Economic efficiency, Government Price settings, and taxes

Government interventions

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.

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

2.0

15,000

Consumer surplus

Quantity

Pri

ce p

er

cup

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

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

2.0

15,000

Producer surplus

Quantity

Pri

ce p

er

cup

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

Effect o government interventions in markets can be analyzed using the concepts of consumer surplus, producer surplus, and economic surplus.

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

2.00

15,000

High output market

Quantity

Pri

ce p

er

cup

Low output market

14,000

16,000

2.20

1.80

Deadweight loss The reduction in economic surplus resulting

from a market not being in competitive equilibrium is called the deadweight loss.

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

Producers or consumers who are dissatisfied with equilibrium price can pressurize government to change the price

Price floor and Price Ceiling

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

2.00

15,000

Quantity

Pri

ce p

er

cup

14,000

16,000

2.20

1.80

A BC

The results of government interventions: winners, losers, and inefficiency

Some people win Some people lose There is loss of economic efficiency

Effect of taxes on Economic Efficiency Whenever a government taxes a good or

service, less of that good or service will be produced