Transcript Efficiency, Consumer and Producer Surplus

Efficiency
Consumer, Producer and Markets
Efficiency Defined
• Overall: Greatest human satisfaction from scarce
resources.
• Allocative Efficiency – resources are dedicated to
the combination of goods and services that best
satisfy consumer wants
• Production Efficiency – goods and services are
produced using the least cost combination of
resources and technology
• Dynamic Efficiency – how the economy over time
promotes allocative and productive efficiency
Efficiency: Positive versus
Normative Perspectives
• Positive – an objective analysis of how
economic variables are related
• Normative – a prescriptive analysis to help
determine what ought to be.
• Welfare economics – the study of how the
allocation of resources affects economic
well-being.
Problem of Revealed Preference
• Economic agents, unlike many variables in other
sciences, are not passive. Therefore, it is difficult
to measure willingness to pay.
• Normal Auction – Ascending price with sale to the
highest bidder. May yield the person who most
highly values the item, but does not measure their
maximum willingness to pay.
• Dutch Auction – Descending Price with sale to
first bidder. May yield the person who most
highly values the good and the maximum
willingness to pay.
Measuring Economic Welfare:
Consumer Surplus
• So far, we have demonstrated that people maximize total
net benefits from an activity at the point where MB=MC
• Marginal benefits are equal to the (max.) willingness to
pay and decline as quantity demanded increase because of
the law of diminishing marginal utility (jelly bean
example).
• Since consumer as price takers in competitive markets, the
price equals the marginal costs to consumers.
• Consumer surplus equals willingness to pay minus the
price, which is the same as net benefits we have discussed
before.
• Using the demand curve to measure consumer
surplus
• Before: giving a price and finding the
corresponding quantity demanded
• Now: giving the quantity and finding the amount
people are willing to pay for a good or go without
it
• MB=MC occurs where price intersects the demand
curve and total net benefits=consumer surplus is
maximized.
Cool, no!
Figure 2 Measuring Consumer Surplus with the
Demand Curve
(a) Price = $80
Price of
Album
$100
John’s consumer surplus ($20)
80
70
50
Demand
0
1
2
3
4
Quantity of
Albums
Copyright©2003 Southwestern/Thomson Learning
Figure 2 Measuring Consumer Surplus with the
Demand Curve
(b) Price = $70
Price of
Album
$100
John’s consumer surplus ($30)
80
Paul’s consumer
surplus ($10)
70
50
Total
consumer
surplus ($40)
Demand
0
1
2
3
4 Quantity of
Albums
Copyright©2003 Southwestern/Thomson Learning
Figure 3 How the Price Affects Consumer Surplus
(a) Consumer Surplus at Price P
Price
A
Consumer
surplus
P1
B
C
Demand
0
Q1
Quantity
Copyright©2003 Southwestern/Thomson Learning
Figure 3 How the Price Affects Consumer Surplus
(b) Consumer Surplus at Price P
Price
A
Initial
consumer
surplus
P1
P2
0
C
B
Consumer surplus
to new consumers
F
D
E
Additional consumer
surplus to initial
consumers
Q1
Demand
Q2
Quantity
Copyright©2003 Southwestern/Thomson Learning
Producer Surplus
• Consumer surplus measures the difference
between the (max.) willingness to pay and
the price.
• Producer surplus measure the difference
between the (min.) needed to be willing to
sell and the price.
• Remember, the Law of Diminishing Marginal
Returns causes marginal costs to rise in the shortrun as output increases.
– As more the the variable input is added to the fixed
input, its marginal product eventually begins to
diminish (production exercise in class).
– If all workers are paid the same wage, the LDMR
implies that the extra (marginal) costs of producing
extra (marginal) outputs increases.
• If the seller is a price taker, they receive the
same price for very output sold. So the
difference between the price and the
marginal cost (the willingness to sell) is the:
Producer Surplus
Figure 4 The Supply Schedule and the Supply Curve
Figure 5 Measuring Producer Surplus with the Supply
Curve
(a) Price = $600
Price of
House
Painting
Supply
$900
800
600
500
Grandma’s producer
surplus ($100)
0
1
2
3
4
Quantity of
Houses Painted
Copyright©2003 Southwestern/Thomson Learning
Figure 5 Measuring Producer Surplus with the Supply
Curve
(b) Price = $800
Price of
House
Painting
$900
Supply
Total
producer
surplus ($500)
800
600
Georgia’s producer
surplus ($200)
500
Grandma’s producer
surplus ($300)
0
1
2
3
4
Quantity of
Houses Painted
Copyright©2003 Southwestern/Thomson Learning
Figure 6 How the Price Affects Producer Surplus
(a) Producer Surplus at Price P
Price
Supply
P1
B
Producer
surplus
C
A
0
Q1
Quantity
Copyright©2003 Southwestern/Thomson Learning
Figure 6 How the Price Affects Producer Surplus
(b) Producer Surplus at Price P
Price
Supply
Additional producer
surplus to initial
producers
P2
P1
D
E
F
B
Initial
producer
surplus
C
Producer surplus
to new producers
A
0
Q1
Q2
Quantity
Copyright©2003 Southwestern/Thomson Learning
Competitive Markets and
Efficiency
• Assume competitive markets (many buyers
and sellers, identical products, free entry
and exit, price takers, etc.)
• Assume that consumer surplus measures
consumers economic well-being and
producer surplus that of sellers.
• So, MB = willingness to pay by consumers
and MC = willingness to sell to producers
MB=MC
Occurs where the demand and supply curve
intersect, and
Total Well-being is Maximized
Figure 7 Consumer and Producer Surplus in the Market
Equilibrium
Price A
D
Supply
Consumer
surplus
Equilibrium
price
E
Producer
surplus
B
Demand
C
0
Equilibrium
quantity
Quantity
Copyright©2003 Southwestern/Thomson Learning
Figure 8 The Efficiency of the Equilibrium Quantity
Price
Supply
Value
to
buyers
Cost
to
sellers
Cost
to
sellers
0
Value
to
buyers
Equilibrium
quantity
Value to buyers is greater
than cost to sellers.
Demand
Quantity
Value to buyers is less
than cost to sellers.
Copyright©2003 Southwestern/Thomson Learning
Efficiency
• Competitive markets result in the
combination of goods and services that
maximize consumer well-being (allocative
efficiency) and produce goods at least
possible cost (production efficiency).
• Over time, competitive forces will move to
promote allocative and production
efficiency (dynamic efficiency).
Economic Efficiency and the Liberal
Revolution
• Adam Smith, building on the work of other philosophers,
was the first to develop a comprehensive argument for the
efficiency of markets.
• The efficiency of markets has proven a powerful force in
altering historical perspectives on effective ways humans
can interact.
• The revolutionary idea that the pursuit of self-interest,
tempered by competition, promotes social interest is the
basis for the tremendous economic growth of the last
century.
Efficiency, a Second Look
• If markets are not competitive, efficiency might
not be guaranteed.
• In some cases, consumer surplus might not be
considered a good measure of consumer wellbeing (drugs or externalities), or producer surplus
might not be a good measure of producer wellbeing (externalities or inefficiency due to
monopoly).
Deadweight Welfare Loss
• The loss in economic welfare from restricting
voluntary exchange.
• When the MB, or the willingness to pay, is greater
than the MC, or the willingness to sell, then more
voluntary transactions would increase economic
welfare (net benefits)
• Graph – ignore the tax and just think about
anything that restricts trade like a price floor or
ceiling
Figure 2 Tax Revenue
Price
Supply
Price buyers
pay
Size of tax (T)
Tax
revenue
(T × Q)
Price sellers
receive
Demand
Quantity
sold (Q)
0
Quantity
with tax
Quantity
without tax
Quantity
Copyright © 2004 South-Western
Figure 3 How a Tax Effects Welfare
Price
Price
buyers = PB
pay
Supply
A
B
C
Price
without tax = P1
Price
sellers = PS
receive
E
D
F
Demand
0
Q2
Q1
Quantity
Copyright © 2004 South-Western
Case Studies
• A market for transplantable organs
– Current price is zero and there is a shortage of
transplantable organs
– Allowing companies to contract with
individuals to donate organs for a price would
likely increase the supply of organs
– Positive versus normative considerations
• Pilgrims, communal agriculture, and
starvation
• Is a tuition cap a price control?
– NPR presentation
http://www.npr.org/features/feature.php?wfId=1474621
– Who pays the cost of a college education?
– Why are the costs of a college education rising?
• Demand side
• Supply side
– What are the likely effects of tuition caps?
– Increased financial aid as an alternative to price
controls.
Costs of Taxation
• Taxes create a wedge between the price buyers
pay and sellers receive and result in a reduction in
quantity bought and sold.
• The reduction in quantity leaves production at a
point where MB>MC and consumer surplus and
producer surplus is not maximized.
• The consumer and producer surplus that is lost
from not producing where MB=MC is call the
Deadweight Welfare Loss (DWL).
• DWL is the economic cost of taxation.
Figure 1 The Effects of a Tax
Price
Supply
Price buyers
pay
Size of tax
Price
without tax
Price sellers
receive
Demand
0
Quantity
with tax
Quantity
without tax
Quantity
Copyright © 2004 South-Western
Figure 2 Tax Revenue
Price
Supply
Price buyers
pay
Size of tax (T)
Tax
revenue
(T × Q)
Price sellers
receive
Demand
Quantity
sold (Q)
0
Quantity
with tax
Quantity
without tax
Quantity
Copyright © 2004 South-Western
Figure 3 How a Tax Effects Welfare
Price
Price
buyers = PB
pay
Supply
A
B
C
Price
without tax = P1
Price
sellers = PS
receive
E
D
F
Demand
0
Q2
Q1
Quantity
Copyright © 2004 South-Western
How a Tax Affects Welfare
How Large is the DWL?
• As in the case of tax incidence, the key to
understanding the extent of DWL are the
elasticities of demand and supply.
• When demand and supply are more elastic
or responsive, the greater will be the decline
in equilibrium quantity for any tax increase.
• The greater the tax, the larger the
deadweight welfare loss.
Figure 5 Tax Distortions and Elasticities
(a) Inelastic Supply
Price
Supply
When supply is
relatively inelastic,
the deadweight loss
of a tax is small.
Size of tax
Demand
0
Quantity
Copyright © 2004 South-Western
Figure 5 Tax Distortions and Elasticities
(b) Elastic Supply
Price
When supply is relatively
elastic, the deadweight
loss of a tax is large.
Size
of
tax
Supply
Demand
0
Quantity
Copyright © 2004 South-Western
Figure 5 Tax Distortions and Elasticities
(c) Inelastic Demand
Price
Supply
Size of tax
When demand is
relatively inelastic,
the deadweight loss
of a tax is small.
Demand
0
Quantity
Copyright © 2004 South-Western
Figure 5 Tax Distortions and Elasticities
(d) Elastic Demand
Price
Supply
Size
of
tax
Demand
When demand is relatively
elastic, the deadweight
loss of a tax is large.
0
Quantity
Copyright © 2004 South-Western
Figure 6 Deadweight Loss and Tax Revenue from Three
Taxes of Different Sizes
(a) Small Tax
Price
Deadweight
loss Supply
PB
Tax revenue
PS
Demand
0
Q2
Q1 Quantity
Copyright © 2004 South-Western
Figure 6 Deadweight Loss and Tax Revenue from Three
Taxes of Different Sizes
(c) Large Tax
Price
PB
Tax revenue
Deadweight
loss
Supply
Demand
PS
0
Q2
Q1 Quantity
Copyright © 2004 South-Western
Case Studies of DWL
• Taxes on labor (federal income tax, social security,
medicare) add up to about a 50% marginal tax on
labor for many US workers.
• DWL and the labor market
– Elastic or inelastic labor supply?
– Full time work regardless of wage or is labor
responsive to wages?
– Overtime, second earners, retirement, indergrond
economy (barter and illegal activity)
– Laffer curve and supply side economics – large tax
rates create a disincentive to work and invest.
• The land tax and Henry George
– Promoting equity while minimizing tax shifting
and DWL
– Is land in inelastic or elastic supply?
• Raw land versus improvements
– A tax for today?