Transcript Lecture Slides 7 - Yogesh Uppal`s Website

Econ 2610: Principles of
Microeconomics
Yogesh Uppal
Email: [email protected]
Chapter 7
Efficiency and Exchange
Role of the Market

Market allocation of resources



Often maximizes efficiency
Unintended consequences of government
policies, such as public utilities, taxes, subsidies
etc.
Some Caveats, which we shall talk about
later
First-Come, First-Served
A


non-market way of allocating scarce goods
Airline seats
Prime student seats at a basketball game
 The
price mechanism used is time spent
waiting


People who wait generally have lower opportunity
cost of time
People with high opportunity cost would pay to
move up in the line
Market Equilibrium and
Efficiency

Economic efficiency exists when no change
could be made to benefit one party without
harming the other



Sometimes called Pareto efficiency
Equilibrium price and quantity are efficient
Prices above or below equilibrium are not
Price Below Equilibrium (A
price ceiling)
Suppose milk is $1 per gallon
2.50
Price ($/gallon)

S
2.00
1.50
1.00
0.50
D
1
2
3
4
5
Quantity (1,000s of gallons/day)
Price above Equilibrium (Price
Floor)
S
Price ($/gallon)
2.50
2.00
1.75
1.50
Only equilibrium
price is efficient
1.00
0.50
D
1
2
3
4
5
Quantity (1,000s of gallons/day)
Efficiency Conditions
Perfectly
Competitive
Markets
No Costs or
Benefits
Shifted
Market
Efficiency
Price Subsidy for Bread

Imported bread costs $2


Perfectly elastic supply
Government program to subsidize bread



Government imports bread for $2
Government sells bread for $1
Results


More bread
Less efficiency
Price Subsidies for Bread
Price
($/loaf)
$4.00
Consumer Surplus = $4 M/month
$3.00
S
$2.00
Consumer Surplus = $9 M/month
$1.00
D
S with subsidy
2
4
6
8
Quantity (millions of loaves/month)
BUT…
The Cost of the Subsidy


The bread subsidy appears to increase
consumer surplus from $4 million to $9
million
BUT …

The government loses $1 on every loaf



Imports 6 million loaves for $2 per loaf
Government losses are $6 million
The net benefit of the subsidy program


Consumer surplus – government losses
Net benefit = $3 million
Price Subsidies for Bread
Price
($/loaf)
Consumer Surplus
$4.00
$3.00
Total Surplus Lost
= $1 M/month
$2.00
S
Government Losses
$1.00
D
S with subsidy
2
4
6
8
Quantity (millions of loaves/month)
Taxes on Sellers

Tax program



Seller reports sales in units to government
Seller pays a fixed dollar amount per unit sold
A tax on the seller shifts the supply curve up
by the amount of the tax

Vertical interpretation of the supply curve

For each level of output, seller charges his marginal
cost PLUS the tax
Tax on Avocado Sellers
S + tax
S
Price ($/pound)
6
5
4
3.50
3
2.50
2
1
D
1
2
3
4
5
2.5
Quantity (millions of pounds/month)
Taxes and Total Surplus

Taxes lead to



Lower equilibrium quantity
Higher equilibrium price
What happens to total economic surplus?
Tax on Avocado Sellers
P
6
Before Tax
Consumer surplus = $4.5 M
Producer surplus = $4.5 M
S
3
P
6
D
3
S + tax
Q
After Tax
Consumer surplus = $3.125 M
Producer surplus = $3.125 M
Total surplus = $6.25 M
Loss = $2.75 M
3.50
1
D
2.5
Q
Total Surplus Lost

Tax revenue is $2.5 million

If other taxes go down by $2.5 million, this is not a
loss


Net loss is $0.25 million
Deadweight loss is the reduction in total
economic surplus that results form the
adoption of a policy
Taxes and Price Elasticity of
Demand

Avocado tax was shared equally



Buyers paid $0.50 more
Sellers received $0.50 less
The amount of the tax paid by buyers and
sellers depends on the price elasticity of
demand

Implications for deadweight loss of the tax
Taxes and Price Elasticity of
Demand
More Elastic Demand
P
Less Elastic Demand
P
S+T
S+T
2.40
2.00
1.40
2.60
2.00
1.60
S
S
D1
D2
19 24
Q
21 24
Q
Consumers pay a smaller share of the tax when demand is more elastic
Taxes and Deadweight Loss
More Elastic Demand
P
Less Elastic Demand
P
Deadweight loss
Deadweight loss
S+T
S+T
2.40
2.00
1.40
2.60
2.00
1.60
S
S
D1
D2
19 24
Q
21 24
Deadweight loss is larger when demand is relatively elastic
Q
Caveats to the role of the
Market

Not right for all objectives
Income distribution
 Public goods such as clean air and public safety

Trade-Offs
Efficiency
Equity