Chapter 4: Economic Efficiency, Government Price Setting, and Taxes

Price Ceiling

A legally determined maximum price that sellers may charge

Price Floor

A legally determined minimum price that sellers may receive

4.2 Summary

Equilibrium in a competitive market is economically efficient. Economic surplus is the sum of consumer surplus and producer surplus. Economic efficiency is a market outcome in which the marginal benefit to consumers from he last unit produced is equal to the marginal cost of production and in which the sum of consumer surplus and producer surplus is at maximum. When the market price is above or below the equilibrium price, there is a reduction in economic surplus. The reduction in economic surplus resulting from a market not being in competitive equilibrium is called the deadweight loss.

Competitive Equilibrium

Equilibrium in a competitive market results in the economically efficient level of output, at which marginal benefit equals marginal cost

4.4 Summary

Most taxes result in a loss of consumer surplus, a loss of producer surplus, and deadweight loss. The true burden of a tax is not just the amount consumers and producers pay to the government but also includes the deadweight loss. The deadweight loss from a tax is called the excess burden of the tax. Tax incidence is the actual division of the burden of a tax. In most cases, consumers and firms share the burden of a tax levied on a good or service.

4.3 Summary

Producers or consumers who are dissatisfied with the equilibrium in a market can attempt to convince the gov. to impose a price floor or a price ceiling. Price floors usually increase producer surplus, decrease consumer surplus, and cause a dead weight loss. Price ceilings usually increase consumer surplus, reduce producer surplus, and cause a deadweight loss. The results of the government imposing price ceilings and price floors are that some people win, some people loos, and a loss of economic efficiency occurs. Price ceilings and price floors can lead to a black market, in which buying and selling take place at prices that violate government price regulations. Positive analysis is concerned with what is, and normative analysis is conserve with what should be. Positive analysis shows that price ceilings and price floors cause deadweight losses. Whether these policies are desirable or undesirable, though, is a normative question.

economic efficiency (broad)

a market outcome in which the marginal benefit to consumers of the last unit produced is equal to its marginal cost of production and in which the sum of consumer surplus and producer surplus is at a maximum

4.1 Summary

although most prices are determined by demand and supply in markets, the government sometimes imposes price ceilings and price floors. A price ceiling is a legally determined maximum price that sellers may charge. A price floor is a legally determined minimum price that sellers may receive. Economists analyze the effects of price ceilings and price floors by using the concepts of consumer surplus, producer surplus, and deadweight loss. Marginal benefit is the additional benefit to a consumer from consuming one more unit of a good or service. The demand curve is also a marginal benefit curve. Consumer surplus is the difference between the highest price the consumer pays. The titan aniybt of consumer surplus in a market is equal to the area below the demand curve and above the market price. Marginal cost is the additional cost to a firm of producing one more good or service. The supply curve is also a marginal cost curve. Producer surplus is the difference between the lowest price a firm is willing to accept for a good or service and the price it actually receives. The total amount of producer surplus in a market is equal to the area above the supply curve and below the market price.

what consumer surplus and producer surplus measure

consumer surplus measures the benefit to consumers from participating in a market, and producer surplus measures the benefit to producers from participating in a market

economic efficiency

equilibrium in a competitive market results in the greatest amount of economic surplus, or total net benefit to society, from the production of a good or service

tax incidence

the actual division of the burden of a tax

Marginal benefit

the additional benefit to a consumer from consuming one more unit of a good or service

Marginal Cost

the additional cost to a firm of producing one more unit of a good or service

Consumer Surplus

the difference between the highest price a consumer is willing to pay for a good or service and the actual price the consumer pays

producer surplus

the difference between the lowest price a firm would be willing to accept for a good or service and the price it actually receives

Deadweight loss

the reduction in economic surplus resulting from a market not being gin competitive equilibrium

Economic Surplus

the sum of consumer surplus and producer surplus

economic efficiency

when the marginal benefit from the last unit sold should equal the marginal cost of production