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Economic Efficiency
and the Role of Government
ECONOMICS: Principles and Applications 3e
HALL & LIEBERMAN
© 2005 Thomson Business and Professional Publishing
Figure 1 The Marginal Benefit
from Guitar Lessons
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
Figure 2 The Marginal Cost of
Guitar Lessons
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
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
Bo
McCollum
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
Figure 4 Consumer Surplus in a Small
and a Large Market for Guitar Lessons
(a)
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
Figure 4 Consumer Surplus in a Small
and a Large Market for Guitar Lessons
(b)
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
Figure 5 Producer Surplus from
Selling Guitar Lessons
(a)
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
Figure 5 Producer Surplus from
Selling Guitar Lessons
(b)
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
Figure 6 Total Net Benefits in a
Competitive Market for Guitar Lessons
Price
S
Equilibrium
Price
$19
D
4,000
Equilibrium Quantity
Figure 7 Why Price Ceilings and
Price Floors Are Inefficient
(a)
1. A price ceiling of $15 . . .
2. transfers surplus from
producers to consumers.
Price
S
$23
C
3. It also decreases market
quantity, taking away
some consumer surplus
E
$19
B
D
$15
D
A
4 . . . . and some producer
surplus, which are not
transferred to anyone.
2,000
4,000
6,000
Figure 7 Why Price Ceilings and
Price Floors Are Inefficient
1. A price floor of $21 . . .
Price
2. transfers surplus from
consumers to producers.
S
C
$21
$19
$17
B
3. It also decreases market
quantity, taking away
some consumer surplus
E
D
A
D
4 . . . . and some producer
surplus, which are not
transferred to anyone.
3,000
4,000
5,000
Average Output per Worker
Figure 8 Government Infrastructure
and Output per Worker
$18,000
14,000
10,000
6,000
2,000
Low
Medium
High
Quality of Infrastructure
Figure 9 The Welfare Loss from
Monopoly
1. A monopoly charges a higher price
than a competitive market . . .
3. The result is a welfare loss . . .
MC
Dollars
$22
E
$19
MR
2. and produces a
lower quantity.
2,500
4,000
4. from not producing
the efficient quantity,
at point E.
D
Number of Lessons per Week
Figure 10 Regulating a Natural
Monopoly
Dollars
Unregulated monopoly
$60
A
Efficient production
(requires subsidy)
C
$29
$15
"Fair rate of return"
production
F
MR
50,000
B
LRATC
MC
D
100,000
85,000
Number of
Households
Served
Figure 11A Tax on Producers to
Correct a Negative Externality
(a)
Dollars
1. This market has a negative
externality of $0.50 per unit.
MSC
C
2. The efficient quantity is here . . .
$0.50
B
S
A
3. but the equilibrium
quantity is here.
$1.00
D
4. In equilibrium, the welfare
loss is triangle ABC.
100
125
Millions of Gallons
per Period
Figure 11A Tax on Producers to
Correct a Negative Externality
5.(b)
A tax per unit on producers, equal
to the negative externality per unit,
Dollars
6. shifts the supply curve upward . . .
SAfter Tax
B
$1.30
SBefore Tax
$0.50
A
$1.00
$0.80
7. and moves the
equilibrium to the
efficient quantity.
D
100
(b)
125
Millions of Gallons
per Period
Figure 12 A Subsidy for Consumers to
Correct a Positive Externality
(a)
1.This market has a positive externality
of $30,000 per college degree.
Dollars
2. The equilibrium quantity is here . . .
S
$30,000
B
$100,000
3. but the efficient
quantity is here.
A
MSB
C
D
800,000
1,000,000
4. In equilibrium, the welfare loss is triangle ABC.
Number of
Degrees per Year
Figure 12 A Subsidy for Consumers to
Correct a Positive Externality
5. A subsidy per unit for consumers equal
to the positive externality per unit . . .
Dollars
(b)
6. shifts the demand curve upward . . .
$30,000
B
$114,000
$100,000
A
7. and moves
the
S
market to the
efficient quantity
DAfter Subsidy
$84,000
DBefore Subsidy
800,000
1,000,000
Number of
Degrees per Year
Figure 13 Pure Private, Pure
Public, and Mixed Goods
Pure Private Good
More Excludable
More Rival
More Nonrival
• food, clothing,
housing
• sold-out movie
• crowded
highway
Mixed Good
• software
• movie with empty
seats
• uncrowded highway
• newspaper
• downloaded
• cable
television music file
• urban park
• crowded
city streets
• fish in international
waters
• police and fire
protection
• national defense,
legal system
More Nonexcludable
Mixed Good
Pure Public Good