Market intervention Flashcards
What is welfare in economic terms?
The net benefit to buyers and sellers who engage in economic transactions
This is measured through consumer and producer surplus.
Define consumer surplus.
The difference between the maximum price a consumer is willing to pay and the price they actually pay
Reflects the marginal benefit to the consumer.
Define producer surplus.
The difference between the lowest price a seller is willing to sell for and the price actually received
Reflects the marginal benefit to the seller.
What is allocative efficiency?
Occurs when marginal benefit equals marginal cost (MB = MC)
This is consistent with free market equilibrium.
What is deadweight loss (DWL)?
The loss of potential surplus that is not transferred to any party, i.e., not enjoyed by anyone
It measures inefficiency in the market.
How do governments intervene in markets?
By placing restrictions on prices, quantities, implementing taxes, and providing subsidies
This is done to improve market efficiency or fairness.
What is a price ceiling?
A government-mandated maximum price
If the market price exceeds this ceiling, it may have no effect.
What is a price floor?
A government-mandated minimum price
If the market price is below this floor, it may have no effect.
What happens when a price ceiling is imposed?
A shortage develops if the ceiling is below the equilibrium price
This leads to a loss of allocative efficiency.
What are the consequences of rent controls?
Shortages develop, and a black market may emerge
Consumers may pay bribes to secure housing.
What is the effect of a price floor on wool prices?
A surplus may develop if the price floor is above the equilibrium price
This can lead to stockpiles of unsold wool.
What are the three types of efficiency in economics?
- Allocative efficiency
- Productive efficiency
- Dynamic efficiency
Allocative efficiency is focused on in this context.
What does it mean when MB > P for the last ticket sold?
It indicates that there is a potential surplus that could be enjoyed by both buyers and sellers
This situation suggests allocative inefficiency.
What is market failure?
A situation where markets fail to deliver allocative efficiency
Governments may intervene to correct this.
What is a tax in economic terms?
An added cost that drives a wedge between the price paid by buyers and the price received by sellers
It typically leads to a decrease in quantity traded.
What is a subsidy?
An added benefit that drives a wedge between the price paid by sellers and the price paid by buyers
It encourages production and consumption.
Fill in the blank: Total economic surplus is maximized when the market is in _______.
equilibrium
True or False: Allocative efficiency is achieved when MB = MC.
True
True or False: A black market can develop as a result of a price ceiling.
True
How does a quota affect market equilibrium?
It restricts the quantity supplied, potentially leading to a shortage
Consumers may be willing to pay more than the regulated price, leading to black market activity.
What is a tax in economic terms?
An artificial added cost that drives a wedge between the price paid by buyers (PB) and the price received by sellers (PS).
What is the formula for tax (t)?
Tax (t) = PB - PS.
What happens to sellers and buyers in a taxed market?
Sellers receive less and buyers pay more, resulting in losses for both.
What is the effect of a tax on quantity?
A tax is a contractionary policy tool that produces a decrease in quantity (Q).
What is a subsidy in economic terms?
An artificial added benefit that drives a wedge between the price paid by sellers (PS) and the price paid by buyers (PB).
What is the formula for subsidy (s)?
Subsidy (s) = PS - PB.
What happens to sellers and buyers in a subsidized market?
Sellers receive more and buyers pay less, resulting in benefits for both.
What is the effect of a subsidy on quantity?
A subsidy is an expansionary policy tool that produces an increase in quantity (Q).
How is a tax typically implemented?
Assumed as a ‘flat tax’ charged directly from the producer when a good is produced.
What is the economic implication of where taxes are levied?
It does not matter whether taxes are on consumers or producers; the economic implications are the same.
What happens to the supply curve when a tax is implemented?
The supply curve shifts upward by the amount of the tax.
What is the impact of a tax on the equilibrium quantity?
It reduces both quantity demanded (QD) and quantity supplied (QS).
What happens to consumer surplus (CS) and producer surplus (PS) after a tax is imposed?
CS decreases and PS decreases.
What becomes of the areas that were part of CS and PS before tax?
They become government tax revenue and deadweight loss (DWL).
What is a price floor?
A government stipulation of a minimum allowed price.
What is the incentive behind a price floor?
To provide ‘insurance’ for producers.
What is a potential problem with a price floor?
It can lead to surplus (excess supply).
What is a price ceiling?
A government stipulation of a maximum allowed price.
What is the incentive behind a price ceiling?
To provide ‘insurance’ for consumers.
What is a potential problem with a price ceiling?
It can lead to shortage (excess demand).
What are quantity restrictions?
Government-imposed limits on the quantity produced or sold.
What is the definition of prohibition in economic terms?
Government prohibits buying and/or selling of a good/service.
What is a mandate?
Government makes an activity compulsory by law.
What are quotas?
Government stipulates a maximum allowed quantity produced.
What are permits in economic regulation?
Government issues licenses to allow production/consumption.
How do taxes and subsidies differ from price floors and ceilings?
Taxes and subsidies are flexible interventions that adjust observed prices.
What is the overall effect of a tax on total surplus (TS)?
It usually results in a decrease in total surplus and an increase in deadweight loss.
What happens to market equilibrium after a subsidy is imposed?
The market adjusts to a new equilibrium with increased quantity.
What is the impact of a subsidy on consumer and producer surplus?
Consumer surplus increases and producer surplus increases.
What is the deadweight loss associated with subsidies?
It arises because marginal cost (MC) is greater than marginal benefit (MB).
What is the equilibrium price when QD = QS?
Equilibrium occurs when quantity demanded equals quantity supplied.
What is the formula for consumer surplus (CS)?
CS = (Maximum price - Equilibrium price) * Quantity sold * 0.5.
What happens to prices when a tax is implemented?
Buyer price (PB) increases and seller price (PS) decreases.
What is the new price buyers pay after a tax is imposed?
The price is determined by the demand curve adjusted for the tax.
What is the new price sellers receive after a tax is imposed?
The price is determined by the supply curve adjusted for the tax.
How is total surplus (TS) calculated after a tax is imposed?
TS = Consumer Surplus + Producer Surplus + Government Revenue.
What is the net welfare effect of a tax?
It generally results in a net welfare loss due to deadweight loss.
