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Economic efficiency, Government Price settings, and taxes
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Government interventions
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Consumer surplus: measures the dollar benefit consumers receive from
buying goods or services in a particular market Marginal benefit is the additional benefit to a
consumer from consuming one more unit of a good or service
It is the difference between the highest price a consumer is willing to pay and the price the consumer actually pays
Consumer surplus is the area below the demand curve and above the market price
In a market, it is equal to total benefits received by the consumers minus the total amount the must pay to buy the good.
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Demand curve/marginal benefit curve
Marginal benefit from consuming the 4th cup is 3
3.0
2.0
4 5
Marginal benefit from consuming the 5th cup is 2
Quantity
Quantity
Pri
ce p
er
cup
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2.0
15,000
Consumer surplus
Quantity
Pri
ce p
er
cup
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Producer surplus: measures the dollar benefit firms receive from
selling goods or services in a particular market Marginal cost is the additional benefit to a firm
of producing one more unit of a good or service It is the difference between the lowest price a
firm would have been willing to accept and the price it actually receives
Producer surplus is the area below the market price and above the supply curve
It is equal to the total amount firms receive from the consumers minus the cost of producing the goods
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Supply curve/marginal cost curve
Marginal cost of producing the 50th cup is 2
2.0
40 50
Marginal benefit from producing the 40th cup is 1.80
Quantity
Quantity
Pri
ce p
er
cup
1.80
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2.0
15,000
Producer surplus
Quantity
Pri
ce p
er
cup
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Economic Surplus Economic surplus = Consumer surplus+
producer surplus Note: when a government imposes a price
ceiling or a price floor, the amount of economic surplus in a market is reduced
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Effect o government interventions in markets can be analyzed using the concepts of consumer surplus, producer surplus, and economic surplus.
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Market Efficiency Inefficient market: Marginal cost > Marginal benefit
(inefficiently high output market ) Marginal cost < Marginal benefit
(inefficiently low output market)
Efficient market: Marginal cost = Marginal benefit
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2.00
15,000
High output market
Quantity
Pri
ce p
er
cup
Low output market
14,000
16,000
2.20
1.80
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Deadweight loss The reduction in economic surplus resulting
from a market not being in competitive equilibrium is called the deadweight loss.
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Economic Efficiency Is a market outcome in which the marginal
benefit to consumers of the last units produced is equal to its marginal cost of production, and in which the sum of consumer surplus and producer surplus is at a maximum
This does not mean that every individual is better off if a market is at its competitive equilibrium
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Producers or consumers who are dissatisfied with equilibrium price can pressurize government to change the price
Price floor and Price Ceiling
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Price Ceiling vs Price Floor Price ceiling: Government imposed, legally
determined maximum price that seller may charge
Price floor: Government imposed, legally determined minimum price that sellers may receive
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2.00
15,000
Quantity
Pri
ce p
er
cup
14,000
16,000
2.20
1.80
A BC
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The results of government interventions: winners, losers, and inefficiency
Some people win Some people lose There is loss of economic efficiency
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Effect of taxes on Economic Efficiency Whenever a government taxes a good or
service, less of that good or service will be produced