Economic Efficiency and the Role of Government

1. Economic Efficiency and the Role of Government

2. While the first lesson is worth $25 to some consumer (Flo) . . . Price the second lesson is worth only $23 . . . and the third is worth $21. Number of Lessons per Week Figure 1 The Marginal Benefit from Guitar Lessons Flo $25 Joe $23 Flo (again) $21 Bo $19 Zoe $17 Demand 1 2 3 4 5

3. Price The smallest cost for this first lesson is $13 . . . but it's $15 for the second . . . and $17 for the third. Number of Lessons per Week Figure 2 The Marginal Cost of Guitar Lessons Supply $21 McCollum $19 Martin (again) $17 Gibson $15 Martin (again) $13 Martin 1 2 3 4 5

4. Price 1. Joe would pay as much as $23 for the second lesson . . . 3. Four lessons is the equilibrium and the efficient quantity. 2. while Martin would offer it for as little as $15. Number of Lessons per Week Figure 3 Efficiency in the Market for Guitar Lessons Flo $25 Supply Joe $23 Flo $21 McCollum $19 Bo Martin $17 Zoe Gibson $15 Martin $13 Demand Martin 1 2 3 4 5

5. (a) 1. When market price is $19, someone (Flo) gets $6 in consumer surplus on the first lesson . . . 2. someone (Joe) gets $4 in consumer surplus on the second . . . Price 3. and someone (Flo again) gets $2 in consumer surplus on the third. The total shaded area is market consumer surplus. Assumed Market Price Number of Lessons per Week Figure 4 Consumer Surplus in a Small and a Large Market for Guitar Lessons $25 $23 $21 $19 $17 Demand 1 2 3 4 5

6. (b) Price In a market with many buyers, market consumer surplus is the entire area under the demand curve and above the market price. Number of Lessons per Week Figure 4 Consumer Surplus in a Small and a Large Market for Guitar Lessons $19 Market Price Demand 4,000

7. 1.When market price is $19, someone (Martin) gets $6 in producer surplus on the first lesson . . . (a) Price 2. someone (Martin again) gets $4 in producer surplus on the second . . . 3. and someone (Gibson) gets $2 on the third. Assumed Market Price The total shaded area is market producer surplus. Number of Lessons per Week Figure 5 Producer Surplus from Selling Guitar Lessons Supply $21 $19 $17 $15 $13 1 2 3 4 5

8. (b) Price In a market with many sellers, market producer surplus is the entire area above the market supply curve and below the market price. Number of Lessons per Week Figure 5 Producer Surplus from Selling Guitar Lessons Supply Market Price $19 4,000

9. Price Equilibrium Quantity Figure 6 Total Net Benefits in a Competitive Market for Guitar Lessons S Equilibrium Price $19 D 4,000

10. 1. A price ceiling of $15 . . . 2. transfers surplus from producers to consumers. Price 3. It also decreases market quantity, taking away some consumer surplus 4 . . . . and some producer surplus, which are not transferred to anyone. Figure 7 Why Price Ceilings and Price Floors Are Inefficient (a) S $23 C E $19 D B $15 D A 2,000 4,000 6,000

11. 1. A price floor of $21 . . . Price 2. transfers surplus from consumers to producers. 3. It also decreases market quantity, taking away some consumer surplus 4 . . . . and some producer surplus, which are not transferred to anyone. Figure 7 Why Price Ceilings and Price Floors Are Inefficient S C $21 B E $19 D $17 A D 3,000 4,000 5,000

12. $18,000 14,000 10,000 Average Output per Worker 6,000 2,000 Low Medium High Quality of Infrastructure Figure 8 Government Infrastructure and Output per Worker

13. 1. A monopoly charges a higher price than a competitive market . . . Dollars 3. The result is a welfare loss . . . 4. from not producing the efficient quantity, at point E. 2. and produces a lower quantity. Number of Lessons per Week Figure 9 The Welfare Loss from Monopoly MC $22 E $19 D MR 2,500 4,000

14. Dollars Unregulated monopoly "Fair rate of return" production Efficient production (requires subsidy) Number of Households Served Figure 10 Regulating a Natural Monopoly A $60 C $29 LRATC F $15 MC B MR D 50,000 100,000 85,000

15. (a) 1. This market has a negative externality of $0.50 per unit. Dollars 2. The efficient quantity is here . . . 3. but the equilibrium quantity is here. Millions of Gallons per Period 4. In equilibrium, the welfare loss is triangle ABC. Figure 11A Tax on Producers to Correct a Negative Externality MSC C $0.50 B S A $1.00 D 100 125

16. 5. A tax per unit on producers, equal to the negative externality per unit, (b) 6. shifts the supply curve upward . . . Dollars 7. and moves the equilibrium to the efficient quantity. Millions of Gallons per Period Figure 11A Tax on Producers to Correct a Negative Externality SAfter Tax SBefore Tax B $0.50 $1.30 A $1.00 $0.80 D 100 125 (b)

17. (a) 1.This market has a positive externality of $30,000 per college degree. Dollars 2. The equilibrium quantity is here . . . 3. but the efficient quantity is here. Number of Degrees per Year 4. In equilibrium, the welfare loss is triangle ABC. Figure 12 A Subsidy for Consumers to Correct a Positive Externality S $30,000 B $100,000 A MSB C D 800,000 1,000,000

18. (b) 5. A subsidy per unit for consumers equal to the positive externality per unit . . . 6. shifts the demand curve upward . . . Dollars 7. and moves the market to the efficient quantity Number of Degrees per Year Figure 12 A Subsidy for Consumers to Correct a Positive Externality S $30,000 B $114,000 $100,000 A DAfter Subsidy $84,000 DBefore Subsidy 800,000 1,000,000

19. Mixed Good Pure Private Good Mixed Good Pure Public Good Figure 13 Pure Private, Pure Public, and Mixed Goods More Rival More Nonrival More Excludable • software • food, clothing, housing • sold-out movie • movie with empty seats • crowded highway • uncrowded highway • newspaper • downloaded music file • cable television • urban park • police and fire protection • crowded city streets • national defense, legal system • fish in international waters MoreNonexcludable