Download Economics Principles and Applications

Chapter 7: Efficiency and Exchange
Market Equilibrium and Efficiency
• Economic efficiency exists when no change
could be made to benefit one party without
harming the other
– Sometimes called Pareto efficiency
– Equilibrium price and quantity are efficient
• Prices above or below equilibrium are not
1
Price Below Equilibrium
• Suppose milk is $1 per gallon
Price ($/gallon)
2.50
S
2.00
1.50
1.00
0.50
D
1
2
3
4
5
Quantity (1,000s of gallons/day)
2
Price Below Equilibrium
• A buyer offers $1.25 per gallon
Price ($/gallon)
2.50
S
2.00
1.50
1.25
1.00
0.50
D
1
2
3
4
5
Quantity (1,000s of gallons/day)
3
Price above Equilibrium
S
Price ($/gallon)
2.50
2.00
1.75
1.50
Only equilibrium
price is efficient
1.00
0.50
D
1
2
3
4
5
Quantity (1,000s of gallons/day)
4
Efficiency Conditions
5
Heating Oil Market
Price ($/gallon)
2.00
1.80
S
1.60
Consumer surplus = $900/day
1.40
1.20
Producer surplus = $900/day
1.00
.80
D
1 2 3 4 5
8
Quantity (1,000s of gallons/day)
6
Price Ceiling on Heating Oil
2.00
1.80
Consumer surplus = $900/ day
S
Price ($/gallon)
1.60
1.40
Lost surplus = $800/ day
1.20
1.00
0.80
Producer surplus = $100/ day
D
1 2 3 4 5
8
Quantity (1,000s of gallons/day)
7
Price Subsidies for Bread
Price
($/loaf)
$4.00
Consumer Surplus = $4 M/month
$3.00
S
$2.00
Consumer Surplus = $9 M/month
$1.00
D
S with subsidy
2
4
6
8
Quantity (millions of loaves/month)
BUT…
8
The Cost of the Subsidy
 BUT …
 The government loses $1 on every loaf
 Imports 6 million loaves for $2 per loaf
 Government losses are $6 million
 The net benefit of the subsidy program
 Consumer surplus – government losses
 Net benefit = $3 million
9
Taxes on Sellers
• Tax program
– Seller reports sales in units to government
– Seller pays a fixed dollar amount per unit sold
• A tax on the seller shifts the supply curve
up by the amount of the tax
– Vertical interpretation of the supply curve
• For each level of output, seller charges his marginal
cost PLUS the tax
10
Tax on Avocado Sellers
S + tax
S
Price ($/pound)
6
5
4
3.50
3
2.50
2
1
D
1
2
3
4
5
2.5
Quantity (millions of pounds/month)
11
Taxes and Perfectly Elastic Supply
Price
($/car)
If supply is perfectly elastic,
buyers pay all of the tax
S + $100
S
$20,100
$20,000
D
1.9 2.0
Quantity (millions of cars/month)
12
Tax on Avocado Sellers
P
6
Before Tax
Consumer surplus = $4.5 M
Producer surplus = $4.5 M
S
3
P
6
D
3
S + tax
Q
After Tax
Consumer surplus = $3.125 M
Producer surplus = $3.125 M
Total surplus = $6.25 M
Loss = $2.75 M
3.50
1
D
2.5
Q
13
Taxes and Price Elasticity of Demand
More Elastic Demand
Less Elastic Demand
P
P
S+T
S+T
2.40
2.00
1.40
2.60
2.00
1.60
S
S
D1
D2
19 24
Q
21 24
Q
Consumers pay a smaller share of the tax when demand is more elastic
14
Taxes and Deadweight Loss
More Elastic Demand
P
Less Elastic Demand
P
Deadweight loss
Deadweight loss
S+T
S+T
2.40
2.00
1.40
2.60
2.00
1.60
S
S
D1
D2
19 24
Q
21 24
Q
Deadweight loss is larger when demand is relatively elastic
15