantity has fall. Price celling is therefore inefficient, often leading to black market prices.

Question 58

What is a price floor?

Answer 58

A price floor is a legislated minimum price that sellers are allowed to charge in the market.

Question 59

Who benefits from a price floor?

Answer 59

They are designed to benefit producers by keeping the price above the market clearing or equilibrium price. - Often done to help boost income for specific producers

Question 60

What role do producers play in the implementation of price floors?

Answer 60

Produces may have pressured the government to increase the market price for an important good or service.

Question 61

How do price floors effect quantity?

Answer 61

A price floor results in a surplus At the higher price floor, producers want to supply more because they receive a higher price. Consumers want to buy less because the product is now more expensive.

Question 62

What is the effect of a price floor on surpluses?

Answer 62

All consumers will lose from a price floor because they have to pay more and consume less. Producers will gain from the higher price but may lose from lower quantity depending on whether demand is price elastic or inelastic.

Question 63

How does a price floor create a deadweight loss?

Answer 63

The total surplus is decreases because quantity has fallen. A price floor is therefore inefficient.