Taxes & Market Efficiency
What does “tax incidence” measure in a market?
The distribution of the tax burden between buyers and sellers.
What is a price floor?
A government-imposed minimum price that sellers can charge.
What is consumer surplus?
The difference between what a buyer is willing to pay and what they actually pay.
What does a budget constraint show?
All combinations of goods a consumer can afford given their income and prices.
What is an inferior good?
A good for which demand decreases as income increases.
When demand is more inelastic than supply, who bears more of the tax burden?
Buyers bear more of the burden.
A binding price floor causes what market condition?
A surplus.
On a supply and demand graph, where is consumer surplus located?
The area below the demand curve and above the price.
When a consumer’s budget line shifts outward, what happens?
They can reach a higher indifference curve (more satisfaction).
What is a normal good?
A good for which demand increases as income increases.
What condition represents an efficient allocation of resources?
When total surplus is maximized.
What is a price ceiling?
A legal maximum price that sellers can charge.
What is producer surplus?
The difference between the price sellers receive and their opportunity cost.
What is the marginal rate of substitution (MRS)?
The rate at which a consumer is willing to trade one good for another while keeping utility constant.
How do you know if demand is elastic?
When the percentage change in quantity demanded is greater than the percentage change in price.
What does deadweight loss represent in a market with a tax?
The lost total surplus due to reduced trade caused by the tax.
A binding price ceiling leads to what?
A shortage, because quantity demanded exceeds quantity supplied.
Where is producer surplus shown on a graph?
The area above the supply curve and below the market price.
What happens when the price of one good falls?
The budget constraint pivots outward, allowing more of that good to be consumed.
When demand is elastic, how does total revenue change when price rises?
Total revenue decreases.
On a tax graph, what does the vertical gap between buyer price and seller price represent?
The size of the tax per unit.
If the government sets a nonbinding price floor, what happens?
Nothing changes—market equilibrium remains the same.
What happens to consumer surplus when the price of a good increases?
It decreases because buyers lose part of their benefit from trade.
At a consumer’s optimum, what is true about the slope of the indifference curve and budget line?
They are equal: MRS = Price ratio (Px/Py).
How does elasticity affect tax incidence?
The side of the market that is more inelastic bears more of the tax burden.