Download Ch.14+Externality

Chapter 14
Economic Efficiency and
the Competitive Ideal
ECONOMICS: Principles and Applications, 4e
HALL & LIEBERMAN, © 2008 Thomson South-Western
Economic Efficiency
• Is achieved when
– Cannot rearrange the production or
allocation of goods
– to make one person better off
– without making anybody else worse off
• Pareto improvement
– At least one person is better off, and no
one is harmed
2
Economic Efficiency
• Economic efficiency
– achieved when every possible Pareto
improvement is exploited.
• Side payment
– action will benefit one group and harm
another
3
Economic Efficiency
• Greater total gains than total losses
– Side payment
– Transferred from the gainers to the
losers
– Pareto improvement
4
Competitive Markets and Economic Efficiency
• Demand curve
– The maximum price someone would be
willing to pay for each unit
– Value of the last unit of the good
consumed
• Supply curve
– The minimum price a seller must get in
order to supply that unit
– Additional cost of each unit of the good
supplied
5
Reinterpreting the Demand Curve
• Figure 1 The Value of Another Guitar Lesson
Price
$25
$23
$21
$19
$17
While the first lesson is worth $25 to
some consumer (Flo) . . .
Flo
Joe
Flo (again)
Bo
Zoe
the second lesson is worth
only $23 . . .
and the third is worth $21.
Demand
1
2
3
4
5
Number of Lessons per Week
6
Reinterpreting the Supply Curve
• Figure 2 The Cost of Another Guitar Lesson
Price
Supply
$21
$19
$17
$15
$13
McCollum
Martin (again)
Gibson
Martin (again)
Martin
1
2
3
4
5
The smallest cost for this
first lesson is $13 . . .
but it's $15 for the second . . .
and $17 for the third.
Number of Lessons per Week
7
The Efficient Quantity of a Good
• Whenever the demand curve is higher
than the supply curve
– the value of one more unit to some
consumer is greater than its additional
cost to some producer
• Efficient quantity of a good
– Market demand curve and market supply
curve intersect
– Automatically achieved in perfect
competition at equilibrium
8
The Efficient Quantity of a Good
• Figure 3 Efficiency In The Market For Guitar Lessons
1. Joe would pay as much as
$23 for the second lesson . . .
Price
$25
$23
$21
$19
$17
$15
$13
Flo
Joe
Supply
Flo
McCollum
Bo Martin
Gibson Zoe
Martin
Demand
Martin
3. Four lessons is the equilibrium
and the efficient quantity.
2. while Martin would offer
it for as little as $15.
1
2
3
4
5
Number of Lessons per Week
9
Measuring Market Gains
• Consumer surplus - difference between
– Value of a unit of a good to the buyer
– And what the buyer actually pays for it
• Market consumer surplus
– Total consumer surplus enjoyed by all
consumers in a market.
– Total area under the demand curve,
above the market price
10
Consumer surplus
• Figure 4a Consumer Surplus in a Small Market for Guitar Lessons
1. When market price is $19, someone (Flo) gets
$6 in consumer surplus on the first lesson . . .
Price
2. someone (Joe) gets $4 in consumer
surplus on the second . . .
$25
$23
$21
$19
$17
3. and someone (Flo again) gets $2
in consumer surplus on the third.
Demand
Assumed
Market Price
The total shaded area is
market consumer surplus.
1
2
3
4
5
Number of Lessons per Week
11
Consumer surplus
• Figure 4b Consumer Surplus in a Large Market for Guitar Lessons
Price
In a market with many buyers, market
consumer surplus is the entire area
under the demand curve and above
the market price.
$19
Market
Price
Demand
4,000
Number of Lessons per Week
12
Measuring Market Gains
• Producer surplus - difference between
– Price the seller gets
– And the additional cost of providing it
• Market producer surplus
– Total producer surplus enjoyed by all
sellers in a market.
– Total area above the supply curve,
below the market price
13
Producer surplus
• Figure 5a Producer Surplus from Selling Guitar Lessons
Price
1.When market price is $19, someone (Martin) gets
$6 in producer surplus on the first lesson . . .
Supply
$21
$19
$17
$15
$13
2. someone (Martin again) gets $4 in
producer surplus on the second . . .
3. and someone (Gibson) gets $2 on the third.
Assumed
Market Price
The total shaded area is
market producer surplus.
1
2
3
4
5
Number of Lessons per Week
14
Producer surplus
• Figure 5b Producer Surplus from Selling Guitar Lessons
Price
Supply
Market Price
$19
In a market with many sellers, market
producer surplus is the entire area
above the market supply curve and
below the market price.
4,000
Number of Lessons per Week
15
Total Benefits and Efficiency
• Total benefits
– Sum of consumer surplus and producer
surplus
• Efficient market
– Total benefits are maximized
• Equilibrium quantity
– Maximizes total benefits
16
Total Benefits and Efficiency
• Figure 6 Total Benefits in a Competitive Market for Guitar Lessons
Price
S
Equilibrium
Price
$19
D
4,000
Equilibrium Quantity
Number of Lessons per Week
17
Inefficiency and Deadweight Loss
• Price ceiling
– May benefit consumers as a group
– Reduces total net benefits in the market
• Price floor
– May benefit producers as a group
– Reduces total net benefits in the market
• Deadweight loss
– The loss of potential benefits due to a
deviation from the efficient outcome
18
Price Ceiling
• Figure 7 The Inefficiency of a Price Ceiling
1. A price ceiling of $15 . . .
2. transfers surplus from
producers to consumers.
Price
deadweight
loss
$23
C
S
3. It also decreases market
quantity, taking away
some consumer surplus
$19
B
$15
D
4 . . . . and some producer
surplus, neither of which are
transferred to anyone.
A
2,000
4,000
6,000
Number of Lessons
per Week
19
Price Floor
• Figure 8 The Inefficiency of a Price Floor
1. A price floor of $21 . . .
2. transfers surplus from
consumers to producers.
Price
deadweight
loss
H
S
$21
$19
$17
3. It also decreases market
quantity, taking away
some consumer surplus
G
F
D
4 . . . . and some producer
surplus, neither of which are
transferred to anyone.
3,000
4,000
5,000
20
Monopoly and Market Power
• Monopoly and imperfectly competitive
markets
– Firms charge a single price on all units
– P>MC
– Price is too high
– Output is too low
– Inefficient
21
Monopoly and Market Power
• Figure 9 The Deadweight Loss from Monopoly
Dollars
$8
Dollars
Perfectly Competitive
Market
Monopoly Market
$8
consumer
surplus
S
consumer
surplus
3
F
5
producer
surplus
E
deadweight
loss
S
E
producer
surplus
D
500,000
D
300,000
500,000
MR
22
Taxes and Deadweight Losses
• Imposing a tax on an efficient market
– Creates a deadweight loss
– The loss in benefits to buyers and sellers
is greater than the gain in revenue to the
government
• Taxes create smaller deadweight loss
– when they are imposed on markets in
which demand or supply is relatively
inelastic
23
Deadweight Loss From an Excise Tax
• Figure 10 The Deadweight Loss from an Excise Tax
Price
per
Ticket
Consumer Surplus
SAfter Tax
Deadweight Loss
B
$340
S1
Government Tax Revenue
300
A
280
Producer Surplus
D
7.5 10
Millions of Tickets per Year
24
A Tax on Land
• Figure 11 A Tax on Land
Monthly
Rent
per Acre
S
Government Revenue
$800
A
600
B
D
Dafter Tax
3,000,000
Number of Acres
25
Externalities
• By-product of a good or activity
• Affects someone not immediately
involved in the transaction
• Negative externality
– Causes harm to others
• Positive externality
– Creates benefits for others
26
The Private Solution to a Negative Externality
• Coase theorem
– A side payment can be arranged
without cost
– Market will solve an externality problem
on its own
• Conditions
1. Legal rights are clearly established
2. Legal rights can be easily transferred
3. Number of people involved is very small
27
Externalities
• The Free Rider Problem
– When the efficient outcome requires a
side payment
– Individual gainers will not contribute
28
Government Solutions
• A market with a negative externality
– Produce more than the efficient quantity
– Creates a deadweight loss
• Correcting negative externalities
– Taxes
– Regulations
– Tradable permits
29
Government Solutions
• Taxing a Negative Externality
– A tax on each unit of a good = external
harm it causes
– Can correct a negative externality
– Bring the market to an efficient output
level
30
Taxing a Negative Externality
• Figure 3a A Tax on Producers to Correct a Negative Externality
Dollars
MSC
C
$1.00
B
S
A
$2.00
D
100
Efficient
Quantity
125
Millions of Gallons
per Period
Equilibrium
Quantity
31
Taxing a Negative Externality
• Figure 3b A Tax on Producers to Correct a Negative Externality
Dollars
SAfter Tax
B
$2.60
S
$1.00
A
$2.00
$1.60
D
100
125
Millions of Gallons
per Period
New Equilibrium
Quantity with Tax
32
Regulation and Tradable Permits
• Regulations
– Move a market closer to the efficient
point
• Tradable permit
– License that allows a company to release
a unit of pollution into the environment
over some period of time
33
Dealing with a Positive Externality
• A market with a positive externality
– Produce less than the efficient quantity
– Creates a deadweight loss
• Correcting positive externalities
– Subsidies
• A subsidy on each unit of a good = external
benefits it creates,
• Can correct a positive externality
• Brings the market to an efficient output level
34
Dealing with a Positive Externality
• Figure 4a A Subsidy for Consumers to Correct a Positive Externality
Price
S
$200
B
$400
A
MSB
D
100
200
Quantity of
Devices
(thousands)
35
Dealing with a Positive Externality
• Figure 4b A Subsidy for Consumers to Correct a Positive Externality
Price
S
$200
B
$450
400
A
DAfter Subsidy
250
D
100
200
Quantity of
Devices
(thousands)
36