SAT / PSAT
SAT / PSAT Prep
History & Social Science
AP World History AP US History AP European History AP Human Geography AP US Government & Politics AP Psychology AP Macroeconomics AP Microeconomics
English
AP English Language & Composition AP English Literature & Composition
Math & Computer Science
AP Calculus AB/BC AP Precalculus AP Statistics AP Computer Science A AP Computer Science Principles
Sciences
AP Biology AP Chemistry AP Environmental Science AP Physics 1 AP Physics 2
World Languages & Arts
AP Spanish Language AP Art History AP Music Theory Start studying →
Unit 6 · Market Failure & Government Unit Hub Flashcards Cheat Sheet Essentials Visual Review MC Practice FRQ Practice
Unit 6 Essentials

Unit 6 Essentials

The 3 big ideas behind Market Failure and the Role of Government, plus a searchable glossary of all 30 vocabulary terms you need for the exam.

3 big ideas
30 key terms
Searchable glossary
College Board aligned
← Back to Unit 6 hub
Big Idea 1
Efficiency has one test: does marginal social benefit equal marginal social cost?
Every diagnosis in this unit runs through the same comparison. When MSB = MSC, total surplus is maximized and the market is allocatively efficient. Market failure is simply any circumstance that drives the actual quantity away from that point — and the size of the resulting deadweight loss measures how badly the market failed.
MSB = MSC Total Surplus Deadweight Loss
Big Idea 2
Externalities put a wedge between private and social curves
When a cost or benefit spills onto third parties, the curve the market responds to is not the curve society should care about. A negative externality lifts MSC above MPC and the market overproduces; a positive externality lifts MSB above MPB and the market underproduces. The vertical gap between the two curves is the size of the spillover — and the size of the corrective tax or subsidy.
Externalities MSC vs MPC Overproduction
Big Idea 3
Non-excludability is what breaks the market for public goods
A public good is non-rival and non-excludable. The non-excludability is the fatal part: because no one can be stopped from benefiting, everyone would rather let someone else pay. Private markets therefore collect too little revenue and underproduce, which is why public goods are typically financed through taxation rather than sales.
Public Goods Free Riding Taxation
Market failure
A market outcome that does not maximize total surplus.
Efficiency
Total surplus
Consumer surplus plus producer surplus; maximized at the allocatively efficient quantity.
Efficiency
Allocative efficiency
The condition MSB = MSC, where resources go to their highest-valued use.
Efficiency
Marginal social benefit (MSB)
Marginal private benefit plus any external benefit.
Efficiency
Marginal social cost (MSC)
Marginal private cost plus any external cost.
Efficiency
Deadweight loss
Surplus lost when output differs from the socially optimal quantity.
Efficiency
Externality
A cost or benefit falling on a third party outside the transaction.
Externalities
Negative externality
A spillover cost, such as pollution. MSC > MPC, so the market overproduces.
Externalities
Positive externality
A spillover benefit, such as vaccination. MSB > MPB, so the market underproduces.
Externalities
Pigouvian tax
A per-unit corrective tax equal to the external cost, used to reduce output to the social optimum.
Externalities
Corrective subsidy
A per-unit subsidy equal to the external benefit, used to raise output to the social optimum.
Externalities
Coase theorem
The idea that if property rights are clear and bargaining is costless, private parties can resolve externalities themselves.
Externalities
Rivalry
One person's consumption reduces the amount available to others.
Public and Private Goods
Excludability
Non-payers can be prevented from consuming the good.
Public and Private Goods
Private good
Rival and excludable — an ordinary market good.
Public and Private Goods
Public good
Non-rival and non-excludable, such as national defense.
Public and Private Goods
Common resource
Rival but non-excludable, prone to overuse — the tragedy of the commons.
Public and Private Goods
Club good
Non-rival but excludable, such as a subscription service.
Public and Private Goods
Free-rider problem
People consume a non-excludable good without paying, so markets underprovide it.
Public and Private Goods
Price ceiling
A legal maximum price; if binding, it sits below equilibrium and causes a shortage.
Government Intervention
Price floor
A legal minimum price; if binding, it sits above equilibrium and causes a surplus.
Government Intervention
Antitrust policy
Government action limiting market power to reduce the deadweight loss from monopoly.
Government Intervention
Regulation
Rules constraining firm behaviour, including price regulation of natural monopolies.
Government Intervention
Lorenz curve
A plot of cumulative income share against cumulative population share, ordered poorest to richest.
Inequality
Line of perfect equality
The 45-degree line a Lorenz curve would follow if income were distributed equally.
Inequality
Gini coefficient
A 0-to-1 measure of inequality based on the area between the Lorenz curve and the equality line.
Inequality
Human capital
The education, training, and skills embodied in workers; differences in it are a major source of income inequality.
Inequality
Progressive tax
A tax taking a larger share of income as income rises.
Inequality
Regressive tax
A tax taking a smaller share of income as income rises.
Inequality
Transfer payment
A government payment made without a good or service in return, such as unemployment benefits.
Inequality