Microeconomics: Chapter 4

Price floor

A legally determine minimum price that sellers may receive

Price ceiling

A legally determined maximum price that sellers may charge

Economic efficiency

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

Summary A: Consumer surplus and producer surplus

Almost most prices are determined by demand 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 determine minimum price that sellers may receive. Economists analyze the effects of price ceilings and price floors using consumer surplus, producer surplus, and deadweight loss. Marginal benefit is the additional benefit to a consumer 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 a consumer is willing to pay for a good or service and the actual price a consumer pays. The total amount of consumer surplus is a market is equal to area below the demand curve and above the market price. Marginal cost is the additional cost to a firm of producing one more unit of a good or service. The supply curve is also a marginal cost curve. Producer surplus 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.

Summary B: The efficiency of competitive markets

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 the last unit produced is equal to the marginal cost of production and in which the sum of consumer surplus is at a 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.

Summary D: The economic impact of taxes

Most taxes result in a loss of consumer surplus, a loss of producer surplus and a 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 or firms share the burden of a tax levied on a good or service.

Summary C: Government intervention in the market - price floors and price ceilings

Producers or consumers who are dissatisfied with the equilibrium in a market can attempt to convince the government to impose a price floor or ceiling. Price floors usually increase producer surplus, decrease producer surplus, and cause a deadweight loss. The results of government imposing price ceilings and price floors are that some people win, some people lose, 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 concerned with what should be. Positive analysis shows that price ceilings and floors cause deadweight losses. Whether these policies are desirable or undesirable though, is a normative question.

Tax incidence

The actual division of the burden of tax between buyers and sellers in a market

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 in competitive equilibrium

Economic surplus

The sum of consumer surplus and producer surplus