Chapter7 - Chapter Chapter 7 Efficiency and Exchange...

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Unformatted text preview: Chapter Chapter 7 Efficiency and Exchange Consumer and Producer Surplus • To understand efficiency, it’s useful to first understand consumer surplus and producer surplus. • Consumer surplus: the difference between the amount that consumers value a good or service and the amount they pay for that good or service. P = $100 V1 = $200 (reservation price) V2=$50 C.S. = $0 C.S. = $200 - $100 = $100 • Producer surplus: the difference between the amount that producers are paid for a good or service and the amount the good or service costs P.S. = P - reservation price of producer- reservation price of producer them. Consumer Consumer Surplus C.S. = reservation price of a consumer - price P $18 $16 $10= P* C.S. 1 2 D (willingness to pay) Q 5 Producer Surplus P S (MC) PS. = area of triangle under P* and above S(MC) P* 1 2 5 Q Consumer & Producer Surplus in in Equilibrium Total Economic Surplus = CS + PS CS P S P* PS D Q Efficiency • Engineering Efficiency: Use the least resources to do something. • In economics, an allocation is considered as efficient if no change could be made to help some people without harming others. • Pareto Improvement: arrangements that could make some better off without making anybody worse off. Example Example • Suppose I have 100 bags of chips and 100 sodas to distribute between 2 students, Alice and Betty. • Are the following allocations likely to be efficient or inefficient? 1. Betty has all the chips and soda. Alice has nothing. Efficient 2. Betty has all the chips. Alice has all the soda. inefficient 3. Alice and Betty each have 40 bags of chips and 50 sodas. Not Sure Efficiency • Markets coordinate the production of a wide range of goods and services. • Are market outcomes efficient? P Is Is Q* Efficient? S 8 7 6 5 P* 4 3 2 1 D Q (thousands) 5678 Q* whether it is possible to choose another quantity that both producers and consumers are better off 123 4 What if Q<Q* P 8 MB=$ 7 6 MC=5 5 Q* the only efficient point, no other way to make it more efficient S 4 3 MB=2.5 MC=$ 2 1 123 4 5678 Q* D Q (thousands) combined What What if Q>Q* P 8 7 6 5 4 3 2 1 123 4 5678 D Q (thousands) S MC>MB not good for producers Efficiency • Market outcomes are generally efficient. – Since you cannot choose another level of output that makes both producers and consumers better off, the equilibrium level of output Q* must be efficient. – Another way to say this is that at Q*, the sum of CS and PS (total economic surplus) is maximized. Efficiency Efficiency Conditions • Market outcomes are only efficient when 1. Market activities only affect the buyers and sellers in the market. – Sellers pay all the costs of production – Buyers receive all the benefits of their purchase 2. The market is perfectly competitive. – The price of a good must be equal to the marginal cost _____________________. Externalities • Producers can sometimes shift costs to others – Total marginal cost for the society is higher than ______ seller's factory that causes pollution marginal cost is higher than – Equilibrium quantity ___________ socially optimal. – Regulation, taxes, or fines could move the market to socially optimal. • Buyers may create benefits for others is higher than ___________ H1N1 vaccine – Total marginal benefit for the society buyer’s marginal benefit is less than – Equilibrium quantity _____________ socially optimal. – Subsidies could move the market to socially optimal. Efficiency vs. Equity vs. • Is efficiency the only goal? – No. We also care about equity. • But efficiency should be the first goal. – Efficiency can make the economic pie bigger and everyone can potentially get a bigger slice. – Society can best deal with problems such as inequality if output is efficient. Economic Policies • Attempts to interfere with market outcomes often lead to loss in economic surplus. • Deadweight loss (DWL): the reduction in total economic surplus that results form the adoption of a policy. Deadweight Deadweight Loss of Price Ceilings C.S. P DWL S $3 price ceiling D PS 8 10 14 Q (gasoline) (million) Deadweight Loss of Price Ceilings P S Pceiling D Q (gasoline) Deadweight Deadweight Loss of Price Floors P total economic surplus S 4 D 20 Q (corn) Deadweight Loss of Price Floors P CS $6 Pfloor $4 DWL S PS D Q (corn) 16 20 24 Subsidies Subsidies • Perfectly elastic supply P CS before subsidy DWL increase in consumer surplus $2= P* $1=Ps $1=subsidy subsidy per unit S S-Sub D Q* 15 Qs 20 Q Price consumers pay 1.Consumer surplus=Consumer's Reservation Price - Market Price 2. Producer Surplus = Market Price - Producer's Reservation Price (Cost) 3. Total Economic Surplus = C.S. + P.S. Subsidies • Imperfectly elastic supply P C.S S $S per unit (MC)=> MC decreases by $S j => supply curve moves down by $$ S-sub Amount producers Ps+S* receive Amount Consumer's Pay P* DWL Ps $S { Q* D Q P.S. cost of subsidy Efficiency loss First First-Come, First-Served • A non-market way of allocating scarce goods – 33 seats, 37 reservations (all show up) – Who will get the seats if first-come first-served? – How much consumer surplus will be lost? (Reservation price ranges from $24 to $60; Average is $42) First-Come, First-Served • Alternative: Offer cash compensation to make 4 passengers to volunteer to give up their seats. • How much should the cash compensation be? (the lowest reservation prices are $24, $25, $26, and $27) • What is the total consumer surplus lost? Taxes Taxes • Governments impose taxes to generate revenue or to discourage certain kinds of behavior. • Important Questions – – – – – How do taxes affect equilibrium price and quantity? How much tax revenue is generated from a tax? Should governments tax consumers or firms? Who bears the burden of a tax? Is it “better” to tax some goods relative to others? Taxes on Sellers • Sellers pay a fixed dollar amount per unit $T sold. • A tax on sellers raises the marginal cost of production by the amount of the tax. – The supply curve shifts up by the amount of the tax. DWL T.R. Tax Tax on a Seller C.S. P S Price buyers Pt P* pay Price Sellers Pt-T receive $T The price buyers pay increases The price sellers receive decreases Tax burden on buyers = Pt-P* Tax burden on sellers = P* - (Pt-T) { D Qs Q* C.S. decrease P.S. decrease Tax revenue = $T x Qt Q P.S. Taxes on Buyers • Buyers pay a fixed dollar amount per unit purchased. $T • A tax on consumers lowers the benefit of the good or service by the amount of the tax. – Taxes will shift demand curve down by the amount of the tax. Tax Revenue P Tax on a CSuyer Buyer B S DWL $T Price buyers pay Price sellers receive { P* Pt+T Pt D Q* price paid by buyers increases tax burden on buyers =(Pt+T) - P* -price received by sellers decreases tax burden on sellers =P*-Pt Q D-T Total tax burden = [(Pt+T)-P*] +[P*-Pt]=$T PS Tax Revenue : $T x Qt Taxes and Price Elasticity • Both buyers and sellers share some of the tax burden. • Sharing of the tax burden between buyers and sellers depends on the price elasticity of supply (εs) and the price elasticity of demand (εd) – If εs >εd , the tax burden is borne primarily by buyers ______________. – If εs <εd , the tax burden is borne primarily by sellers ______________. Taxes Taxes and Perfectly Elastic Supply Price ($/car) $20,100 εs= ∞>εd price buyers pay increased by $100 price sellers receive doesn't change S+$100 $20,000 S All tax burden on buyers D 2.0 Quantity (millions of cars/month) 1.9 Taxes and Perfectly Elastic Demand Price ($/car) εd= ∞ > εs price buyers pay doesn't change price sellers receive decreased by $100 S+100 S $20,000 $19,000 price sellers receive D All tax burden is on sellers 2.0 Quantity (millions of cars/month) 1.8 Deadweight Loss and Price Elasticity Elasticity DWL=1/2* T * (Q*-Qt) • Deadweight Loss = ½ ⅹ Tax ⅹDecrease in quantity – Deadweight loss is larger if quantity decreases more • elasticity of demand is larger – the same increase in price can cause a larger decrease in quantity. • elasticity of supply is larger => a larger theme of tax burden on buyers – the increase in the price consumers pay is larger, which will cause a larger change in quantity. • Is it better to tax some goods than others? better to tax necessity goods better to tax goods with lower εs or lower εd Is Is it better to tax some goods than others more elastic demand others? less elastic demand S+T P S P S+T S lower DWL higher DWL D D Q gasoline Q ECON 1 Conclusion Conclusion about Taxes THIS CLASS IS STUPID THIS CLASS IS BORING Tax effects are the same no matter whether taxes are imposed on buyers or sellers: 1. price consumers pay increases 2. price producers receive decreases 3. quantity produced and sold decreases 4. C.S. and P.S. decreases 5. Tax revenue is paid by both the buyers and the sellers 6. There is deadweight loss ...
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This note was uploaded on 12/07/2009 for the course ECON ECON 1 taught by Professor Foster during the Fall '08 term at UCSD.

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