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HUBBARD_MICRO_SG_04 - Chapter 4 Economic Efficiency...

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Chapter 4 Economic Efficiency, Government Price Setting, and Taxes Chapter Summary Governments of over 200 cities in the United States have placed ceilings on the maximum rent some landlords can charge for their apartments. Governments also impose taxes in some markets. To understand the economic impact of government in markets, it is necessary to understand consumer surplus and producer surplus. Consumer surplus is the dollar benefit consumers receive from buying goods and services at market prices that are less than the maximum prices they would be willing to pay. Producer surplus is the dollar benefit producers receive from selling goods and services at prices greater than the minimum prices they would be willing to accept. Economic surplus is the sum of consumer surplus and producer surplus. In a competitive market with no externalities, the equilibrium price for a good or service occurs where the marginal cost of the last unit produced and sold is equal to the marginal benefit consumers receive from the last unit bought. Therefore the equilibrium quantity produced in a competitive market is economically efficient. At this equilibrium level of output, economic surplus is maximized. In some markets, producers lobby for government action to set a legal price greater than the equilibrium price a price floor . Some consumers lobby the government to force firms to charge a price lower than the equilibrium price a price ceiling . Price floors were established in agricultural markets in the United States during the Great Depression. The minimum wage is another example of a price floor. For most occupations, it is illegal for an employer to pay less than the minimum wage established by Congress. Price ceilings are most often found in the markets for apartments in various cities. You’re probably more familiar with these ceilings under their usual name: rent control . Compared to the competitive equilibrium, price ceilings and price floors reduce economic efficiency. A tax on the sale of a good or service also reduces economic efficiency. Tax incidence is the actual division of the burden of a tax between buyers and sellers. The incidence of a tax depends on how responsive producers and consumers are to the price change caused by the tax.
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CHAPTER 4 | Economic Efficiency, Government Price Setting, and Taxes 86 Learning Objectives When you finish this chapter, you should be able to: 1. Distinguish between the concepts of consumer surplus and producer surplus . Consumer surplus is the benefit consumers receive from paying a price lower than the maximum price they would be willing to pay. Producer surplus is the benefit a firm receives from selling a good or a service at a price higher than the minimum the firm would be willing to accept. Economic surplus is the consumer surplus plus producer surplus.
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