Unit 2 Study Guide: Market Dynamics and Policy Impacts

Market Equilibrium

Occurs when quantity demanded equals quantity supplied, leading to no price change unless an external factor shifts the curves.

Equilibrium Price ($P_e$)

The price at which quantity demanded equals quantity supplied.

Equilibrium Quantity ($Q_e$)

The quantity bought and sold at the equilibrium price.

Surplus

Occurs when the market price is above equilibrium, leading to excess supply.

Shortage

Occurs when the market price is below equilibrium, leading to excess demand.

Consumer Surplus (CS)

The difference between what a consumer is willing to pay and what they actually pay.

Producer Surplus (PS)

The difference between the price a producer receives and the minimum price they were willing to accept.

Total Surplus (Social Surplus)

Total Surplus = Consumer Surplus + Producer Surplus.

Allocative Efficiency

Achieved when total surplus is maximized, occurring in an equilibrium market without interference.

Deadweight Loss

The loss of total surplus resulting from market inefficiencies.

Price Ceiling

A legal maximum price a good can be sold at, aimed at helping consumers.

Binding Price Ceiling

A ceiling set below equilibrium price, resulting in a shortage.

Price Floor

A legal minimum price a good can be sold at, aimed at helping producers.

Binding Price Floor

A floor set above equilibrium price, resulting in a surplus.

Excise Tax

A per-unit tax on a specific good that shifts the supply curve upward.

Tax Wedge

The vertical distance between the supply and supply with tax curves at the new quantity.

Tax Incidence

Who ultimately pays the tax, depending on the elasticity of demand and supply.

Subsidy

A government payment supporting a business or market, effectively a negative tax.

Importing

Occurs when a country's world price is less than domestic price, leading to decreased domestic supply.

Exporting

Occurs when a country's world price is greater than domestic price, leading to increased domestic supply.

Tariff

A tax on imported goods that raises the effective price of imports.

Government Revenue from Tariffs

Generated from tariffs on imports, but also leads to deadweight loss.

Comparative Advantage

The ability of a country to produce a good at a lower opportunity cost than another country.

Common Mistakes – Binding vs. Non-Binding

Mistake of thinking a price ceiling allows price to rise to the ceiling; it actually prevents it.

Common Mistakes – Tax Incidence

Mistake of assuming statutory payer bears the whole tax burden; the burden depends on elasticity.

Common Mistakes – Deadweight Loss

Misplacing DWL; it always represents trades that didn't occur due to market inefficiency.

Shortages and Black Markets

Result from binding price ceilings preventing proper allocation of goods.