Unit 3: Market Efficiency and Government Intervention
The triangle of value a free market creates, and what happens to it when a price ceiling, a tax, or a subsidy pushes the market away from equilibrium.
11 topics · 40 questions
Each topic is a path, not a menu: work down it in order and every question builds on the one above. Click any of them to watch the answer draw itself.
Consumer Surplus
- How it worksHow does the area between the demand curve and the price line measure consumer surplus?
- Worked exampleFind the consumer surplus when demand is Qd = 100 - 2P and the market price is 30 dollars.
- Going furtherWhat happens to consumer surplus when the market price falls?
Your turn1 of 2
Demand is P = 108 minus 2 times Q, and the market price is 48 dollars. What is total consumer surplus?Producer Surplus and Total Surplus
- How it worksHow does the area above the supply curve and below the price line measure producer surplus?
- Worked exampleFind the producer surplus when supply is Qs = 3P - 30 and the market price is 20 dollars.
- Ties togetherHow do consumer surplus and producer surplus combine into the total surplus a market creates?
Your turn1 of 2
Supply is Qs = 4 times P, starting from the origin, and the market price is 23 dollars. What is total producer surplus?Market Efficiency and the Invisible Hand
- How it worksHow does the equilibrium quantity end up maximizing the total surplus of buyers and sellers combined?
- How it worksHow does Adam Smith's invisible hand describe self-interested buyers and sellers landing on an efficient outcome?
- Common mistakeWhy doesn't an efficient market outcome mean the same thing as a fair one?
Your turn1 of 2
In a competitive market, no single buyer or seller is trying to maximize the market's total surplus; each is simply pursuing their own self-interest. Yet the equilibrium outcome ends up maximizing total surplus anyway. What does Adam Smith call this?Price Ceilings and Shortages
- How it worksHow does a price ceiling set below equilibrium create a gap between quantity supplied and quantity demanded?
- Worked exampleFind the shortage created by a rent ceiling of 800 dollars a month when Qd = 2000 - P and Qs = 3P - 1600.
- Going furtherWhat happens to the size of a shortage when a price ceiling is set even lower below equilibrium?
- Common mistakeWhy doesn't a price ceiling actually get more people the apartment they want at the lower price?
Your turn1 of 2
A price ceiling of 597 dollars is imposed on a market where Qd = 2279 minus P and Qs = 3 times P minus 1000. What is the size of the shortage created?Black Markets and Non-Price Rationing
- How it worksHow do long waiting lines end up rationing a good when price is no longer allowed to do it?
- How it worksHow does a black market form on top of a binding price ceiling?
- Going furtherWhat happens to the incentive to bribe or favor certain buyers once a price ceiling creates a shortage?
Your turn1 of 2
A price ceiling creates a shortage of a good, and price can no longer rise to ration who gets it. What ends up rationing the good instead?Price Floors and Surpluses
- How it worksHow does a price floor set above equilibrium create a gap between quantity supplied and quantity demanded?
- Worked exampleFind the surplus created by a price floor of 6 dollars a bushel when Qd = 200 - 10P and Qs = 20P - 100.
- Going furtherWhat happens to the size of a surplus when a price floor is set even higher above equilibrium?
- Common mistakeWhy doesn't a price floor guarantee that every seller who wants to sell at that price actually finds a buyer?
Your turn1 of 2
A price floor of 886 dollars is imposed on a market where Qd = 1339 minus P and Qs = 2 times P minus 530. What is the size of the surplus created?The Effect of a Tax on a Market
- How it worksHow does a per-unit tax wedge the price buyers pay away from the price sellers receive?
- Worked exampleFind the new quantity traded when a 5 dollar per-unit tax is added to a market with Qd = 100 - 2P and Qs = 3P - 20.
- How it worksHow does the vertical gap between the demand and supply curves at the new quantity equal the size of the tax?
- Common mistakeWhy doesn't a tax placed entirely on sellers mean sellers alone lose money from it?
Your turn1 of 2
A 4 dollar per-unit tax is added to a market where Qd = 128 minus 2 times P and Qs = 4 times P, supply starting from the origin. What is the new quantity traded?Tax Incidence: Who Really Pays
- How it worksHow does the price buyers end up paying and the price sellers end up keeping split a tax's burden between them?
- Worked exampleFind how a 4 dollar tax splits between buyers and sellers when demand is more elastic than supply near equilibrium.
- Common mistakeWhy isn't a tax actually paid by whichever side legally writes the check to the government?
- Going furtherWhat happens to who bears more of a tax when supply becomes far more elastic than demand?
Your turn1 of 2
A 8 dollar per-unit tax is imposed on a good. The price buyers pay rises by 2 dollars as a result. How many dollars of the tax burden falls on sellers?How Elasticity Determines Who Bears a Tax
- How it worksHow does the side of a market with the less elastic curve end up bearing the larger share of a tax?
- Worked exampleFind who bears more of a 2 dollar tax when demand is highly inelastic and supply is highly elastic near equilibrium.
- Going furtherWhat happens to the split of a tax burden as demand becomes more and more elastic?
Your turn1 of 2
Demand has an elasticity of 0.648, and supply has an elasticity of 2.47, both reported as positive magnitudes. If a 8 dollar tax is imposed, how many dollars of the tax do buyers pay, using tax times supply elasticity divided by the sum of the two elasticities?The Deadweight Loss of Taxation
- How it worksHow does a tax eliminate trades that would have made both a buyer and a seller better off?
- Worked exampleFind the deadweight loss triangle created by a 4 dollar per-unit tax on a good with Qd = 100 - 2P and Qs = 3P - 20.
- Common mistakeWhy isn't the money the government collects in tax revenue the whole story of a tax's cost to society?
- Going furtherWhat happens to the size of a tax's deadweight loss as the tax rate itself gets larger?
- Ties togetherHow does the size of a tax's deadweight loss depend on how elastic demand and supply are, the same way tax incidence does?
Your turn1 of 2
A 8 dollar per-unit tax is imposed on a good where demand falls by 4 units for every dollar price rises and supply is Qs = 4 times P, starting from the origin. What is the deadweight loss created by the tax?Subsidies and Their Effects
- How it worksHow does a per-unit subsidy push equilibrium quantity above the level that maximizes total surplus?
- How it worksHow does a subsidy shift the effective supply curve down by the size of the payment per unit?
- Going furtherWhat happens to a subsidy's cost to the government as the subsidized quantity grows larger?
- Common mistakeWhy isn't a subsidy a free gain for society just because it makes buyers and sellers both better off?
Your turn1 of 2
A per-unit subsidy of 3 dollars is given to sellers in a market where Qd = 142 minus 3 times P and Qs = 4 times P, starting from the origin. What is the new quantity traded?