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Understanding Market Efficiency and Failure

Learn about price ceilings, price floors, externalities, consumer surplus, producer surplus, economic surplus, deadweight loss, government intervention, black markets, and the effect of externalities on economic efficiency.

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Understanding Market Efficiency and Failure

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  1. Market Efficiency and Market Failure • Price ceiling A legally determined maximum price that sellers may charge. • Price floor A legally determined minimum price that sellers may receive. • Externality A benefit or cost that affects someone who is not directly involved in the production or consumption of a good or service.

  2. Learning Objective 4.1 Consumer Surplus and Producer Surplus 4.1 • Consumer Surplus Consumer surplusThe difference between the highest price a consumer is willing to pay and the price the consumer actually pays. Marginal benefitThe additional benefit to a consumer from consuming one more unit of a good or service.

  3. Learning Objective 4.1 Consumer Surplus and Producer Surplus Consumer Surplus FIGURE 4-3 Total Consumer Surplus in the Market for Chai Tea

  4. Learning Objective 4.1 MakingtheConnection • The Consumer Surplus fromSatellite Television Consumer surplus allows us to measure the benefit consumers receive in excess of the price they paid to purchase a product.

  5. Learning Objective 4.1 Consumer Surplus and Producer Surplus • Producer Surplus Marginal cost The additional cost to a firm of producing one more unit of a good or service. Producer surplus The difference between the lowest price a firm would have been willing to accept and the price it actually receives.

  6. Learning Objective 4.1 Consumer Surplus and Producer Surplus • Producer Surplus FIGURE 4-4 Calculating Producer Surplus

  7. Learning Objective 4.1 Consumer Surplus and Producer Surplus • What Consumer Surplus and Producer Surplus Measure Consumer surplus measures the net benefit to consumers from participating in a market rather than the total benefit. The net benefit equals the total benefit received by consumers minus the total amount they must pay to buy the good. Similarly, producer surplus measures the net benefit received by producers from participating in a market, or the total amount firms receive from consumers minus the cost of producing the good.

  8. Learning Objective 4.2 The Efficiency of Competitive Markets Marginal Benefit Equals Marginal Cost in Competitive Equilibrium FIGURE 4-5 Marginal Benefit Equals Marginal CostOnly at Competitive Equilibrium

  9. Learning Objective 4.2 The Efficiency of Competitive Markets Economic Surplus Economic surplus The sum of consumer surplus and producer surplus. FIGURE 4-6 Economic Surplus Equals the Sum of Consumer Surplus and Producer Surplus

  10. Learning Objective 4.2 The Efficiency of Competitive Markets Deadweight Loss FIGURE 4-7 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.

  11. Learning Objective 4.2 The Efficiency of Competitive Markets 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 in which the sum of consumer surplus and producer surplus is at a maximum.

  12. Learning Objective 4.3 Government Intervention in the Market:Price Floors And Price Ceilings Price Floors: Government Policy in Agricultural Markets FIGURE 4-8 The Economic Effect of a Price Floor in the Wheat Market

  13. Learning Objective 4.3 MakingtheConnection • Price Floors in Labor Markets: The Debate Over Minimum Wage Policy

  14. Learning Objective 4.3 Government Intervention in the Market:Price Floors And Price Ceilings Price Ceilings: Government Rent Control Policy in Housing Markets FIGURE 4-9 The Economic Effect of a Rent Ceiling Don’t Let This Happen to YOU!Don’t Confuse “Scarcity” with a “Shortage”

  15. Learning Objective 4.3 Government Intervention in the Market:Price Floors And Price Ceilings Black Markets Black markets A market in which buying and selling take place at prices that violate government price regulations.

  16. Learning Objective 4.3 4-3 Solved Problem What’s the Economic Effect of a “Black Market” for Apartments?

  17. Learning Objective 4.3 Government Intervention in the Market:Price Floors And Price Ceilings The Results of Government Price Controls: Winners, Losers, and Inefficiency • When 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.

  18. Learning Objective 4.3 Government Intervention in the Market:Price Floors And Price Ceilings Positive and Normative Analysis of Price Ceilings and Price Floors • Whether rent controls or federal farm programs 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.

  19. Learning Objective 4.4 Externalities and Economic Efficiency The Effect of Externalities • Private cost The cost borne by the producer of a good or service. • Social cost The total cost of producing a good, including both the private cost and any external cost. • Private benefit The benefit received by the consumer of a good or service. • Social benefit The total benefit from consuming a good or service, including both the private benefit and any external benefit.

  20. Learning Objective 4.4 Externalities and Economic Efficiency The Effect of Externalities How a Negative Externality in Production Reduces Economic Efficiency FIGURE 4-10 The Effect of Pollution on Economic Efficiency

  21. Learning Objective 4.4 Externalities and Economic Efficiency The Effect of Externalities • How a Positive Externality in Consumption ReducesEconomic Efficiency FIGURE 4-11 The Effect of a Positive Externality on Efficiency

  22. Learning Objective 4.4 Externalities and Economic Efficiency Externalities May Result in Market Failure Market failure A situation in which the market fails to produce the efficient level of output. What Causes Externalities? Property rights The rights individuals or businesses have to the exclusive use of their property, including the right to buy or sell it.

  23. Learning Objective 4.5 Government Policies to Deal with Externalities FIGURE 4.12 When There Is a Negative Externality, a Tax Can Bring about the Efficient Level of Output

  24. Learning Objective 4.5 4-5 Solved Problem Using a Tax to Deal witha Negative Externality

  25. Learning Objective 4.5 Government Policies to Deal with Externalities FIGURE 4-13 When There Is a Positive Externality, a Subsidy Can Bring about the Efficient Level of Output

  26. Learning Objective 4.5 Government Policies to Deal with Externalities Pigovian taxes and subsidies Government taxes and subsidies intended to bring about an efficient level of output in the presence of externalities. Command and Control versus Tradable Emissions Allowances Command and control approach An approach that involves the government imposing quantitative limits on the amount of pollution firms are allowed to emit or requiring firms to install specific pollution control devices.

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