5.2: Benefit, Cost and Surplus
Economics Notes:
5.2: Benefit, Cost and Surplus Supply and Marginal Cost Supply and cost parallels the ideas between demand and benefit Question: Marginal Cost is a) The same as marginal benefit because producers benefit from the money they receive when they sell the good b) The opportunity cost of producing one more unit c) The total opportunity cost of producing all the units of the good d) Zero at the efficient level of production Supply, Cost, and Minimum Supply Price (page 110) Producers point of view: they distinguish between cost and price Cost is what the firm give up and price is what the firm receives when they sell the good or service. Marginal cost (cost of producing one more unit of it) determines whether a firm would want to produce another unit of it, but the minimum Supply price determines supply. Marginal cost is the minimum price that a firm is willing to accept If a unit of coffee costs the firm 5 bucks to produce, how much would the firm charge at least? They will charge at least 5 dollars. The minimum price determines supply. A supply curve is a marginal cost curve. If you pay enough, the firm is willing to sell. (Marginal Cost) Supply price is a marginal cost curve Market supply curve give answers to the quantity that this market is willing to produce at a certain price. Market supply: quantity in the graph is the addition of the individuals supply quantity at the given prices. How do you know marginal cost is increasing? It increases because increases opportunity cost. They have to sacrifice some resources. Marginal cost is increasing because of increasing opportunity cost. You must give up more of one resource to get another. Individual Supply and Market Supply (page 110) The relationship between the price of good and the quantity supplied is called the individual supply The relationship between the price of good and the quantity supplied by all producers is called the market supply MARKET SUPPLY CURVE: horizontal sum of all the individual supply curve and is formed by adding the quantities supplied by all the producers at each price Society marginal cost is referred to as marginal social cost (MSC)
Producer Surplus (page 111) Producer surplus is the excess amount received from a sale of good or service over the cost of producing it Producer surplus is the price received for the good – marginal cost It is measured by the area below the market price and above the supply curve, summed over the quantity sold More they sell, the higher the producer surplus Producer surplus = price received – marginal cost (minimum supply price) For example: The market price for pizza is 15 dollars. If she is willing to produce the 50th pizza for 10, then she will receive a producer surplus of 5 on the 50th pizza. Assume that Mario and Max are the only ones making pizza in the market: The area between the cost and the MC of both max and Mario’s producer surplus is the economy producer surplus Area under the MC is the total cost. The marginal benefit is determine by demand Marginal social benefit curve related to marginal benefit related to demand Question: The producer surplus on a unit of a good is a) Difference between the marginal social benefit and the marginal cost b) Number of dollars worth of other goods and services forgone to produce this unit of the good c) Difference between the price of the good and the marginal cost of producing the good d) Difference between the total cost of the good and the marginal cost Consumer surplus and producer surplus can be used to measure the efficiency of a market What is the relationship between marginal benefit, value and demand? Marginal benefit is the amount that someone is willing to pay for one more unit of it. Value is what we get. Willingness to pay determines demand. The market demand curve tells us the quantity the market is willing to pay for a certain price. Consumer surplus is the excess of the benefit received from a good over the amount paid for it. What is the relationship between marginal cost, minimum supply price, and supply? 1. The cost of producing one more unit of a good or service is its marginal cost 2. Marginal cost is the minimum supply price that producer must receive to induce them to offer to sell another unit of the good or service 3. But the Minimum supply price determines supply 4. So a supply curve is a marginal cost curve 5. It is not true that minimum supply price is the value of one more unit of a good or service. 6. Marginal benefit is the value of one more unit of a good or service.
What is the relationship between individual supply and market supply? 1. The market supply curve is the horizontal sum of the individual supply curve. 2. It is formed by adding the quantities supplied by all producers at each price What is producer surplus? How is it measured? 1. Producer surplus is the excess of the amount received from the sale of a good or service over the cost of producing it. 2. It is calculated by the price received for the good and the amount spent producing it (marginal cost / minimum supply price) What is consumer surplus? How is it measured? 1. Consumer surplus is the excess marginal benefit from the sale of a good or service over the price paid for it. 2. It is measured by the marginal benefit minus the price summed over the quantity bought.
Marginal social benefit from 30 kilometres is the benefit that the entire society receives, which is the sum of the marginal benefits that the people in the society receive.
The marginal benefit from 30 kilometers that one person receives is the maximum price that the person is willing to paid to travel 30 kilometres
A demand curve is a marginal benefit curve, so the demand schedule tells us the willingness (maximum) price willingly paid at each quantity demanded.
Consumer surplus is the area below the demand curve and above the equilibrium price
The producer surplus is the area above the supply curve and below the equilibrium price
5.3: Is the Competitive Market Efficient?
Efficiency of Competitive Equilibrium
Marginal demand curve – Marginal social benefit Market supply curve – marginal social cost Equilibrium in a market occurs when quantity supplied equals quantity demanded At this point, the intersection, marginal social benefit equals marginal social cost on the supply curve (Condition for allocative efficiency) A competitive market achieves allocative efficiency
At the equilibrium quantity marginal benefit equals marginal cost, so the quantity is efficient quantity When efficient quantity is produced, total surplus (the sum of consumer surplus and producer surplus) is maximized. Total Surplus: The sum of consumer surplus and producer surplus is the total surplus. TS = CS + PS This number does not indicate welfare exactly but the higher the number the better. BIG TS = Good TS (see graph on textbook)
Question: The competitive market is efficient because A) People can buy the good at a price that matches their marginal benefit B) Marginal social benefit from the good equals the marginal social cost of producing the good C) Sellers of the good get a price that exceeds their marginal cost D) Total surplus is reduced to zero Market Failure
Market delivers inefficient outcome and it occurs when a market delivers too little of an item or is over produced. o Underproduction: Tal surplus is smaller than its maximum possible level When too little of an item is produced Deadweight loss: the decrease in total surplus from an inefficient level of production. Equals the decrease in total surplus o Overproduction: Too much of an item is produced When quantity produced is greater than quantity that Consumers is willing to pay at a certain price The price consumers are willing to pay is less than what it costs to produce The grey triangle shows deadweight loss
Question: At the efficient level of production, ______ a) Producer surplus must be greater than consumer surplus b) There is no deadweight loss c) Total surplus is maximized d) Both C) and D) are correct
Question: A deadweight loss: a) Is possible only if the good is under produced but not possible if the good is overproduced b) Subtracts only form producer surplus c) A loss to consumer and a gain to producer d) Is a loss inflicted Sources of Market Failure and obstacles to Efficiency Sources that creates deadweight losses are o Price and quantity regulation (underproduction) For example minimum wage o Taxes and subsidies (underproduction) (paying taxes, HST o Externalities (overproduction) o Public goods and common resources (underproduction) Private goods are coffee, hamburger, etc. (when you consume the foods it is gone only for yourself) Public goods where everyone can have o Monopoly (underproduction) o High transaction costs (high costs (underproduction) Price and Quantity Regulation Price regulation can lead to underproduction because a quantity regulation limits the amount that a firm is permitted to produce. For example: CAP on housing for University staffs 25% lower Price regulations make market inefficient Taxes and Subsidies Taxes increase the prices paid by buyers and lower the prices received by sellers Subsidies lower the prices paid by buyers and increase the prices received by sellers So subsidies increase the quantity produced and lead to overproduction Externalities: Externality is a cost or benefit that affects someone other than the seller or the buyer of a good Example if you smoke and it effects other people Positive externality (flu vaccine) government subsidize education and it is a positive externality Negative externalities (air pollution) External cost example: electricity creates an external cost by burning coal that creates acid rain. The utility doesn’t consider this cost when it chooses the quantity of power to produce. Overproduction results Underproduction external cost example: an apartment owner would provide an external benefit if she installed an smoke detector. She doesn’t consider
her neighbor’s marginal benefit and decides not to install the smoke detector. The result is underproduction Public Goods and Common Resources Public good benefits everyone and no one can be excluded from its benefits Example: when everyone does not want to pay for public good (free rider problem), this leads to underproduction Common resource is owned by no one but can be used by everyone For example everyone ignores the cost of their own use of a common resource (tragedy of the commons). The tragedy of the commons leads to overproduction (fishing) Example: turn on the lights: it is a public good Cost of turning on the lights would be 100. To finance public goods, government taxes individuals Common resources: Fishing. Leads to overfishing. Monopoly Monopoly is a firm that has sole provider of a good or service Inefficient outcome One firm selling the product will always lead to inefficiency Self interest of monopoly is to maximize its profit Monopoly charges a price that too high and produces too little. As a result, underproduction Alternatives to the Market When market is inefficient, can one of the alternative nonmarket methods that we describe at the beginning of this chapter do a better job? Review: Do competitive markets use resources efficiently? Competitive markets use resources efficiently when quantity demanded equals the quantity supplied. This happens at the point when the demand curve and supply curve intersect. What is deadweight loss and under what conditions does it occur? Deadweight loss is the scale of inefficiency, which is the decrease in total surplus from an inefficient level of production. Deadweight loss can occur when there is an overproduction or underproduction. The grey triangle shows the deadweight loss, which reduces the surplus, to less than its maximum. What are the obstacles to achieving an efficient allocation of resources in the market economy? Obstacles include: 1) price and quantity regulation 2) Taxes and subsidies
3) 4) 5) 6)
Externalities Public goods and common resources Monopoly High transaction costs
Question 1: Equilibrium in a competitive market occurs when the quantity demanded equals the quantity supplied at the intersection of the demand curve and the supply curve. At this point of intersection marginal social benefit equals marginal social cost, which is the condition for allocative efficiency. So in equilibrium, a competitive market achieves allocative efficiency
Question 2 Market demand curve tells of the marginal social benefit Market supply curve tells of the marginal social cost Where the demand curve and the supply curve intersect, the marginal social benefit equals the marginal cost This is the condition for allocative efficiency and at this point, it delivers an efficient use of resources for the entire society. At allocative efficiency, the sum of the consumer surplus (green area) and the producer surplus (blue area) is maximized Question 3: Deadweight loss: when inefficient quantity is produced, consumer surplus decreases and producer surplus decreases. The loss of the total surplus is the deadweight loss Question 5 Demand curve is a marginal benefit curve, and we measure marginal benefit by the maximum price that is willingly paid for another unit of a good or service
Is the competitive market fair? Views of economics: 1) Its not fair if the result isn’t fair 2) Its not fair if the rules aren’t fair 1) Its not fair if the results isn’t fair: a. Unfair if people’s incomes are too unequal: for example it is unfair that bank president earns million of dollars a year
Utilitarianism: The idea that only equality brings efficiency. The principle states that we should strive to achieve the greatest happiness for he greatest number. The big trade off: The utilitarian ideal of complete equality I that it ignores the costs of making income transfers: Recognizing costs of making income transfer leads to the big tradeoff. Market system is the best Is the competitive market efficient? Chapter 6: Government Actions in Markets Objectives: 1. 2. 3. 4.
Explain rent ceilings create housing shortages and inefficiency Explain how minimum wage laws create unemployment Explain the effect of a tax Explain the effects of a production quotas, and subsidies on production costs and prices 5. Explain how markets for illegal goods work
Housing Market with a Rent Ceiling
Price Ceiling: a government regulation that makes it illegal to charge a price higher than a specified level. For example: controlling price of rent Makes the price cheaper A price ceiling can be above or below the equilibrium Above the equilibrium price: has no effect because the price ceiling does not contrail the market forces. For example: law and the market forces are not in conflict. Below the equilibrium price: powerful effect on the market because it prevents the price from regulating the quantities demanded and supplied The force of the law and the market forces are in conflict Rent ceiling: when a price ceiling is applied to a housing market o A rent ceiling set above the equilibrium creates a black market, increased search activity and housing shortage Housing Market with a Rent ceiling Quiz questions: Question 1 When the rent ceiling is higher than the equilibrium rent, the force of the law and mthe market are not in conflict. The rent would remain at the equilibrium price
Question 2: A rent ceiling set below the equilibrium rent has powerful effects on market. This is because the rent ceiling attempts to prevent rent from regulating the quantities demanded and supplied. Question 3: With an effective rent ceiling, housing is allocated by a method other than by price. Search activity increases and black markets arise. Question 4: An effective rent ceiling creates an inefficient outcome because at the rent ceiling, marginal social benefit exceeds marginal social cost. Question 5: If the rent ceiling is above the equilibrium, then it has no effect on the rent. When the rent ceiling is set above the equilibrium rent, the quantity of housing rented is the equilibrium quantity They quantity of housing demanded equals the quantity of housing supplied, so there is no shortage. Housing shortage When there is a housing shortage, the rent is below the equilibrium price. This means that the quantity demanded exceeds the quantity supplied. There are limited houses for those frustrated demanders who want houses. As a result, they look elsewhere for houses. Which of the following effects is typical of a price ceiling set below the equilibrium price? A) Less of the good is produced with the ceiling than would be produced without the ceiling. B) The price ceiling has no effect on the market equilibrium. C) Consumers can buy more than what they can at the equilibrium price because the ceiling price is lower. D) None of the above options is correct.
Increased search activity Search activity is the time spent looking for someone whom to do business with The opportunity cost equals the value of the search time as well as the rent and resources spent to find places to rent. Search activity increases and the cost of searching might actually bring up the price of the rent (even without rent ceiling)
Black market Black market is an illegal market in which equilibrium price exceeds the price ceiling The black market rent is equal to the maximum price that a renter is willing to pay Shortage of housing increase a black market in housing Illegal arrangements made between renters and landlords at rents above the rent ceiling – generally above what the rent would have been in an unregulated market At 800 a month, the price is below equilibrium. Rents above 800 are illegal. There is a shortage at this 800 regulated price. Through black market or increased search activity, the rent price might increase to 1200, Incurring a cost that exceeds what the equilibrium rent would be in an unregulated market Inefficiency of Rent Ceiling Rend ceiling below the equilibrium rents result in inefficient underproduction of housing services. Marginal social benefit of housing exceeds its marginal social cost and a deadweight loss shrinks the producer surplus and consumer surplus Figure 6.2: shows it inefficiency Question 7: A price ceiling set below the equilibrium price is effective. When the price falls, a movement occurs down along the supply curve – a decrease in the quantity supplied. When the price falls, a movement occurs down along the demand curve- an increase in the quantity demanded. Question 8: A price ceiling set below the equilibrium price is effective. When the price falls a movement occurs down along the supply curve – there is a decrease in quantity supplied. The quantity of fertilizer sold is equal to the quantity supplied. The quantity of fertilizer sold with the price ceiling is less than the quantity sold at equilibrium price. When the price falls a movement along the demand curve – an increase in quantity demanded. When the quantity demanded exceeds the quantity supplied, a shortage emerges. Therefore, the maximum price that someone is willing to pay for the last fertilizer increases. The demand curve tells us that maximum price. The demand curve is a downward sloping curve, so when the quantity available decreases the maximum price hat someone is wiling to pay for the last fertilizer available increases.
Question 10 When a price ceiling on fertilizer is set below the market equilibrium price, the consumer who can find fertilizer at the lower price are better off. Consumers who cannot find nay fertilizer due to the shortage created by the price ceiling are worse off. All producers are worse off because they are selling less fertilizer at a lower price than prior to the price ceiling When a price ceiling on fertilizer is set below the market price, some consumers are better off and all producers are worse off
MISSING: rest of housing shortages
Labour market with minimum wage
Price floor: a government regulation that makes it illegal to charge a price lower than a specified level o Below the equilibrium, price has no effect o Above the equilibrium price: it has powerful effects because the price floor attemsps to prevent the pirce from regulating quantities demanded and supplied Minimum wage: a minimum wage imposed at a level that is above the equilibrium wage creates unemployment
Minimum wage Brings unemployement At equilibrium price, quantity demanded equals quantity supplied Labor market, the wage rate is at equilibrium level the quantity of labor demanded equals the quantity supplied Above equilibrium: quantity of labor supplied exceed the quantity of labor demanded (surplus of labor) Demand for labor determines the level of employment and the surplus of labor is unemployed Is minimum wage fair?
Most economists belive that minimum wage laws increase the unemployment rate of low skilled younger workers
The minimum wage is set at $10 per hour Any wage below 10 is illegal Mimum wage of 10 dollars an hour, 20 million hours are hired but 22 million hours are available Unemployment – AB- of 2 million hours a year is created
With only 20 million hours demanded, someone is willing to supply the 20th million for 8 bucks Frustrated unemployed workers spend time and other resources searching for hard to find jobs Inefficiency of a Minimum wage The supply curve measures the marginal social cost of labor to workers Demand curve measures marginal benefit from labor An unrelated labour market allocates the economy’s scarce labor resources to the jobs in which they are valued most highly. The market is efficient Minimm wage frustrate market and reults in unemployment and job search At quantity mployed, labour exceeds marginal social cost and deadweight loss shrinks worker and firm’s surplus.
TAXES
Tax incident: the division of the burden of tax between buyers and sellers When an item is taxed, its price might rise by the full amount of the tax, by a lesser amount or not at all If the price rises by the full amount of tax, buyers pay the tax If price rise by a lesser amount than the tax, buyers and sellers share the burden of he tax If the price doesn’t rise at all, sellers pay the tax Taxes don’t’ depend on the law Ex: Ontario raised the tax on sales of cigarettes to 1.5 a pack
A tax on sellers NO tax: the equilibrium price is 3 bucks a pack However, a tax of 1.5 bucks is introduced This causes the supply to decrease and the curve S plus tax on seller show the new supply curve
A tax on seller would increase cost, thus decreases supply To determine position of the new supply curve, add the tax to the minimum price that sellers are willing to accept for each quantity sold Without tax: sellers are willing to offer 350 million packs at 6 bucks With 3 dollar tax, they are willing to offer 350 million at 9 bucks The equilibrium occurs where the new supply curve intersect he demand curve at 325 million packs a year The price paid by buyers rises by 2 dollars to 8 bucks a pack The price received by seller falls by 1 to 5 dollars a pack. Buyer pay 2 dollar of the tax Seller pay 1 dollar of the tax Without tax, price paid by the buyer = price received by the seller With the tax, market price = price paid by the buyer /=/ price received y the firm Based on the graph, we can see the tax burden. Suppliers have to bear the full tax Example: we can tell by the graph that the buyer pays 0.5 dollars and consumers pay 1dollar tax. Total amount of tax is $1.5 Without tax With tax Price received by the firm 3 2.5 - Supply: P = 24 +2Qs Price 24 25 26 28
Quantity 0 1 2 -
Parallel shift in supply curve
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when taxes increase and suppliers want to shift the tax to the buyers, supply shifts to the left
Taxes on Buyers Instead of taxing sellers, Ontario taxes buyers Tax on buyers lower the amount they are willing to pay to sellers It decreases demand and increases and shifts demand curve leftward Subtract the tax front eh maximum price that buyers are willing to pay D: P=80 – 5Q Demand Shifted down parallel shift
P 80 (-tax) 75(-tax) 70(-tax) 65(-tax)
Q d 0 1 2 3
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Market price is 4 If demand if more elastic, buyer pays less tax
Question: Rather than prohibiting a good or service, the government might tax it. Imposing such a tax on a good or service ____ the equilibrium price and ____ the equilibrium quantity a) raises; increases b) B raises; decrease c) Lowers; increases d) Lowers; decreases Consider the marke for gasoline. Suppose the market demand and supply curves are iven below. Price is the price per litre (in cents). Quantity refers to millions of litres of gasoline per month. For the moment, the government puts the tax on sellers Demand: P=80-5Qd Supply: P=24+2Qs A) Plot the demand and supply curves on a clearly labeled diagram a. P b. Qs c. 34 d. e. f. B) Compute the equilibrium price and quantity C) Now suppose the government imposes a tax of 14 cents per litre on sellers. What is the new equilibrium price and quantity?
New equilibrium price D) Compute the (per liter) tax burden on the consumer and producer E) Now suppose the tax is put on buyers, redo part c and d
Tax Incidence and Elasticity of Demand Perfectly inelastic demand (Buyers pay) Insulin, a vital daily medication for those with diabetes No matter what price it is, the buyer will pay the tax because they NEED the product
The price is 2 dollar a dase and quantity is 100 000 doses a day Tax of 20 cents a dose shifts the supply curve to s pus tax The price rises to 2.20 but quantity of doses bought has not changed The buyer pays the entire tax
Perfectly elastic demand (sellers pay) Pink pens: Demand is perfectly elastic The more inelastic the demand, the larger is the amount of tax paid by buyers Taxes are always split
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the demand is perfectly elastic no tax, the price is 1 dollar and quantity is 4000 with tax, the of 10 cents a pink pen shifts the supply curve to s plus tax. The price remains at 1 dollar a pen and the quantity sold decreases to 1000 ta week. The sellers pay the tax. Tax Incidence and Elasticity of Supply
SOLUTIONS: 1-5 DDEDA 6-10 ABDEB 11-15 BACBB Number 2 part b Stock market: People expect higher price in the future : Since price is higher, you want it now. Demand goes up Who are the sellers? Demand increases and supply decreases.
5.2: Benefit, Cost and Surplus Supply and Marginal Cost Supply and cost parallels the ideas between demand and benefit Question: Marginal Cost is a) The same as marginal benefit because producers benefit from the money they receive when they sell the good b) The opportunity cost of producing one more unit c) The total opportunity cost of producing all the units of the good d) Zero at the efficient level of production Supply, Cost, and Minimum Supply Price (page 110) Producers point of view: they distinguish between cost and price Cost is what the firm give up and price is what the firm receives when they sell the good or service. Marginal cost (cost of producing one more unit of it) determines whether a firm would want to produce another unit of it, but the minimum Supply price determines supply. Marginal cost is the minimum price that a firm is willing to accept If a unit of coffee costs the firm 5 bucks to produce, how much would the firm charge at least? They will charge at least 5 dollars. The minimum price determines supply. A supply curve is a marginal cost curve. If you pay enough, the firm is willing to sell. (Marginal Cost) Supply price is a marginal cost curve Market supply curve give answers to the quantity that this market is willing to produce at a certain price. Market supply: quantity in the graph is the addition of the individuals supply quantity at the given prices. How do you know marginal cost is increasing? It increases because increases opportunity cost. They have to sacrifice some resources. Marginal cost is increasing because of increasing opportunity cost. You must give up more of one resource to get another. Individual Supply and Market Supply (page 110) The relationship between the price of good and the quantity supplied is called the individual supply The relationship between the price of good and the quantity supplied by all producers is called the market supply MARKET SUPPLY CURVE: horizontal sum of all the individual supply curve and is formed by adding the quantities supplied by all the producers at each price Society marginal cost is referred to as marginal social cost (MSC)
Producer Surplus (page 111) Producer surplus is the excess amount received from a sale of good or service over the cost of producing it Producer surplus is the price received for the good – marginal cost It is measured by the area below the market price and above the supply curve, summed over the quantity sold More they sell, the higher the producer surplus Producer surplus = price received – marginal cost (minimum supply price) For example: The market price for pizza is 15 dollars. If she is willing to produce the 50th pizza for 10, then she will receive a producer surplus of 5 on the 50th pizza. Assume that Mario and Max are the only ones making pizza in the market: The area between the cost and the MC of both max and Mario’s producer surplus is the economy producer surplus Area under the MC is the total cost. The marginal benefit is determine by demand Marginal social benefit curve related to marginal benefit related to demand Question: The producer surplus on a unit of a good is a) Difference between the marginal social benefit and the marginal cost b) Number of dollars worth of other goods and services forgone to produce this unit of the good c) Difference between the price of the good and the marginal cost of producing the good d) Difference between the total cost of the good and the marginal cost Consumer surplus and producer surplus can be used to measure the efficiency of a market What is the relationship between marginal benefit, value and demand? Marginal benefit is the amount that someone is willing to pay for one more unit of it. Value is what we get. Willingness to pay determines demand. The market demand curve tells us the quantity the market is willing to pay for a certain price. Consumer surplus is the excess of the benefit received from a good over the amount paid for it. What is the relationship between marginal cost, minimum supply price, and supply? 1. The cost of producing one more unit of a good or service is its marginal cost 2. Marginal cost is the minimum supply price that producer must receive to induce them to offer to sell another unit of the good or service 3. But the Minimum supply price determines supply 4. So a supply curve is a marginal cost curve 5. It is not true that minimum supply price is the value of one more unit of a good or service. 6. Marginal benefit is the value of one more unit of a good or service.
What is the relationship between individual supply and market supply? 1. The market supply curve is the horizontal sum of the individual supply curve. 2. It is formed by adding the quantities supplied by all producers at each price What is producer surplus? How is it measured? 1. Producer surplus is the excess of the amount received from the sale of a good or service over the cost of producing it. 2. It is calculated by the price received for the good and the amount spent producing it (marginal cost / minimum supply price) What is consumer surplus? How is it measured? 1. Consumer surplus is the excess marginal benefit from the sale of a good or service over the price paid for it. 2. It is measured by the marginal benefit minus the price summed over the quantity bought.
Marginal social benefit from 30 kilometres is the benefit that the entire society receives, which is the sum of the marginal benefits that the people in the society receive.
The marginal benefit from 30 kilometers that one person receives is the maximum price that the person is willing to paid to travel 30 kilometres
A demand curve is a marginal benefit curve, so the demand schedule tells us the willingness (maximum) price willingly paid at each quantity demanded.
Consumer surplus is the area below the demand curve and above the equilibrium price
The producer surplus is the area above the supply curve and below the equilibrium price
5.3: Is the Competitive Market Efficient?
Efficiency of Competitive Equilibrium
Marginal demand curve – Marginal social benefit Market supply curve – marginal social cost Equilibrium in a market occurs when quantity supplied equals quantity demanded At this point, the intersection, marginal social benefit equals marginal social cost on the supply curve (Condition for allocative efficiency) A competitive market achieves allocative efficiency
At the equilibrium quantity marginal benefit equals marginal cost, so the quantity is efficient quantity When efficient quantity is produced, total surplus (the sum of consumer surplus and producer surplus) is maximized. Total Surplus: The sum of consumer surplus and producer surplus is the total surplus. TS = CS + PS This number does not indicate welfare exactly but the higher the number the better. BIG TS = Good TS (see graph on textbook)
Question: The competitive market is efficient because A) People can buy the good at a price that matches their marginal benefit B) Marginal social benefit from the good equals the marginal social cost of producing the good C) Sellers of the good get a price that exceeds their marginal cost D) Total surplus is reduced to zero Market Failure
Market delivers inefficient outcome and it occurs when a market delivers too little of an item or is over produced. o Underproduction: Tal surplus is smaller than its maximum possible level When too little of an item is produced Deadweight loss: the decrease in total surplus from an inefficient level of production. Equals the decrease in total surplus o Overproduction: Too much of an item is produced When quantity produced is greater than quantity that Consumers is willing to pay at a certain price The price consumers are willing to pay is less than what it costs to produce The grey triangle shows deadweight loss
Question: At the efficient level of production, ______ a) Producer surplus must be greater than consumer surplus b) There is no deadweight loss c) Total surplus is maximized d) Both C) and D) are correct
Question: A deadweight loss: a) Is possible only if the good is under produced but not possible if the good is overproduced b) Subtracts only form producer surplus c) A loss to consumer and a gain to producer d) Is a loss inflicted Sources of Market Failure and obstacles to Efficiency Sources that creates deadweight losses are o Price and quantity regulation (underproduction) For example minimum wage o Taxes and subsidies (underproduction) (paying taxes, HST o Externalities (overproduction) o Public goods and common resources (underproduction) Private goods are coffee, hamburger, etc. (when you consume the foods it is gone only for yourself) Public goods where everyone can have o Monopoly (underproduction) o High transaction costs (high costs (underproduction) Price and Quantity Regulation Price regulation can lead to underproduction because a quantity regulation limits the amount that a firm is permitted to produce. For example: CAP on housing for University staffs 25% lower Price regulations make market inefficient Taxes and Subsidies Taxes increase the prices paid by buyers and lower the prices received by sellers Subsidies lower the prices paid by buyers and increase the prices received by sellers So subsidies increase the quantity produced and lead to overproduction Externalities: Externality is a cost or benefit that affects someone other than the seller or the buyer of a good Example if you smoke and it effects other people Positive externality (flu vaccine) government subsidize education and it is a positive externality Negative externalities (air pollution) External cost example: electricity creates an external cost by burning coal that creates acid rain. The utility doesn’t consider this cost when it chooses the quantity of power to produce. Overproduction results Underproduction external cost example: an apartment owner would provide an external benefit if she installed an smoke detector. She doesn’t consider
her neighbor’s marginal benefit and decides not to install the smoke detector. The result is underproduction Public Goods and Common Resources Public good benefits everyone and no one can be excluded from its benefits Example: when everyone does not want to pay for public good (free rider problem), this leads to underproduction Common resource is owned by no one but can be used by everyone For example everyone ignores the cost of their own use of a common resource (tragedy of the commons). The tragedy of the commons leads to overproduction (fishing) Example: turn on the lights: it is a public good Cost of turning on the lights would be 100. To finance public goods, government taxes individuals Common resources: Fishing. Leads to overfishing. Monopoly Monopoly is a firm that has sole provider of a good or service Inefficient outcome One firm selling the product will always lead to inefficiency Self interest of monopoly is to maximize its profit Monopoly charges a price that too high and produces too little. As a result, underproduction Alternatives to the Market When market is inefficient, can one of the alternative nonmarket methods that we describe at the beginning of this chapter do a better job? Review: Do competitive markets use resources efficiently? Competitive markets use resources efficiently when quantity demanded equals the quantity supplied. This happens at the point when the demand curve and supply curve intersect. What is deadweight loss and under what conditions does it occur? Deadweight loss is the scale of inefficiency, which is the decrease in total surplus from an inefficient level of production. Deadweight loss can occur when there is an overproduction or underproduction. The grey triangle shows the deadweight loss, which reduces the surplus, to less than its maximum. What are the obstacles to achieving an efficient allocation of resources in the market economy? Obstacles include: 1) price and quantity regulation 2) Taxes and subsidies
3) 4) 5) 6)
Externalities Public goods and common resources Monopoly High transaction costs
Question 1: Equilibrium in a competitive market occurs when the quantity demanded equals the quantity supplied at the intersection of the demand curve and the supply curve. At this point of intersection marginal social benefit equals marginal social cost, which is the condition for allocative efficiency. So in equilibrium, a competitive market achieves allocative efficiency
Question 2 Market demand curve tells of the marginal social benefit Market supply curve tells of the marginal social cost Where the demand curve and the supply curve intersect, the marginal social benefit equals the marginal cost This is the condition for allocative efficiency and at this point, it delivers an efficient use of resources for the entire society. At allocative efficiency, the sum of the consumer surplus (green area) and the producer surplus (blue area) is maximized Question 3: Deadweight loss: when inefficient quantity is produced, consumer surplus decreases and producer surplus decreases. The loss of the total surplus is the deadweight loss Question 5 Demand curve is a marginal benefit curve, and we measure marginal benefit by the maximum price that is willingly paid for another unit of a good or service
Is the competitive market fair? Views of economics: 1) Its not fair if the result isn’t fair 2) Its not fair if the rules aren’t fair 1) Its not fair if the results isn’t fair: a. Unfair if people’s incomes are too unequal: for example it is unfair that bank president earns million of dollars a year
Utilitarianism: The idea that only equality brings efficiency. The principle states that we should strive to achieve the greatest happiness for he greatest number. The big trade off: The utilitarian ideal of complete equality I that it ignores the costs of making income transfers: Recognizing costs of making income transfer leads to the big tradeoff. Market system is the best Is the competitive market efficient? Chapter 6: Government Actions in Markets Objectives: 1. 2. 3. 4.
Explain rent ceilings create housing shortages and inefficiency Explain how minimum wage laws create unemployment Explain the effect of a tax Explain the effects of a production quotas, and subsidies on production costs and prices 5. Explain how markets for illegal goods work
Housing Market with a Rent Ceiling
Price Ceiling: a government regulation that makes it illegal to charge a price higher than a specified level. For example: controlling price of rent Makes the price cheaper A price ceiling can be above or below the equilibrium Above the equilibrium price: has no effect because the price ceiling does not contrail the market forces. For example: law and the market forces are not in conflict. Below the equilibrium price: powerful effect on the market because it prevents the price from regulating the quantities demanded and supplied The force of the law and the market forces are in conflict Rent ceiling: when a price ceiling is applied to a housing market o A rent ceiling set above the equilibrium creates a black market, increased search activity and housing shortage Housing Market with a Rent ceiling Quiz questions: Question 1 When the rent ceiling is higher than the equilibrium rent, the force of the law and mthe market are not in conflict. The rent would remain at the equilibrium price
Question 2: A rent ceiling set below the equilibrium rent has powerful effects on market. This is because the rent ceiling attempts to prevent rent from regulating the quantities demanded and supplied. Question 3: With an effective rent ceiling, housing is allocated by a method other than by price. Search activity increases and black markets arise. Question 4: An effective rent ceiling creates an inefficient outcome because at the rent ceiling, marginal social benefit exceeds marginal social cost. Question 5: If the rent ceiling is above the equilibrium, then it has no effect on the rent. When the rent ceiling is set above the equilibrium rent, the quantity of housing rented is the equilibrium quantity They quantity of housing demanded equals the quantity of housing supplied, so there is no shortage. Housing shortage When there is a housing shortage, the rent is below the equilibrium price. This means that the quantity demanded exceeds the quantity supplied. There are limited houses for those frustrated demanders who want houses. As a result, they look elsewhere for houses. Which of the following effects is typical of a price ceiling set below the equilibrium price? A) Less of the good is produced with the ceiling than would be produced without the ceiling. B) The price ceiling has no effect on the market equilibrium. C) Consumers can buy more than what they can at the equilibrium price because the ceiling price is lower. D) None of the above options is correct.
Increased search activity Search activity is the time spent looking for someone whom to do business with The opportunity cost equals the value of the search time as well as the rent and resources spent to find places to rent. Search activity increases and the cost of searching might actually bring up the price of the rent (even without rent ceiling)
Black market Black market is an illegal market in which equilibrium price exceeds the price ceiling The black market rent is equal to the maximum price that a renter is willing to pay Shortage of housing increase a black market in housing Illegal arrangements made between renters and landlords at rents above the rent ceiling – generally above what the rent would have been in an unregulated market At 800 a month, the price is below equilibrium. Rents above 800 are illegal. There is a shortage at this 800 regulated price. Through black market or increased search activity, the rent price might increase to 1200, Incurring a cost that exceeds what the equilibrium rent would be in an unregulated market Inefficiency of Rent Ceiling Rend ceiling below the equilibrium rents result in inefficient underproduction of housing services. Marginal social benefit of housing exceeds its marginal social cost and a deadweight loss shrinks the producer surplus and consumer surplus Figure 6.2: shows it inefficiency Question 7: A price ceiling set below the equilibrium price is effective. When the price falls, a movement occurs down along the supply curve – a decrease in the quantity supplied. When the price falls, a movement occurs down along the demand curve- an increase in the quantity demanded. Question 8: A price ceiling set below the equilibrium price is effective. When the price falls a movement occurs down along the supply curve – there is a decrease in quantity supplied. The quantity of fertilizer sold is equal to the quantity supplied. The quantity of fertilizer sold with the price ceiling is less than the quantity sold at equilibrium price. When the price falls a movement along the demand curve – an increase in quantity demanded. When the quantity demanded exceeds the quantity supplied, a shortage emerges. Therefore, the maximum price that someone is willing to pay for the last fertilizer increases. The demand curve tells us that maximum price. The demand curve is a downward sloping curve, so when the quantity available decreases the maximum price hat someone is wiling to pay for the last fertilizer available increases.
Question 10 When a price ceiling on fertilizer is set below the market equilibrium price, the consumer who can find fertilizer at the lower price are better off. Consumers who cannot find nay fertilizer due to the shortage created by the price ceiling are worse off. All producers are worse off because they are selling less fertilizer at a lower price than prior to the price ceiling When a price ceiling on fertilizer is set below the market price, some consumers are better off and all producers are worse off
MISSING: rest of housing shortages
Labour market with minimum wage
Price floor: a government regulation that makes it illegal to charge a price lower than a specified level o Below the equilibrium, price has no effect o Above the equilibrium price: it has powerful effects because the price floor attemsps to prevent the pirce from regulating quantities demanded and supplied Minimum wage: a minimum wage imposed at a level that is above the equilibrium wage creates unemployment
Minimum wage Brings unemployement At equilibrium price, quantity demanded equals quantity supplied Labor market, the wage rate is at equilibrium level the quantity of labor demanded equals the quantity supplied Above equilibrium: quantity of labor supplied exceed the quantity of labor demanded (surplus of labor) Demand for labor determines the level of employment and the surplus of labor is unemployed Is minimum wage fair?
Most economists belive that minimum wage laws increase the unemployment rate of low skilled younger workers
The minimum wage is set at $10 per hour Any wage below 10 is illegal Mimum wage of 10 dollars an hour, 20 million hours are hired but 22 million hours are available Unemployment – AB- of 2 million hours a year is created
With only 20 million hours demanded, someone is willing to supply the 20th million for 8 bucks Frustrated unemployed workers spend time and other resources searching for hard to find jobs Inefficiency of a Minimum wage The supply curve measures the marginal social cost of labor to workers Demand curve measures marginal benefit from labor An unrelated labour market allocates the economy’s scarce labor resources to the jobs in which they are valued most highly. The market is efficient Minimm wage frustrate market and reults in unemployment and job search At quantity mployed, labour exceeds marginal social cost and deadweight loss shrinks worker and firm’s surplus.
TAXES
Tax incident: the division of the burden of tax between buyers and sellers When an item is taxed, its price might rise by the full amount of the tax, by a lesser amount or not at all If the price rises by the full amount of tax, buyers pay the tax If price rise by a lesser amount than the tax, buyers and sellers share the burden of he tax If the price doesn’t rise at all, sellers pay the tax Taxes don’t’ depend on the law Ex: Ontario raised the tax on sales of cigarettes to 1.5 a pack
A tax on sellers NO tax: the equilibrium price is 3 bucks a pack However, a tax of 1.5 bucks is introduced This causes the supply to decrease and the curve S plus tax on seller show the new supply curve
A tax on seller would increase cost, thus decreases supply To determine position of the new supply curve, add the tax to the minimum price that sellers are willing to accept for each quantity sold Without tax: sellers are willing to offer 350 million packs at 6 bucks With 3 dollar tax, they are willing to offer 350 million at 9 bucks The equilibrium occurs where the new supply curve intersect he demand curve at 325 million packs a year The price paid by buyers rises by 2 dollars to 8 bucks a pack The price received by seller falls by 1 to 5 dollars a pack. Buyer pay 2 dollar of the tax Seller pay 1 dollar of the tax Without tax, price paid by the buyer = price received by the seller With the tax, market price = price paid by the buyer /=/ price received y the firm Based on the graph, we can see the tax burden. Suppliers have to bear the full tax Example: we can tell by the graph that the buyer pays 0.5 dollars and consumers pay 1dollar tax. Total amount of tax is $1.5 Without tax With tax Price received by the firm 3 2.5 - Supply: P = 24 +2Qs Price 24 25 26 28
Quantity 0 1 2 -
Parallel shift in supply curve
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when taxes increase and suppliers want to shift the tax to the buyers, supply shifts to the left
Taxes on Buyers Instead of taxing sellers, Ontario taxes buyers Tax on buyers lower the amount they are willing to pay to sellers It decreases demand and increases and shifts demand curve leftward Subtract the tax front eh maximum price that buyers are willing to pay D: P=80 – 5Q Demand Shifted down parallel shift
P 80 (-tax) 75(-tax) 70(-tax) 65(-tax)
Q d 0 1 2 3
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Market price is 4 If demand if more elastic, buyer pays less tax
Question: Rather than prohibiting a good or service, the government might tax it. Imposing such a tax on a good or service ____ the equilibrium price and ____ the equilibrium quantity a) raises; increases b) B raises; decrease c) Lowers; increases d) Lowers; decreases Consider the marke for gasoline. Suppose the market demand and supply curves are iven below. Price is the price per litre (in cents). Quantity refers to millions of litres of gasoline per month. For the moment, the government puts the tax on sellers Demand: P=80-5Qd Supply: P=24+2Qs A) Plot the demand and supply curves on a clearly labeled diagram a. P b. Qs c. 34 d. e. f. B) Compute the equilibrium price and quantity C) Now suppose the government imposes a tax of 14 cents per litre on sellers. What is the new equilibrium price and quantity?
New equilibrium price D) Compute the (per liter) tax burden on the consumer and producer E) Now suppose the tax is put on buyers, redo part c and d
Tax Incidence and Elasticity of Demand Perfectly inelastic demand (Buyers pay) Insulin, a vital daily medication for those with diabetes No matter what price it is, the buyer will pay the tax because they NEED the product
The price is 2 dollar a dase and quantity is 100 000 doses a day Tax of 20 cents a dose shifts the supply curve to s pus tax The price rises to 2.20 but quantity of doses bought has not changed The buyer pays the entire tax
Perfectly elastic demand (sellers pay) Pink pens: Demand is perfectly elastic The more inelastic the demand, the larger is the amount of tax paid by buyers Taxes are always split
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the demand is perfectly elastic no tax, the price is 1 dollar and quantity is 4000 with tax, the of 10 cents a pink pen shifts the supply curve to s plus tax. The price remains at 1 dollar a pen and the quantity sold decreases to 1000 ta week. The sellers pay the tax. Tax Incidence and Elasticity of Supply
SOLUTIONS: 1-5 DDEDA 6-10 ABDEB 11-15 BACBB Number 2 part b Stock market: People expect higher price in the future : Since price is higher, you want it now. Demand goes up Who are the sellers? Demand increases and supply decreases.
