Download Surplus, Efficiency, and Deadweight Loss

ECON 1100 – Global Economics (Fall 2013)
“Surplus, Efficiency, and Deadweight Loss”
Relevant Readings from the Required Textbooks:
 Economics – Chapter 5, Surplus, Efficiency, and Deadweight Loss
Definitions and Concepts:
 consumer’s surplus – a measure of the net gain that a buyer realizes from making a
purchase, equal to the difference between his reservation price for the item and the
price he actually pays for the item.
 producer’s surplus – a measure of the net gain that a seller realizes from making a
sale, equal to the difference between the price she actually receives for the item and
her reservation price for the item.
 social surplus – a measure of the net gains to society from a trade, equal to the
summation of the individual gains (or losses) from the trade over all members of
society.
 total social surplus – a measure of the total gains from trade realized by society,
defined as Social Surplus, added over all units traded.
 total consumers’ surplus – a measure of the total gains from trade realized by all
consumers, defined as each individual’s Consumer’s Surplus, added over all units
purchased.
 total producers’ surplus – a measure of the total gains from trade realized by all
sellers, defined as each individual’s Producer’s Surplus, added over all units sold.
 efficient level of trade – the level of trade which maximizes Total Social Surplus
 deadweight loss – the difference between maximum possible Total Social Surplus
and realized Total Social Surplus.
 by construction, Deadweight Loss is zero at the efficient level of trade and is
positive at any other level of trade.
 open-ended fallacy – a logical error whereby someone incorrectly concludes that
simply because there are benefits (to some people) from higher levels of an activity,
that more of the activity is always better.
“Maximum Total Social Surplus” and “Inefficiency of too much or too little trade”:
To maximize
 Do trade all units for which (rb  rs )  0 (or equivalently rb  rs )

Do not trade any units for which (rb  rs )  0 (or equivalently rb  rs )
price
Supply
Maximum possible
Social Surplus
Demand
0
quantity
“Social Surplus Maximizing”
or “Efficient” Level of Trade
0
Any other level of trade (either higher or lower) leads to a smaller realized value of Total
Social Surplus.
Inefficiency from “too little trade”:
price
Inefficiency from “too much trade”:
Realized Social
Surplus equal to
“orange area”
DWL equal to
“black area”
price
Supply
Realized Social
Surplus equal to
“orange area minus
black area”
Supply
Demand
0
quantity
0
Level of Trade below
“Efficient Level”
DWL
equal to
“black
area”
Demand
0
quantity
0
Level of Trade above
“Efficient Level”
“Equilibrium Price” serves to define the “split” of “total gains from trade” between
buyers and sellers under the market equilibrium outcome:
price
Total
Consumers’
Surplus
(“green area”)
Supply
*** Total Social Surplus (“green
area” plus “purple area”) ***
Equilibrium
Price
Total Producers’
Surplus (“purple area”)
Demand
0
quantity
0
“Efficient” Level of Trade, as well
as “Equilibrium” Level of Trade
Multiple Choice Questions:
1.
“Deadweight Loss” refers to
A.
the negative impact of industrial production on our scarce environmental
resources.
B.
the difference between “maximum possible Total Social Surplus” and
“realized Total Social Surplus.”
C.
the profits that firms make in a free market economy.
D.
the burden that consumers incur from having to pay for goods, instead of
being given the goods for free.
2.
Ty owns a copy of the book “The Economic Naturalist: In Search of Explanations
for Everyday Enigmas,” autographed by the author Robert Frank. His reservation
price as a seller of this item is $70. Bob’s reservation price as a buyer of this item
is $60. If this unit was traded (i.e., transferred from Ty to Bob)
A.
Social Surplus would be decreased by $10.
B.
Social Surplus would be increased by $10.
C.
Social Surplus would be increased by $130.
D.
Social Surplus would be increased, but the magnitude of the increase
depends upon the price at which trade takes place.
3.
The _______________ refers to the logical error whereby someone incorrectly
concludes that simply because there are benefits (to some people) from higher
levels of an activity, that more of the activity is always better.
A.
Invisible Hand
B.
Economic Calculation Problem
C.
Open-Ended Fallacy
D.
Phillips Curve
4.
Consider a market in which the efficient level of trade is 5,250 units. There
would be a positive Deadweight-Loss if _________ units were traded.
A.
0.
B.
4,500.
C.
7,750.
D.
More than one (perhaps all) of the above answers are correct.
5.
Dave bought 10 comic books from Eric. This trade gave Eric a Producer’s
Surplus of $20 and generated a Social Surplus of $36. It follows that Dave
realized a ______________________ from this trade.
A.
negative Consumer’s Surplus
B.
Consumer’s Surplus of $16
C.
Consumer’s Surplus of $56
D.
None of the above answers are correct.
6.
In most markets Total Social Surplus is equal to
A.
“Total Consumers’ Surplus” plus “Total Producers’ Surplus.”
B.
“Total Consumers’ Surplus” minus “Total Producers’ Surplus.”
C.
“Total Benefit to Buyers” minus “Total Amount Paid by Buyers.”
D.
“Equilibrium Price” multiplied by “Equilibrium Quantity.”
For questions 7 and 8, refer to the graph below. This graph illustrates the supply and
demand for hats in 2013.
price
Supply 2013
(a)
11.95
(b)
(e)
(c)
(f)
(g)
8.10
5.00
(h)
(d)
Demand 2013
0
quantity
0
1,670
3,330
4,635
7.
In equilibrium
A.
both Total Producers’ Surplus and Total Consumers’ Surplus are zero.
B.
both Total Producers’ Surplus and Total Consumers’ Surplus are positive.
C.
Total Producers’ Surplus is positive, but Total Consumers’ Surplus is zero.
D.
Total Consumers’ Surplus is positive, but Total Producers’ Surplus is zero.
8.
If 1,670 units were traded, Deadweight-Loss would be
A.
negative.
B.
equal to “area (g).”
C.
equal to “area (e) plus area (f).”
D.
equal to “area (g) plus area (h).”
Answers to Multiple Choice Questions:
1.
2.
3.
4.
5.
6.
7.
8.
B
A
C
D
B
A
B
C