C h a p t e r f o u r © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien1 st ed. Prepared by: Fernando & Yvonn.

c h a p t e rc h a p t e rf o u rf o u r

Prepared by: Fernando & Yvonn Quijano

Economic Efficiency, GovernmentPrice Setting, and Taxes

After studying this chapter, you should be able to:

Understand the concepts of consumer surplus and producer surplus.

Understand the concept of economic efficiency, and use a graph to illustrate how economic efficiency is reduced when a market is not in competitive equilibrium.

Use demand and supply graphs to analyze the economic impact of price ceilings and price floors.

Use demand and supply graphs to analyze the economic impact of taxes.

Should the GovernmentControl Apartment Rents?

New York City

… About one million of New York City’s two million apartments are subject to rent control. The other one million apartments have their rents determined in the market by the demand and supply for apartments.

esEconomic 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.

esConsumer Surplus And Producer Surplus

Consumer Surplus

LEARNING OBJECTIVE1

Marginal benefit The additional benefit to a consumer from consuming one more unit of a good or service.

Consumer surplus The difference between the highest price a consumer is willing to pay and the price the consumer actually pays.

4 - 1The Demand Curve is Also the Marginal Benefit Curve

esConsumer Surplus and Producer Surplus

Consumer Surplus4 - 2

Total Consumer Surplus in theMarket for Chai Tea

The Consumer Surplus fromSatellite Television

How much consumer surplus will the owner of this satellite dish receive?

Producer Surplus

Producer surplus The difference between the lowest price a firm would have been willing to accept and the price it actually receives.

Marginal cost The additional cost to a firm of producing one more unit of a good or service.

4 - 3Producer Surplus

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.

esThe Efficiency of Competitive Markets

LEARNING OBJECTIVE2

Marginal Benefit Equals Marginal Cost in Competitive Equilibrium

Marginal Benefit Equals Marginal Cost Only at Competitive Equilibrium

Economic Surplus 4 - 5Economic Surplus Equals the Sum of Consumer Surplus and Producer Surplus

Deadweight Loss4 - 6

When a Market Is Not in Equilibrium There is a Deadweight Loss

Deadweight loss The reduction in economic surplus resulting from a market not being in competitive equilibrium.

Economic Surplus and Economic Efficiency

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 where the sum of consumer surplus and producer surplus is at a maximum.

esLEARNING OBJECTIVE3

The Economic Effect of a Price Floor in the Wheat Market

Government Intervention in the Market:Price Floors And Price Ceilings

Price Floors: The Example of Agricultural Markets

Price Floors in Labor Markets: The Minimum Wage

Many economists believe there are better policies than the minimum wage for raising the incomes of low-skilled workers.

esGovernment Intervention In The Market:

Price Floors And Price Ceilings

Price Ceilings: The Example of Rent Controls

The Economic Effect of a Rent Ceiling

Don’t Confuse “Scarcity” with a “Shortage.”

Black Markets

Black markets Buying and selling at prices that violate government price regulations.

What’s the Economic Effect of a “Black Market” for Apartments?

LEARNING OBJECTIVE3

Does Holiday Gift Giving Have a Deadweight Loss?

Caution: Gift giving may lead to deadweight loss.

The Results of Government Intervention: Winners, Losers, and InefficiencyWhen the government imposes price floors or price ceilings, three important results occur:

Some people win. Some people lose. There is a loss of economic efficiency.

Positive and Normative Analysis of Price Ceilings and Price FloorsWhether rent controls are desirable or undesirable is a normative question. Whether the gains to the winners more than make up for the losses to the losers and for the decline in economic efficiency is a matter of judgment and not strictly an economic question.

esThe Economic Impact of Taxes

LEARNING OBJECTIVE4

The Effect of Taxes on Economic Efficiency4 - 9

The Effect of a Tax on the Market for Cigarettes

Tax Incidence: Who Actually Pays a Tax?

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

4 - 10The Incidence of a Tax on Gasoline

DETERMINING TAX INCIDENCE ON A DEMAND AND SUPPLY GRAPH

When Do Consumers Pay All of a Sales Tax Increase?

LEARNING OBJECTIVE4

esThe Economic Impact Of Taxes

4 - 11The Incidence of a Tax on Gasoline Paid by Buyers

DOES IT MATTER WHETHER THE TAX IS ON BUYERS OR SELLERS?

Is the Burden of the Social Security Tax Really Shared Equally between Workers and Firms?

How much FICA do you think this employee pays?

es The Romance of Rent Control

Figure 1: In (a), the elimination of rent control causes an increase from Q1 to Q2 in the quantity of apartments being rented. In (b) this causes the demand for currently non-rent-controlled apartments to shift to the left from D1 to D2. The equilibrium rent declines from $2,000 to $1,500.

Black market

Consumer surplus

Deadweight loss

Economic efficiency

Economic surplus

Marginal benefit

Marginal cost

Price ceiling

Price floor

Producer surplus

Tax incidence

esAppendix 4A:

Quantitative Demand and Supply Analysis

Graphing Supply and Demand Equations

After statistically estimating supply and demand equations, we can use the equations to draw supply and demand curves.

QD = 3,000,000 – 1,000P

QS = – 450,000 + 1,300P

QD = QS

Demand and Supply Equations

500,1$300,2

000,450,3P

Calculating the Economic Effect of Rent Controls

CONSUMER SURPLUS

PRODUCER SURPLUS

DEADWEIGHT LOSS

COMPETITIVE EQUILIBRIUM $1,125 $865.50 $0

RENT CONTROL $1,338.75 $278 $373.75

Appendix 4A: Quantitative Demand and Supply Analysis

Calculating Consumer Surplus and Producer Surplus

C h a p t e r f o u r © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien1 st ed. Prepared by: Fernando & Yvonn.

producer surplus slide

government price setting

total consumer surplus

sum of consumer surplus

concepts of consumer

concept of economic

economic impact of taxes

taxes slide

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