Markets and Efficiency Flashcards
Describe pareto efficiency
A situation where to one person better off, another person needs to be made worse off
we can say that the competitive market is Pareto effiicient if these 3 Conditions for Efficient Outcomes including ____ are fulfilled
what is an attractive feature of competitive markets?
they maximize consumer and producer surplus.
the producer surplus for all producers is the area above the supply curve and below the market price line, and that the consumer surplus for all consumers is the area below the demand curve and above the market price line
what is deadweight loss?
the loss in producer and consumer surplus due to an inefficient level of production. (deviations from competitive equilibrium qty)
- cost to society created by market inefficiency
what is deadweight loss caused by?
anything that leads to an ineffcient allocation of resources e.g.
- Price ceilings (rent controls)
- price floors (such as minimum wage and living wage laws)
- taxation
Consumer surplus and producer surplus are measures
how well off consumers and firms are as a result of buying and selling in the market. The larger the sum of these surpluses, the better off consumers and firms (society as a whole) are.
Describe what happens to producers when there is a price floor?
The price floor creates an excess supply of goods at the new higher price. Some producers gain because they are able to sell at a higher price than before. Others lose because they are no longer able to sell the good because the government doesn’t allow them to lower the price to attract buyers.
what happens to consumer surplus when there is a price ceiling?
On the one hand, those consumers who are able to acquire the good at the lower price will obtain more consumer surplus. But because only a smaller quantity of goods is available for purchase, there will be a loss of consumer surplus for those who were previously able to buy the good but now cannot.
Consumer surplus would be given by the area BFGH
what happens to producers when there is a price ceiling?
they are unambiguously worse off, they sell fewer units at a lower price
as denoted by the reduction of amount CDHG
what happens to consumers when there is a price floor?
consumers unambiguously lose because they buy fewer units at a higher price.
the immediate impact of tax is to
the immediate impact of the tax is to add to the marginal cost of producing the product. Hence, the immediate impact of the tax will be to shift the supply curve to the left
what represents government revenue in the case of tax?
blue rectangle the amount of tax
where is consumer and producer surplus after tax?
Consumer surplus is now given by the triangle BEF, while producer surplus is given by the triangle AGH (keep in mind that producers do not receive the new price; they only get the new price less the tax).
why may taxation lead to deadweight loss?
shift in supply to the left –> total quantity produced is lower, there is a loss in consumer surplus and producer surplus.
This is a loss to society
how to calculate consumer surplus?
value to consumers - consumer expenditure
how to calculate producer surplus?
producer revenues - producer costs
What is total surplus?
CS + PS
or value to consumers - producer costs
What is the efficient output level?
what is deadweight loss?
the reduction in total surplus due to an inefficient qty
how can qty lower than Q* cause deadweight loss
show how competitive market outcomes are efficient
why do competitive markets lead to efficient but inequitable outcomes?
show how competitive markets lead to inequitable outcomes
Application of price ceiling
Find change in TOTAL SURPLUS
Change in Total Surplus
= change in CS + change in PS
= (A-B) + (-A-C)
= -B-C
= deadweight loss
The loss in PS exceeds “gains” in CS
Therefore, price ceiling creates an inefficient outcome by reducing total surplus
Application of price ceiling
Find total change in PS
Producers who still produce now receive a lower price
- decrease in their PS = A
Producers who no longer produce (higher cost producers) lost PS = C
Total change in PS = -A - C
Application of price ceiling
Find total change in CS
Consumers who purchase the good do so at a lower price
increase in their CS = A
Consumers who longer purchase good lost CS = B
Total change in CS = A-B
Show what a price ceiling looks like when demand is inelastic and supply is elastic
for excise tax, what is Pb, Ps, show relationship
what is specific or unit tax
what is an ad valorem tax
show excise tax
distinguish between production and consumption tax
production tax adds to MC of supplying goods
consumumption tax lowers MB of consuming goods
welfare impact of tax
what is the change in total surplus?
Change in total surplus = change in CS + change in PS + GS
= - B-C - D - E +B + D
= - C - E
Deadweight loss of excess burden of taxation
welfare impact of tax
what imapct impact does tax have on the government?
government surplus called tax revenues
GS = t x Qt = B +D
welfare impact of tax
what impact does tax have on producers?
lower price received (Ps
PS (Before) = D + E + F
PS (After) = F
change in PS = - D - E
welfare impact of tax
what impact does tax have on consumers?
Impact on consumers: pay more (Pb>P*) and consume less
CS (Before)= A + B + C
CS (after) = A
Change in CS = - B-C
Economic incidence of tax, who bears the tax?
deadweight loss of tax or excess burden of tax is bigger when
show economic incidence of tax
when there is elastic demand, inelastic supply
show economic incidence of tax
when there is inelastic demand, elastic supply
show how the size of t leads to a greater deadweight loss (more inefficient qty)
show how deadweight loss of tax is greater when demand or supply is more elastic (resulting in lower or more inefficient qty)
what effect do subsidies have on consumers?
The more inelastic the demand curve the greater the consumer’s gain from a subsidy.
Indeed when demand is perfectly inelastic the consumer gains most of the benefit from the subsidy since all the subsidy is passed onto the consumer through a lower price.
When demand is relatively elastic, the main effect of the subsidy is to increase the equilibrium quantity traded rather than lead to a much lower market price.
what effect do producer subsidies have on producers?
The subsidy to the producer is viewed as a decrease in production costs, which allows producers to expand production from S0 to S1.
what is the result of a producer subsidy?
The result of the subsidy is increased production, from an equilibrium quantity of 10 to 13, which is matched by increased consumption by consumers. Consumers now pay $6 instead of the equilibrium $9, and producers receive $10 instead of $9.
what does this graph show in terms of elasticity?
the supply curve is much more elastic than previous examples. Due to the flatness of the curve, the supplier receives less of the subsidy, represented by region A, than consumers, represented by area B.
how to calculate producer surplus?
The amount of producer surplus can be calculated by using the area formula of a trapezoid, which is the average of its bases times the height. The area enclosed by region A represents $11.50 [Calculated as [(13 + 10)/2] x 1
how to calculate consumer surplus?
The consumer surplus, region B, on the other hand, represents $34.50 [[(13+10)/2] x 3]
what is the entire cost of subsidy?
The entire cost of the subsidy is the sum of area ABC, or $52 [Calculated as 4 x 13]
describe how elasticity influences who gains from the subsidy more
It becomes apparent that the flatter the curve of the supplier, the less of the subsidy they receive.
The opposite is also true of demanders – the flatter their demand curve, the less subsidy they would receive. If a curve was perfectly elastic, then any subsidy would go entirely to the other party (i.e., if the supply curve was perfectly elastic, or flat, then the entire amount of the subsidy will fall solely into the hands of the consumers).
