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 Efficiency: finish definitions and graphing
 Efficiency and consumer surplus
 Course information
Where are we on the syllabus? Today, finish
chapter on efficiency and fairness, next chapter
on public goods. Public goods will be the last
chapter covered on the midterm.
Deriving Consumer Surplus
A demand curve (D) is a marginal benefit curve.
D for pizzas: tells us the dollars worth of other goods
people are willing to forgo to consume one more pizza.
D shows the value the consumer places on each pizza.
Consumer Surplus
Consumer surplus is the MB from a good or service
minus the price paid for it, summed over the quantity
consumed.
Consumer Surplus
Consumer surplus from the
10,000 pizzas that people
buy is the area of the
green triangle.
Consumer surplus from
pizzas is $.
The total benefit from
pizzas is $
—the
$
that people
spend on pizzas plus the
$
of consumer
surplus.
From the Production (Supply) Side of the Market
 Supply and Marginal Cost
Sellers distinguish between cost and price.
•  Cost: what a seller must give up to produce the
good.
•  Price: what a seller receives when the good is
sold.
The cost of producing one more unit of a good or
service is its marginal cost (MC).
This gives us the supply curve.
Producer Surplus
Producer surplus from the
10,000 pizzas sold is
$
a day—the
area of the blue triangle.
Cost equals total
revenue of $
minus the producer
surplus of $
Or, the red area under the
marginal cost curve.
The Efficient Market Defined
When marginal cost equals
marginal benefit, quantity
is efficient.
Consumer surplus plus
producer surplus is
maximized.
What is Not Efficient?
 Underproduction and Overproduction
Inefficiency can occur because:
•  Too little is produced—underproduction.
•  Too much is produced—overproduction.
Inefficiency and Deadweight Loss
Deadweight loss: decrease in total surplus and
that results from an inefficient underproduction
or overproduction.
Deadweight loss is borne by the entire society. It is a
social loss.
Deadweight Loss
Underproduction case
Efficient production at
Suppose produce at 5000
Where is deadweight loss?.
Underproduction is inefficient.
ARE MARKETS EFFICIENT?
Overproduction
When the government pays producers a subsidy, the
quantity produced exceeds the efficient quantity.
A deadweight loss arises than reduces total surplus to
less than its maximum.
Barriers to Efficiency
• Price and quantity regulations
• Taxes and subsidies
• Externalities
• Public goods and common resources
• Monopoly
•  High transactions costs
Price and Quantity Regulations
Price regulations prevent price adjustments and lead to
underproduction or overproduction.
Quantity regulations prevent quantity adjustments.
Effect of Taxes
Taxes and Subsidies
Taxes increase the prices paid by buyers and lower the
prices received by sellers.
So taxes decrease the quantity produced and lead to
underproduction.
Effect of Subsidies
Subsidies lower the prices paid by buyers and increase
the prices received by sellers.
So subsidies increase the quantity produced and lead to
overproduction.
BUT, these effects of subsidies and taxes hold only if
there are market failures.
How markets fail
Externalities
An externality is a cost or benefit that affects someone
other than the seller or the buyer of a good.
An electric utility creates an external cost by burning
coal that creates acid rain.
The utility doesn’t consider this cost when it chooses
the quantity of power to produce. Overproduction
results.
How markets fail
A common resource is owned by no one but used by
everyone.
It is in everyone’s self interest to ignore the costs of their
own use of a common resource that fall on others
(called tragedy of the commons).
This leads to overproduction.
When Markets Fail
High Transactions Costs
Transactions costs are the opportunity costs of
making trades in a market.
Some markets are just too costly to operate.
When transactions costs are high, the market might
underproduce.
Are Markets Fair?
Two broad and generally conflicting views of fairness
are:
•  It s not fair if the rules aren t fair
•  It s not fair if the result isn t fair.
EYE on PRICE GOUGING
Should Price Gouging be Illegal?
Following a hurricane, the
demand for camp stoves
increases to D1.
With no price gouging law,
the price jumps to $ and
the quantity increases to
stoves per day.
This outcome is efficient
because the marginal cost
of a stove equals the
marginal benefit from a
stove.
EYE on PRICE GOUGING
Should Price Gouging be Illegal?
If a strict price gouging law
requires the price after the
hurricane to be $20.
At this price, the quantity of
stoves supplied remains at
5 per day.
Where is the deadweight
loss?
The price gouging law is
inefficient, but is it fair?
Inequality