AP Microeconomics Unit 6: Market Failure and the Role of Government

Market Failure

Occurs when the free market fails to allocate resources efficiently, leading to a discrepancy between market equilibrium quantity and socially optimal quantity.

Marginal Private Cost (MPC)

The cost incurred by a firm to produce one additional unit of a good.

Marginal Private Benefit (MPB)

The benefit received by consumers from consuming one additional unit of a good.

Marginal Social Cost (MSC)

The total cost to society from the production of a good, including both private and external costs.

Marginal Social Benefit (MSB)

The total benefit to society from the consumption of a good, including both private and external benefits.

Allocatively Efficient

A situation where resources are allocated in a way that maximizes total societal welfare, occurring when MSC equals MSB.

Negative Externality

A situation where the social cost of a good exceeds its private cost, leading to overproduction.

Examples of Negative Externalities

Pollution and smoking, which impose costs on third parties not involved in the transaction.

Deadweight Loss (DWL)

The loss of economic efficiency that occurs when the market equilibrium is not socially optimal.

Per-Unit Tax

A tax imposed on each unit of a good produced, aimed at correcting negative externalities.

Positive Externality

A situation where the social benefit of a good exceeds its private benefit, leading to underproduction.

Examples of Positive Externalities

Education and vaccinations that provide societal benefits beyond the individual consumption.

Coase Theorem

Proposes that if property rights are well-defined and transaction costs are low, private parties can negotiate solutions to externalities without government intervention.

Private Goods

Goods that are both rivalrous and excludable, like pizza and cars.

Public Goods

Goods that are non-rivalrous and non-excludable, leading to underproduction in private markets.

Free-Rider Problem

A phenomenon where individuals benefit from a good without contributing to its cost, relevant in the context of public goods.

Common Resources

Resources that are rivalrous but non-excludable, like fish in the ocean, leading to potential overuse.

Tragedy of the Commons

A situation where individuals over-consume a common resource, leading to its depletion.

Government Intervention

Actions taken by the government to correct market failures, which may include taxes, subsidies, and regulations.

Per-Unit vs Lump-Sum Tax

Per-Unit taxes affect marginal costs and output, while Lump-Sum taxes only affect fixed costs and do not change output.

Price Ceiling

A government-imposed limit on how high a price can be charged, typically leading to shortages.

Price Floor

A government-imposed limit on how low a price can be charged, typically leading to surpluses.

Sherman Antitrust Act

Legislation aimed at preventing monopolies and promoting competition in the marketplace.

Income Inequality

The unequal distribution of income within a population, often measured by the Lorenz curve.

Lorenz Curve

A graphical representation showing the distribution of income or wealth, with perfect equality represented by a 45-degree line.

Gini Coefficient

A numerical measure of income inequality ranging from 0 (perfect equality) to 1 (perfect inequality).

Sources of Income Inequality

Factors contributing to disparities in income include differences in education, discrimination, inheritance, and market power.

Progressive Tax

A tax system where higher income earners pay a larger percentage of their income in taxes, reducing inequality.

Proportional (Flat) Tax

A tax system where everyone pays the same percentage of their income in taxes, having no effect on relative inequality.

Regressive Tax

A tax system where lower income earners pay a larger percentage of their income in taxes, increasing inequality.

Marginal External Cost

The cost imposed on society for the production of an additional unit of a good due to negative externalities.

Marginal External Benefit

The benefit to society for the consumption of an additional unit of a good due to positive externalities.

Deadweight Loss Arrow Direction

Points toward the socially optimal point where MSC equals MSB.

Public Goods Definition

Non-rival and non-excludable goods that are often underprovided by private markets.

Significance of MSC/MPC and MSB/MPB

Important distinctions to make in economic analysis, especially in free response answers.

Elasticity Impact on Tax Incidence

The degree to which demand or supply responds to price changes affects the distribution of tax burdens.

Shortage Result of Price Ceiling

A situation that arises when the price set is below the equilibrium price, creating excess demand.

Surplus Result of Price Floor

A situation that occurs when the price set is above the equilibrium price, creating excess supply.

Income Productivity Relation

Markets reward individuals based on their productivity, which leads to variations in income distribution.

Transaction Costs in Externalities

Costs incurred during bargaining to resolve externalities, significant in the application of the Coase Theorem.

Market Power Causes

Strong unions or monopolies that influence wages and income distribution in a market.

Socially Optimal Quantity

The quantity of a good produced where the social cost equals the social benefit, maximizing total welfare.

Government Revenue from Taxes

Funds gathered from taxes that are often used to address issues arising from market failures.