Which of the following best describes a binding price ceiling?

A maximum price set below the equilibrium price.

Tax incidence is determined by:

The relative price elasticity of demand and supply.

A negative externality in production leads to:

Overproduction relative to the efficient quantity.

According to the Coase Theorem, which factor is LEAST likely to affect the efficient outcome of externality bargaining?

The assignment of property rights.

Is it true that The side of the market legally responsible for paying a tax bears the full burden of that tax.?

Tax incidence depends on the relative price sensitivity (elasticity) of supply and demand; the side that can adjust its quantity less bears a larger share of the burden, regardless of who remits the tax to the government.

Is it true that The efficient level of pollution is zero.?

The efficient level of pollution reduction occurs where the marginal benefit of reducing pollution equals the marginal cost of reduction. Reducing pollution beyond this point costs more than the benefit gained.

Microeconomics Exam 2: Key Concepts Cheat Sheet

Understand how price controls, taxes, externalities, and different types of goods lead to market inefficiencies, and learn how to analyze these situations quantitatively and qualitatively.

Core Principles

Binding price controls (ceilings below equilibrium, floors above) create shortages or surpluses and deadweight loss by preventing trade at the equilibrium price.
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 with negative, underproduction with positive) because private costs/benefits don't equal social costs/benefits.
The Coase theorem suggests private bargaining can solve externalities if transaction costs are low and property rights are clear, regardless of who holds the right.
Government intervention (Pigovian taxes/subsidies, cap-and-trade) can correct externalities, with market-based approaches generally being more efficient than command-and-control.
Goods are categorized by rivalry and excludability, leading to efficient markets for private goods but market failures (free-riding, tragedy of the commons) for public goods and common resources.

Action Steps

1. Determine if a price control is binding by comparing it to the equilibrium price; if not binding, it has no effect.
2. If a price control is binding, identify the quantity traded as the 'short side' of the market (lower of QD or QS) and calculate shortages/surpluses.
3. Analyze tax incidence by comparing the price buyers pay and sellers keep; the side less sensitive to price (steeper curve) bears more burden.
4. Calculate deadweight loss from price controls or taxes as the lost economic surplus on units not traded (area between curves from new quantity to equilibrium).
5. For externalities, compare marginal private cost/benefit to marginal social cost/benefit to determine over/underproduction and deadweight loss.
6. Apply the Coase theorem by determining if bargaining is feasible (low transaction costs, clear rights) and who would pay whom.
7. Evaluate government policies by comparing Pigovian taxes/subsidies, command-and-control, and cap-and-trade for efficiency.
8. Classify goods based on rivalry and excludability to identify potential market failures like free-riding or tragedy of the commons.

Key Terms

Price Ceiling: A legally mandated maximum price; binding only if set below equilibrium, causing shortages.
Price Floor: A legally mandated minimum price; binding only if set above equilibrium, causing surpluses.
Binding Price Control: A price control that prevents the market from reaching equilibrium.
Shortage: Quantity demanded exceeds quantity supplied at the current price; caused by a binding price ceiling.
Surplus: Quantity supplied exceeds quantity demanded at the current price; caused by a binding price floor.
Deadweight Loss: Reduction in economic surplus due to market inefficiency (e.g., from price controls or taxes).
Tax Incidence: The division of a tax burden between buyers and sellers.
Excess Burden (of a tax): The deadweight loss caused by a tax, representing lost consumer and producer surplus.
Externality: A cost or benefit affecting a third party not directly involved in production or consumption.
Marginal Social Cost (MSC): The total cost to society of producing one more unit (private cost + external cost).
Marginal Social Benefit (MSB): The total benefit to society of consuming one more unit (private benefit + external benefit).
Coase Theorem: Private bargaining leads to efficient externality solutions if transaction costs are low and property rights are clear.
Pigovian Tax: A tax set equal to the marginal external cost to correct a negative externality.
Pigovian Subsidy: A subsidy set equal to the marginal external benefit to correct a positive externality.
Tradable Emissions Allowances (Cap-and-Trade): A market-based policy setting a cap on total emissions and allowing firms to trade permits.
Rivalry: One person's consumption prevents another's.
Excludability: Non-payers can be prevented from consuming.
Public Good: Nonrival and nonexcludable (e.g., national defense); prone to free-riding.
Common Resource: Rival but nonexcludable (e.g., fish in the ocean); prone to the tragedy of the commons.
Free Riding: Benefiting from a good without paying for it, common with public goods.
Tragedy of the Commons: Overuse of a common resource due to individual users ignoring costs imposed on others.

Pro Tips

The burden of a tax is NOT determined by who writes the check to the government; it depends on relative price elasticities.
The efficient level of pollution reduction is NOT zero; it's where the marginal benefit of reduction equals the marginal cost.
Cap-and-trade achieves pollution reduction at the lowest cost because firms with low abatement costs can sell allowances to those with high costs.
Demand for a public good is found by vertically summing individual willingness to pay, reflecting that everyone consumes the same quantity.

Pitfalls to Avoid

Assuming a price control is binding without comparing it to the equilibrium price, leading to incorrect analysis of shortages/surpluses.
Confusing tax revenue (tax per unit * quantity sold) with the excess burden (deadweight loss) or the total burden on buyers and sellers.
Believing that negative externalities lead to underproduction or positive externalities lead to overproduction; the opposite is true.
Ignoring transaction costs when applying the Coase theorem; high transaction costs prevent efficient private solutions.
Assuming command-and-control policies are efficient; they often are not when firms have different costs of compliance.

Myth vs Reality

The side of the market legally responsible for paying a tax bears the full burden of that tax.: Tax incidence depends on the relative price sensitivity (elasticity) of supply and demand; the side that can adjust its quantity less bears a larger share of the burden, regardless of who remits the tax to the government.
The efficient level of pollution is zero.: The efficient level of pollution reduction occurs where the marginal benefit of reducing pollution equals the marginal cost of reduction. Reducing pollution beyond this point costs more than the benefit gained.

Real World Examples

Rent control laws in a city.: Illustrates a binding price ceiling, leading to shortages (fewer available apartments), gains for those who get apartments, losses for landlords, and potential black markets or alternative rationing methods.
Minimum wage laws.: Illustrates a binding price floor in the labor market, potentially causing a surplus of labor (unemployment) and benefiting workers who keep their jobs while harming employers and unemployed workers.
A tax on gasoline.: Demonstrates how a per-unit tax shifts supply, raises the price buyers pay and lowers the price sellers keep, and how tax incidence depends on demand/supply elasticity (gasoline demand is inelastic, so buyers bear most of the burden).
Pollution from a factory affecting a nearby town.: An example of a negative externality where marginal social cost exceeds marginal private cost, leading to overproduction and deadweight loss unless addressed by policy.
Vaccinations providing herd immunity.: A positive externality where the social benefit exceeds the private benefit, leading to underproduction/underconsumption without a subsidy.
The 1990 sulfur dioxide emissions program.: An example of successful cap-and-trade, reducing pollution at a lower cost than initially estimated by allowing firms to trade allowances.
National defense.: A classic public good that is nonrival and nonexcludable, requiring government provision because private firms cannot profitably supply it due to free-riding.
Overfishing in international waters.: An example of the tragedy of the commons, where rival but nonexcludable fish stocks are depleted because individual fishers ignore the cost their catch imposes on others.

Statistics

Exam 2 Multiple Choice Questions: 31 total (14 on Ch. 4, 17 on Ch. 5)
Chapter 4 Questions: 6 (4.3), 6 (4.4), 2 (Appendix)
Chapter 5 Questions: 5 (5.1), 4 (5.2), 4 (5.3), 4 (5.4)
Calculation Questions on Exam: Approximately 11 (more than Exam 1)
Level 1 (Basic Definitions/Concepts) Questions: 13
Level 2 (Application/Scenario) Questions: 14
Level 3 (Multi-step Reasoning) Questions: 4

Timeline

Fall 2026: ECON 2020 – Principles of Microeconomics, Section 017, Lecturer: Yushang Wei
Tuesday, October 6, 2026: Exam 02 date and time: in class, TTh 3:30–4:45 PM

People

Yushang Wei: Lecturer for ECON 2020 – Principles of Microeconomics, Section 017
A. C. Pigou: Economist for whom Pigovian taxes and subsidies are named.
Card and Krueger: Economists who conducted a natural experiment on the minimum wage in fast-food restaurants.

Quiz

Which of the following best describes a binding price ceiling?: A maximum price set below the equilibrium price.
Tax incidence is determined by:: The relative price elasticity of demand and supply.
A negative externality in production leads to:: Overproduction relative to the efficient quantity.
According to the Coase Theorem, which factor is LEAST likely to affect the efficient outcome of externality bargaining?: The assignment of property rights.
Which category describes a good that is rival but nonexcludable?: Common resource