2 Consumer Surplus, Producer Surplus and Efficiency The gains from tradeTotal SurplusIt is the sum of consumer and producer surplusThis illustrates another core principle of economics: There are gains from trade.
3 The Efficiency of Markets A market is efficient if there is no way to make some people better off without making other people worse offOnce a market is in equilibrium there is no way to increase gains from trade
4 An efficient market performs four important function It allocates consumption of the good to the potential buyers who most value it, as indicated by the fact they have the highest willingness to payIt allocates sales to the potential sellers who most value the right to sell the good, as indicated by the fact that they have the lowest cost.
5 It ensures that every consumer who makes a purchase values the good more than every seller who makes a sale, so that all transactions are mutually beneficialIt ensures that every potential buyer who doesn’t make a purchase values the good less than every potential seller who doesn’t make a sale, so that no mutually beneficial transactions are missed.
6 There are three caveats Although the market may be efficient is isn’t necessarily fairMarkets sometimes failEven when the market equilibrium maximizes total surplus, this does not mean that it results in the best outcome for every individual consumer and producer.
7 Equity and EfficiencyThere is often a trade-off between equity and efficiency: Policies that promote equity often come at the cost of decreased efficiency and policies that promote efficiency often result in decreased equity
8 Equity and efficiency is at the core of most debates about taxation Economists classify taxes according to how they vary with the income of individualsProgress Tax: rises more than in proportion to incomeRegressive Tax: rises less than in proportion to incomeProportional Tax: rises in proportion to income
9 Effects of Taxes on Total Surplus To understand the economics of taxes it is helpful to look an excise taxA tax charged on each unit of a good or service that is sold
10 Effect of an excise tax on quantities and prices An excise tax drives a wedge between the price paid by consumers and the price received by producersIt leads to inefficiency by distorting incentives and creating missed opportunities for mutually beneficial transactionsTax incidence is the distribution of the tax burden
11 Price elasticities and tax incidence The incidence of an excise tax depends on the price elasticity surplus and price elasticity of demandWhen an excise tax is paid mainly by consumersThe price elasticity of demand is low and the price elasticity of supply is high, the burden of an excise tax falls mainly on consumersWhen an excise tax is paid mainly by producersThe price elasticity of demand is high and the price elastic of supply is low , the burden of an excise tax falls mainly on producers
12 The Benefits and Cost of Taxation The revenue from an excise taxThe revenue collected by an excise tax is equal to the area of a rectangle with the height of the tax wedge between the supply price and demand price and the width of the quantity sold under the tax
13 The cost of taxationPrevents mutually beneficial transactions from occurring. The value of the forgone mutually beneficial transactions is called the deadweight loss.In considering the total amount of inefficiency caused by the tax we must also take into account administrative costsAdministrative costs of a tax are the resources used by government to collect the tax and by taxpayers to pay (or to evade) it, over and above the amount collected.Also consider lump-sum taxIs a tax of a fixed amount paid by all taxpayersIt is the same for everyone regardless of any actions people take.