Which of the following is NOT a characteristic of a binding price ceiling?

Price is above the equilibrium price

Tax incidence depends primarily on:

The relative price elasticities of demand and supply

A positive externality leads to:

Underproduction and a deadweight loss

According to the Coase theorem, if transactions costs are low, private bargaining will lead to an efficient outcome:

Regardless of who is assigned the property right

Microeconomics Exam 2 Cheat Sheet

Understand how government interventions like price controls and taxes distort markets, leading to inefficiencies, and how externalities and public goods require specific policy responses to achieve economic efficiency.

Core Principles

Binding price controls (ceilings below equilibrium, floors above) create shortages or surpluses, reduce quantity traded, and cause deadweight loss.
Tax incidence depends on relative price sensitivity (steeper curve bears more burden), not who pays the government; taxes create deadweight loss.
Externalities cause market failure (overproduction for negative, underproduction for positive) because private costs/benefits diverge from social ones.
The Coase theorem suggests private bargaining can solve externalities with low transaction costs, regardless of property rights assignment.
Public goods suffer from free-riding, leading to undersupply, while common resources face overuse due to the tragedy of the commons.
Efficient solutions for externalities include Pigovian taxes/subsidies or cap-and-trade; efficient public good provision requires summing willingness to pay.

Action Steps

1. Determine if a price control is binding by comparing it to the equilibrium price; if not binding, no market change occurs.
2. If binding, identify the quantity traded as the 'short side' of the market (lower of QD or QS) and calculate shortages/surpluses.
3. Calculate deadweight loss from price controls or taxes as the lost economic surplus on units between the new quantity and equilibrium quantity.
4. Determine tax incidence by comparing the price buyers pay and sellers receive after the tax; the side less sensitive to price bears more burden.
5. Identify externalities by checking if MSC > MPC (negative) or MSB > MPB (positive) and determine if over- or underproduction occurs.
6. Apply the Coase theorem by checking for assigned property rights, low transaction costs, and knowing parties to determine if private bargaining leads to efficiency.
7. Classify goods based on rivalry and excludability to identify potential market failures like free-riding (public goods) or tragedy of the commons (common resources).
8. Calculate efficient quantities for public goods by summing willingness to pay vertically and comparing to marginal cost.

Key Terms

Binding Price Control: A price ceiling below equilibrium or a price floor above equilibrium that prevents the market from reaching its natural price.
Tax Incidence: The actual division of a tax's burden between buyers and sellers, determined by relative price elasticities.
Externality: A cost or benefit affecting a third party not directly involved in production or consumption.
Coase Theorem: States that private parties can bargain to an efficient solution for externalities if transaction costs are low and property rights are clear.
Public Good: A good that is nonrivalrous and nonexcludable, leading to potential free-riding and undersupply by markets.
Common Resource: A good that is rivalrous but nonexcludable, leading to overuse (tragedy of the commons).
Pigovian Tax: A tax set equal to the marginal external cost of a negative externality to achieve efficient output.
Cap-and-Trade: A market-based policy setting a total emissions cap and allowing firms to trade allowances, lowering abatement costs.

Real World Examples

Rent control laws setting a maximum rent below equilibrium.: Causes a shortage of apartments, reduces quantity supplied, and leads to non-price rationing devices like waiting lists or illegal payments.
Minimum wage laws setting a price floor above the equilibrium wage.: Creates a surplus of labor (unemployment), benefits workers who keep jobs, and harms employers and unemployed workers.
A per-unit tax on gasoline.: Raises the price buyers pay and lowers the price sellers keep; the burden falls more on the side with steeper demand/supply (inelastic).
Pollution from a factory affecting a nearby town.: A negative externality where MSC > MPC, leading to overproduction of the polluting good; requires Pigovian tax or cap-and-trade.
National defense.: A public good (nonrival, nonexcludable) that markets undersupply due to free-riding; typically provided by government.
Overfishing in international waters.: A common resource problem (rival, nonexcludable) leading to depletion due to the tragedy of the commons; requires quotas or tradable permits.

Quiz

Which of the following is NOT a characteristic of a binding price ceiling?: Price is above the equilibrium price
Tax incidence depends primarily on:: The relative price elasticities of demand and supply
A positive externality leads to:: Underproduction and a deadweight loss
According to the Coase theorem, if transactions costs are low, private bargaining will lead to an efficient outcome:: Regardless of who is assigned the property right
Which of the following is an example of a common resource?: Fish in the open ocean