Market Efficiency: Maximizing Welfare and Tax Incidence

1. Markets and efficiency Topic 2

2. Contents • Thefunction of anyeconomicsystem • Efficiencyconcepts • Welfaremarket concept • Taxincidence

3. Thefunction of anyeconomicsystem • Assign resources (natural resources, labor, capital) to the production of goods and services • Decide the amount of production of each type of good and service • Distribute goods and services to the population (income distribution)

4. EconomicInstitutions • Societies have developed various institutions to achieve these goals-Market institutions (private companies, contracts)-Planned systems institutions (government, bureaucracy)

5. Efficiency and institutions • An EFFICIENT system achieves the best possible result for society given the limited resources • To foster an efficient economy, its institutions have to fulfill 2 fundamental functions-Encourage people to want to act for the benefit of society-Give people appropriate information so they can make these decisions

6. Marketefficiency: theclassicaltheory • Marketelements: • Private property • Competition • Freedom to participate or not in the market • Price-takers • Under various assumptions, the market price fulfills these two functions: 1) The price gives them the right incentives. People don't have to be altruistic 2) The price gives enough information to companies to produce the right amount and consumers to consume the right amount

7. Themarketforbeer

8. Total marketwelfare

9. Whyaccordingtotheneoclassicaltheorythemarketoutcomes are “efficient”? • When the market achieves the equilibrium amount, the "total welfare of the market" is maximized • Total market welfare= consumer welfare + producer welfare • If there are no “externalities” (Topic 3)total market welfare = social welfare • Let's see an example to better explain this theory ...

10. Demand:Theconsumerpurchasesif V ≥ P

11. Supply:Thefirm produces ifP≥MCg

12. Equilibrium • A situation in which all individuals (companies and consumers) have chosen the best possible action for themselves& • The action of each individual is consistent with the actions of others (that is, demand = supply)

13. Theselfregulatingmarket • Let's say the price is $3 • Who wants to buy at this price? A + B + C . Total amount of demand 1500 litres • Who wants to produce at this price? W+X+Y+Z. Total supply production 2000 litres • Excess supply  the price is reduced • Equilibrium price is $3

14. Welfare ConsumerWelfare (surplus) = (V-P)*q Producer Welfare(surplus) = (P-Cmg)*q If a company does not produce, its well-being is zero. If a consumer does not buy anything , their well-being is zero Total welfare at equilibrium3000+ 2000 - 5000 Total well-being is reached at its maximum when the price is € 2 / litrelitre

15. Marketwelfare (withouttaxes) Marketequilibriumwithouttax

16. Theincidence of a tax: example • The price of beer on the market is €2 / litre • At this price, demand and supply are 2000 litres • The demand curve has a negative slope • Let’s suppose that the government imposes a tax of € 2 / litreon the producer • How much would the government raise? A) €4000 B) < €4000 C) > €4000 • What would be the final price for the consumer? A) €4 / litro B) < €4 / litro C) > €4 / litro

17. Theincidence of a tax • Taxes raise money for the government, to pay for public services, etc. • But the market price is also increased • This changes incentives for consumers and producers • Rising price discourages consumption • The consequence is an IRRECOVERABLE LOSS for society

18. Deadweightlossdueto a tax New marketequilibriumwith a priceof € 2 litre Deadweightloss= area B+F