Download MODULE 50: Efficiency and Deadweight Loss AP Microeconomics

MODULE 50: Efficiency and
Deadweight Loss
AP Microeconomics
Before you read the module:
Summary
This module introduces the concepts of total surplus and deadweight loss. Markets are an effective way to
organize economic activity and generally make society as well off as possible given the available resources. In
this module, consumer surplus and producer surplus are used to explain why this is so.
Module Objectives
Objective 1. The meaning and importance of total surplus and how it can be used to illustrate efficiency in
markets.
Objective 2. How taxes affect total surplus and can create deadweight loss.
While you read the module:
Key Terms
Define these key terms as you read the module.
Total surplusExcise taxTax incidenceDeadweight lossAdministrative costsAfter you read the module:
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The sum of consumer and producer surplus is known as the total (1) ______________ generated in a
market. When a market is in equilibrium, there is no way to increase the gains from trade; any other
outcome reduces total surplus, therefore the equilibrium market outcome is usually (2) ____________.
There are three caveats to the conclusion that market equilibrium maximizes the gains from trade.
First, although a market may be efficient, it isn’t necessarily fair. Economists say that, fairness, also
known as (3) ______________ is often in conflict with efficiency. Second, there are specific instances
during which the economy experiences (4) _____________ failures. Finally, market equilibrium
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maximizes (5) ________________ surplus but does not necessarily result in the best outcome for every
individual consumer and producer.
Taxes are an example of government intervention in a market that prevents the market from moving
to equilibrium and results in a (6) _________________ loss, which represents total surplus lost to
society because of the tax.
Module Review
Types of Taxes
This module analyzes the effect of an excise tax on total surplus. An excise tax is a tax charged on each
unit of a good sold. Another type of tax is a lump-sum tax. Lump-sum taxes are the same for everyone,
regardless of any actions people take. For example, a lump-sum tax does not change as the quantity bought
or sold increases. Therefore, excise 9or per-unit) taxes change as quantity changes, but lump-sum taxes stay
the same regardless of the quantity. When considering the effect of a tax, remember that it will be different
depending on whether you are looking at a per-unit or a lump-sum tax. A per-unit tax will tend to increase
price and decrease quantity while a lump-sum tax will not affect price or quantity.
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Total surplus is the sum of consumer and producer surplus. At the market equilibrium, total surplus is
maximized: the market equilibrium allocates the consumption of the good among potential consumers
and the sales of the good among potential sellers in order to achieve the maximum possible gains to
society. In a well-functioning market, total surplus cannot be increased by reallocating consumption
among consumers, reallocating sales among sellers, or by changing the quantity traded. In fact, each
of these actions diminishes the level of total surplus in the market.
Preventing a sale in a market that would have taken place in equilibrium reduces both consumer and
producer surplus, resulting in a loss of total surplus.
Even though the market equilibrium maximizes total surplus, it does not necessarily provide equity or
maximize the outcome for any individual buyer or seller. And markets can fail to be efficient: this is
called a market failure.