Market Efficiency and Government Intervention

1. Market Efficiency and Government Intervention

2. Market Efficiency andGovernment Intervention • In this chapter, we will take a closer look at the benefits of exchange, examining the experiences of both buyers and sellers. PRINCIPLE of Voluntary ExchangeA voluntary exchange between two people makes both people better off.

3. The Metaphor of the Invisible Hand • A market equilibrium will generate the largest possible surplus and thus be efficient when four conditions are met: • No external benefits • No external costs • Perfect information • Perfect competition

4. Consumer Surplusand Producer Surplus • Your willingness to pay for a product is the maximum amount you are willing to pay for the product. • Your consumer surplus is the difference between your willingness to pay and the price you actually pay for it.

5. The Demand Curveand Consumer Surplus Willing to Pay Price Paid Consumer Surplus Juan $22 $10 $12 Tupak $19 $10 $9 Thurl $16 $10 $6 Forest $13 $10 $3 Fivola $10 $10 $0 Siggy $7 Total consumer surplus $30 • The market consumer surplus equals the sum of the consumer surpluses obtained by all the consumers in the market.

6. The Supply Curveand Producer Surplus • A sellers willingness to accept is the minimum amount he or she is willing to accept as payment for a product, and is equal to the marginal cost of production. • Producer surplus is the difference between the price a producer receives for a product and the willingness to accept, or the difference between price and marginal cost.

7. The Supply Curveand Producer Surplus Willing to Receive Price Received Producer Surplus Abe $2 $10 $8 Bea $4 $10 $6 Cecil $6 $10 $4 Dee $8 $10 $2 Eve $10 $10 $0 Efrin $12 Market producer surplus $20 • Market producer surplus equals the sum of the surpluses earned by all producers in the market.

8. Market Equilibrium and Efficiency • The total surplus of a market is the sum of consumer surplus and producer surplus. • The market equilibrium generates the highest possible total surplus. That’s why we say that the market equilibrium is efficient.

9. Total Surplus Is Lower witha Price Below the Equilibrium Price • A maximum price of $4 reduces the total surplus of the market because it prevents some mutually beneficial transactions. • The first two consumers gain at the expense of the first two producers. • The consumer and producer surplus of the third and fourth lawns are lost entirely.

10. Total Surplus Is Lower with a PriceAbove the Equilibrium Price • A minimum price of $19 reduces the total value of the market. • The first two producers gain at the expense of the first two consumers. • The consumer and producer surplus of the third and fourth lawns are lost entirely.

11. Government Intervention in Markets • Market failure is a situation in which markets, if left on their own, will fail to generate socially efficient outcomes. • Market failure exists when there is an external benefit, an external cost, imperfect information, or imperfect competition.

12. Controlling the Price • A maximum price of $300 per apartment decreases the total surplus of the market by the amount of the triangle des. This loss is called a deadweight loss.

13. Application: Rent Control • The contributions opposing rent control exceed the contributions favoring it by $375.

14. Controlling the Quantity—Licensingand Import Restrictions Application: Taxi Medallions • The medallion policy creates an excess demand for taxi service, and decreases the total surplus of the taxi market.

15. Restricting Imports • An import ban would ultimately decrease the total surplus in the sugar market. It would cause domestic producers to gain at the expense of domestic consumers.

16. Who Really Pays Taxes? Revenue Sources for Local, Stateand Federal Governments

17. If demand is inelastic, a tax will increase the market price by a large amount, so consumers will bear a large share of the tax. If demand is elastic, the price will increase by a small amount and consumers will bear a small share of the tax. Tax Shifting: Forward and Backward

18. Tax Burden and Deadweight Loss • In a constant-cost industry, a tax increases the equilibrium price by the tax ($1 per pound in this example). Consumer surplus decreases by areas R and E. • Total tax revenue collected is shown by rectangle R, so the total burden exceeds the tax revenue by triangle E, also known as the deadweight loss or excess burden of the tax.

19. Key Terms willingness to pay consumer surplus willingness to accept producer surplus total surplus market failure deadweight loss deadweight loss from taxation excess burden of a tax