ECO 304K, Introduction to Microeconomics | University of Texas at Austin Source: Practice Mock Exam 2026 Difficulty: Introductory | Prerequisites: Supply and demand fundamentals
Once you understand how markets reach equilibrium, the next question is whether that outcome is any good. This section covers how economists measure the welfare gains from trade (surplus), what happens when governments intervene with price controls or taxes, and why those interventions create deadweight loss. You need demand and supply basics before this material will make sense.
Total surplus (consumer surplus + producer surplus) is maximised at the free-market equilibrium. Price ceilings (like rent control) cause shortages, price floors (like minimum wages) cause surpluses, and taxes create deadweight loss. The more inelastic side of the market bears more of the tax burden.
Consumer surplus
The difference between what consumers are willing to pay and what they actually pay. Graphically, it is the area below the demand curve and above the market price.
Producer surplus
The difference between the price producers receive and the minimum price they would have accepted (their marginal cost). Graphically, the area above the supply curve and below the market price.
Total surplus
Consumer surplus + producer surplus. It represents the total net gain to society from trade in a market.
Deadweight loss (DWL)
The reduction in total surplus that occurs when a market is not producing at the socially optimal quantity. In simple terms, it is the value of trades that would have benefited both buyer and seller but did not happen.
Price ceiling
A legal maximum price set below the equilibrium price. It creates a shortage (quantity demanded exceeds quantity supplied). Rent control is the classic example.
Price floor
A legal minimum price set above the equilibrium price. It creates a surplus (quantity supplied exceeds quantity demanded). The minimum wage is the classic example.
Binding vs non-binding
A price control is binding if it prevents the market from reaching equilibrium. A ceiling above equilibrium or a floor below equilibrium is non-binding and has no effect.
Tax incidence
The division of the tax burden between buyers and sellers. It depends on the relative elasticities of supply and demand, not on who the tax is legally imposed on.
Production quota
A government-imposed limit on the quantity of a good that can be produced or sold. A quota set below equilibrium is binding and creates deadweight loss. A quota set above equilibrium is non-binding and has no effect.
Command system
A resource allocation method in which an authority (a manager, government, or institution) directs how resources are used. Typical for internal organisational management, such as at a university.
Utilitarianism
The ethical view that income should be redistributed to maximise the total utility of society. Because of diminishing marginal utility of income, this often implies transferring income from rich to poor.
Consumer surplus = area below the demand curve and above the price, up to the quantity traded.
Producer surplus = area above the supply curve and below the price, up to the quantity traded.
Total surplus = CS + PS. At equilibrium, this is maximised because every unit where the buyer values it more than it costs the seller gets produced.
At equilibrium, Marginal Social Benefit (demand) = Marginal Social Cost (supply).
Below equilibrium quantity, there are units where benefit > cost, so producing them adds to surplus.
Above equilibrium quantity, cost > benefit, so those units destroy surplus.
Any deviation from equilibrium creates deadweight loss.
A binding price ceiling is set below the equilibrium price.
At the lower price, quantity demanded rises and quantity supplied falls, creating a shortage.
Side effects include increased search costs, deterioration of quality, and black markets.
A non-binding ceiling (set above equilibrium) has no effect.
A binding price floor is set above the equilibrium price.
In the labour market, a binding minimum wage means: at the higher wage, more workers want to work (Qs rises) but firms want to hire fewer (Qd falls). The gap is unemployment (a surplus of labour).
A non-binding floor (set below equilibrium) has no effect.
A quota set below the equilibrium quantity is binding: it restricts output, raises the price, and creates deadweight loss.
A quota set above the equilibrium quantity is non-binding: the market already produces less than the quota allows, so nothing changes.
The burden of a tax falls on the more inelastic side of the market, regardless of who the tax is legally imposed on.
If demand is perfectly inelastic (vertical demand curve), buyers bear the entire tax because they will buy the same quantity no matter what.
If supply is perfectly inelastic, sellers bear the entire tax.
Market price: goods go to whoever is willing and able to pay.
Command system: an authority decides (typical within organisations like universities).
Majority rule: a vote decides.
Lottery: random allocation.
Large organisations like UT Austin typically use a command system internally.
Students mix up consumer and producer surplus graphically. Consumer surplus is below demand, above price. Producer surplus is above supply, below price. Draw it and label it.
A minimum wage is a price floor, not a price ceiling. The price of labour has a floor placed under it. This is a very common true/false question.
A non-binding quota or price control has no effect. Students often assume any intervention changes the outcome, but it only does so if it prevents the market from reaching equilibrium.
Tax incidence does not depend on who writes the cheque. It depends on elasticities.
⚠️ Consumer surplus graphical representation is a favourite multiple-choice question. The answer is always: below the demand curve, above the market price.
⚠️ Binding minimum wage = price floor = surplus of labour = unemployment. Know this chain.
⚠️ A production quota above equilibrium has no effect. This trips students up because they assume any quota must restrict output.
⚠️ Perfectly inelastic demand + tax = buyers bear it all. This is almost always tested.
⚠️ Total surplus = CS + PS. At equilibrium MSB = MSC, so total surplus is maximised. Any deviation creates DWL.
True or false: a binding minimum wage is an example of a price ceiling. (False, it is a price floor)
What happens when a price ceiling is set below equilibrium? (Shortage)
If demand is perfectly inelastic and a tax is imposed, who bears the burden? (Buyers)
True or false: a production quota set above equilibrium quantity creates deadweight loss. (False, no effect)
Total surplus = _____ + _____. (Consumer surplus + Producer surplus)
Q: Consumer surplus is graphically represented as the area...?
A: Below the demand curve and above the market price.
Q: When a binding price ceiling is imposed on the housing market (rent control), the most likely result is...?
A: A shortage of housing units and increased search costs. The ceiling holds price below equilibrium, so Qd > Qs.
Q: In the context of the labour market, explain how a binding minimum wage creates a surplus.
A: A binding minimum wage is a price floor set above the equilibrium wage. At the higher wage, more workers want to work (Qs rises) and firms want to hire fewer (Qd falls). The gap (Qs - Qd) is a surplus of labour, which is unemployment.
Q: Describe producer surplus and how it is calculated using a supply curve.
A: Producer surplus is the difference between the price a producer receives and the minimum they would have accepted. On a graph, it is the area above the supply curve and below the market price, up to the quantity sold.
Q: Explain the concept of market efficiency. Define total surplus, explain why equilibrium maximises it, and discuss two reasons a market might fail to be efficient.
A: Total surplus = CS + PS, the total net gain from trade. At equilibrium, MSB = MSC, so every unit where benefit exceeds cost is produced and no unit where cost exceeds benefit is produced, maximising the pie. Two reasons for failure: (1) externalities cause the market to over- or under-produce relative to the social optimum, and (2) public goods are underprovided because of the free-rider problem.
Surplus analysis connects directly to externalities: when external costs or benefits exist, the market equilibrium no longer maximises total surplus, and a Pigovian tax or subsidy can improve the outcome. Tax incidence builds on elasticity from the demand and supply notes.
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