Skip to content
Marlbridge
Free trial

Flashcards · AP® Microeconomics · Unit 6

Unit 6: Market Failure and the Role of Government flashcards

35 cards on topics 6.1 to 6.5. Pick a topic or study the whole unit.

Study mode needs JavaScript. Every card is listed below, so you can still cover the answers and test yourself.

All 35 cards

For a quick read-through or printing. Cover the right-hand side to test yourself.

6.1 Socially Efficient and Inefficient Market Outcomes

What is social (allocative) efficiency?
Producing every unit whose marginal social benefit is at least its marginal social cost, and stopping where MSB = MSC. Total economic surplus is then as large as it can be.
When does a perfectly competitive market reach the efficient quantity?
When nobody outside the market is affected: demand = MPB = MSB and supply = MPC = MSC, so at equilibrium P = MB = MC.
Which market outcomes give too much or too little output?
Market power: too little (P above MC). Negative externality: too much. Positive externality: too little. Asymmetric information: usually too little. Public goods: too little, often none.
MSB = 60 − Q and MSC = Q. A firm with market power produces 20. Find the efficient quantity and the DWL.
60 − Q = Q gives an efficient quantity of 30. At 20, MSB = 40 and MSC = 20, so DWL = ½ × 10 × 20 = 100.
How should policymakers judge an intervention?
With cost-benefit analysis: net gain = deadweight loss removed − cost of the policy. It is worth it only if the surplus restored is larger than its cost.
Graph: where is the deadweight loss when a market produces the wrong quantity?
It is the triangle between MSB and MSC from the actual quantity to the quantity where MSB = MSC. The triangle always points to the efficient quantity, whether output is too low or too high.

6.2 Externalities

What is an externality?
A cost or benefit that falls on a third party and is not paid for through the market. Causes: poorly defined property rights and high transaction costs. Rational agents respond only to private costs and benefits.
Graph: describe a negative production externality.
Price on the vertical axis, quantity on the horizontal. D = MPB = MSB; S = MPC; MSC = MPC + MEC lies above S. The market quantity Qm (MPB = MPC) is larger than the optimum Qs (MSB = MSC) and the price is too low. The DWL triangle lies between MSC and MSB from Qs to Qm.
Graph: describe a positive consumption externality.
Price on the vertical axis, quantity on the horizontal. S = MPC = MSC; D = MPB; MSB = MPB + MEB lies above D. The market quantity is below the optimum where MSB = MSC. The DWL lies between MSB and MSC from Qm to Qs. A per-unit subsidy equal to MEB at Qs corrects it.
How large should a corrective tax or subsidy be?
Equal to the marginal external cost (or benefit) at the socially optimal quantity Qs, not at the market quantity, when the MEC changes with output.
Demand is P = 40 − Q, MPC = 4 + Q and MEC = $6. Find Qm, Qs and the DWL.
Qm: 40 − Q = 4 + Q gives 18. Qs: 40 − Q = 10 + Q gives 15. At 18, MSC = 28 and MSB = 22, so DWL = ½ × 3 × 6 = 9. A $6 tax corrects it: buyers pay $25 and sellers keep $19.
What policies can correct externalities?
Per-unit taxes (negative externalities; raise revenue), per-unit subsidies (positive; cost the government), regulation (output or emission limits), public provision, and property rights that can be traded or bargained over when transaction costs are low.
Is the optimal level of pollution zero?
No. The optimum is where MSB = MSC. The activity that pollutes also has benefits, so the efficient level of output usually still involves some pollution.

6.3 Public and Private Goods

What do rival and excludable mean?
Rival: one person's use leaves less for others. Excludable: non-payers can, in practice, be kept out. Excludability is judged by what is practical, not by what the law allows.
What are the four types of goods?
Private (rival, excludable): markets provide them well. Public (non-rival, non-excludable): underprovided. Open-access resource (rival, non-excludable): overused. Club good (non-rival, excludable): a background term.
Why do markets underprovide public goods?
They are non-excludable, so people can benefit without paying: the free rider problem. Private firms cannot cover their costs, so government usually provides them and funds them with taxes.
Is a good public because the government provides it?
No. Free schooling is still a private good. A public good is defined by being non-rival and non-excludable.
A weather-warning broadcast costs $2,500 a year. Each of 250 residents values it at $12. Should it be provided?
Yes: total benefit = 250 × 12 = $3,000, more than the $2,500 cost, a net gain of $500. Use the sum of all users' benefits.
Why is an open-access resource overused?
It is rival but non-excludable, so each user ignores the cost their use imposes on others, as with groundwater shared by many farms. Responses: quotas, licences, fees and property rights.
How do you find the efficient number of users of an open-access resource?
Add users while the extra output each one adds is at least its cost, not while each user's own (average) share covers the cost.

6.4 The Effects of Government Intervention in Different Market Structures

How does a per-unit tax affect a monopoly?
It raises MC, so the monopoly raises its price and cuts output further below the efficient level: its deadweight loss gets bigger.
What do lump-sum taxes and subsidies change?
Only fixed cost and ATC. MR and MC are unchanged, so price and output stay the same and only profit changes. A new $50 thousand annual licence fee leaves a monopoly's price unchanged.
Can a price ceiling raise output?
Yes, where a firm has market power. A ceiling where demand meets MC gives the efficient quantity. A ceiling between MC at the old output and the old price raises output; one below MC at the old output cuts it.
How can a minimum wage raise employment at a monopsony?
It makes MRC equal the minimum wage, so one more worker no longer raises the wage of all the others. Wage and employment both rise, up to the wage where supply meets MRP. In a competitive labour market a binding minimum wage cuts employment.
How can a natural monopoly be regulated?
Fair-return pricing (P = ATC): zero profit and a smaller deadweight loss. Socially optimal pricing (P = MC): no deadweight loss, but a loss that needs a lump-sum subsidy, not a per-unit one.
A natural monopoly has MC = $5 and fixed cost $300 thousand. At P = MC it serves 60 thousand customers. What subsidy does it need?
ATC = 5 + 300 ÷ 60 = $10. Loss = (10 − 5) × 60 = $300 thousand, paid as a lump-sum subsidy.
Graph: describe socially optimal regulation of a natural monopoly.
Price on the vertical axis, quantity on the horizontal: downward D, MR below it, ATC falling across all of demand, MC below ATC. The regulated price is where D crosses MC. ATC is above that price there, so the loss (ATC − P) × Q must be covered by a lump-sum subsidy.
What is antitrust policy for?
To make markets more competitive. Any intervention raises efficiency only when it fixes the incentive behind the market failure.

6.5 Inequality

What is the difference between income and wealth?
Income is a flow per period (wages, rent, interest, profit, transfers). Wealth is a stock: assets minus debts. Wealth is usually more unequal than income.
Graph: how do you read a Lorenz curve?
Cumulative % of households, poorest to richest, against cumulative % of income. The 45° line is perfect equality; the farther the curve is from it, the more unequal. The richest 20% share = 100% − the cumulative share at 80%.
What does the Gini coefficient show?
Inequality on a scale from 0 (perfect equality) to 1 (one household has everything). A rise from 0.30 to 0.36 means the Lorenz curve moved farther from the line of equality. It measures neither average income nor poverty.
How do you classify a tax as progressive, proportional or regressive?
By the average tax rate = tax ÷ income × 100. Rising with income: progressive. Constant: proportional. Falling: regressive. $2,000 on $20,000 (10%) and $5,000 on $100,000 (5%) is regressive, though the rich pay more dollars.
What are the sources of income and wealth inequality?
Differences in marginal product, human capital, social capital, inheritance, discrimination, access to financial markets, mobility, bargaining power and the tax structure.
How is the poverty rate calculated?
People below the poverty line ÷ population × 100. It is a share, not a count.
What does a factor tend to earn in competitive markets?
Its value of marginal product = marginal product × output price. A worker producing 6 units an hour that sell at $15 each tends to earn $90 an hour.

Study Unit 6 further

AP® and Advanced Placement® are trademarks registered by the College Board, which is not affiliated with, and does not endorse, this website. Marlbridge is an independent tuition provider. It is not an authorized AP course provider, an AP school or an exam centre, and these resources are not official College Board materials. Reading them or doing simulations does not meet the laboratory requirement of an AP science course.