Consumers and Government Efficiency Flashcards
What is deadweight loss?
reduction in total surplus resulting from the tax
What is tax revenue?
Size of tax times quantity sold (area of rectangle between supply and demand curves)
What does a tax wedge do?
Places a wedge between price that buyers pay and price that sellers receive
What is the effect of a tax?
Quantity of the good sold decreases
Welfare without tax?
total surplus = consumer + producer surplus
maximized at equilibrium
Welfare with tax?
price paid by buyers increases, price received by sellers decreases, quantity sold falls
total surplus = consumer surplus + producer surplus + tax revenue
What is welfare economics?
Study of how the allocation of resources affects economic well-being
What’s the willingness to pay (WTP)
Maximum amount that a buyer will pay for a good
Measures how much buyer values the good
Price < Willingness to pay: Buyer would be eager to buy
* Price > Willingness to pay: Buyer would refuse to buy
* Price = Willingness to pay: Buyer would be indifferent about buying
Where to see WTP on demand curve?
At any quantity, the price given by the demand curve shows the willingness to pay of the marginal buyer
What is the marginal buyer?
The buyer who would leave the market first if the price were any higher
What is consumer surplus? (individual)
Amount a buyer is willing to pay for a good - the amount the buyer actually pays
Measures the benefit buyers receive rom participating in a market
Closely related to demand curve
What is consumer surplus (in total)
Sum of all individual consumer surpluses
Area BELOW THE DEMAND CURVE AND ABOVE THE PRICE
Measures consumer surplus in A MARKET
When do we include new customers to consumer surplus?
If price goes down, and there is more demand
What is the cost?
The value of everything a seller must give up to produce a good including opportunity cost
Measure of willingness to sell
* Price > Cost: Seller would be eager to sell
* Price < Cost: Seller would refuse to sell
* Price = Cost: Seller would be indifferent about selling
E.g. for a painter, opportunity cost would include:
out of pocket expenses, his time
What is producer surplus (individual)?
Amount a seller is paid for a good
minus the seller’s cost of
providing it
Measures the benefit sellers
receive from participating in a
market
Closely related to supply
curve
What is producer surplus? (total)
The sum of all individual
producer surpluses
Area below the price and above
the supply curve
Measures the producer surplus in a market
What is total surplus?
Natural variable to consider when judging a market’s allocation of resources
Total surplus = consumer surplus + producer surplus
Area between the supply and demand curves up to the equilibrium quantity
Or
Total surplus = value to buyers - cost to sellers
When does the allocation of resources exhibit efficiency?
If an allocation of resources maximizes total surplus
What is efficiency?
If an allocation of resources maximizes total surplus
e.g. good being produced by sellers with the lowest costs
Why is the equilibrium outcome an efficiency allocation of resources?
Competitive markets allocate the supply of goods to the buyers who
value them most, as measured by their willingness to pay
2. Competitive markets allocate the demand for goods to the sellers who
can produce them at the lowest cost
3. Competitive markets produce the quantity of goods that maximizes the
sum of consumer and producer surplus
What is the efficiency of the equilibrium quantity?
At quantities less than the equilibrium
quantity, such as Q 1, the value to buyers
exceeds the cost to sellers.
* At quantities greater than the equilibrium
quantity, such as Q 2, the cost to sellers
exceeds the value to buyers.
* Therefore, the market equilibrium
maximizes the sum of producer and
consumer surplus.
Total surplus = Value to Buyers- Cost to Sellers
What assumptions do we need to make to conclude that markets are efficienct?
Markets are perfectly competitive
Outcome in a market matters only to the buyers and sellers in that
market
What are externalities?
The welfare implications of market activity depend on more than just the
value realized by buyers and the cost incurred by sellers
(third party, outside influence)
If externalities are ignored, the equilibrium in a market can be inefficient
from the standpoint of society as a whole
What is market failure?
The inability of some unregulated markets to allocate resources
efficiently
When markets fail, public policy can potentially remedy the problem and
enhance economic efficiency
