Macroeconomics ECON 2302 May 2009 Marilyn Spencer, Ph.D. Professor of Economics Chapter 4

Learning Objectives from Chapter 3 - You should now be able to: 1. Discuss the variables that influence demand. 2. Discuss the variables that influence supply. 3. Use a graph to illustrate market equilibrium. 4. Use demand and supply graphs to predict changes in prices and quantities.

Any questions on these topics? Anything else?

Chapter 4. Economic Efficiency, Government Price Setting, and Taxes

After studying this chapter, you should be able to: Understand the concepts of consumer surplus and producer surplus. Understand the concept of economic efficiency, and use a graph to illustrate how economic efficiency is reduced when a market is not in competitive equilibrium. Use demand and supply graphs to analyze the economic impact of price ceilings and price floors. Use demand and supply graphs to analyze the economic impact of taxes. LEARNING OBJECTIVES

Economic Efficiency, Government Price Setting, and Taxes 4 Price ceiling A legally determined maximum price that sellers may charge. 4 Price floor A legally determined minimum price that sellers may receive.

Consumer Surplus And Producer Surplus 4 Consumer Surplus LEARNING OBJECTIVE 1 Marginal benefit The additional benefit to a consumer from consuming one more unit of a good or service. Consumer surplus The difference between the highest price a consumer is willing to pay and the price the consumer actually pays.

Consumer Surplus And Producer Surplus 4 Consumer Surplus LEARNING OBJECTIVE The Demand Curve is Also the Marginal Benefit Curve

Consumer Surplus and Producer Surplus 4 Consumer Surplus Total Consumer Surplus in the Market for Chai Tea

The Consumer Surplus from Satellite Television How much consumer surplus will the owner of this satellite dish receive? 4 - 1

Consumer Surplus and Producer Surplus Producer Surplus 4 Producer surplus The difference between the lowest price a firm would have been willing to accept and the price it actually receives. Marginal cost The additional cost to a firm of producing one more unit of a good or service.

Consumer Surplus and Producer Surplus Producer Surplus Producer Surplus

Consumer Surplus and Producer Surplus What Consumer Surplus and Producer Surplus Measure: ÜConsumer surplus measures the benefit to consumers from participating in a market, and producer surplus measures the benefit to producers from participating in a market.

The Efficiency of Competitive Markets LEARNING OBJECTIVE 2 Marginal Benefit Equals Marginal Cost in Competitive Equilibrium Marginal Benefit Equals Marginal Cost Only at Competitive Equilibrium

The Efficiency of Competitive Markets Economic Surplus Economic Surplus Equals the Sum of Consumer Surplus and Producer Surplus

The Efficiency of Competitive Markets Deadweight Loss 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.

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 where the sum of consumer surplus and producer surplus is at a maximum.

LEARNING OBJECTIVE The Economic Effect of a Price Floor in the Wheat Market Government Intervention in the Market: Price Floors And Price Ceilings: The Example of Agricultural Markets

Price Floors in Labor Markets: The Minimum Wage Many economists believe there are better policies than the minimum wage for raising the incomes of low-skilled workers.

Government Intervention In The Market: Price Floors And Price Ceilings Price Ceilings: The Example of Rent Controls The Economic Effect of a Rent Ceiling Don’t Confuse “Scarcity” with a “Shortage.”

Government Intervention In The Market: Price Floors And Price Ceilings Black Markets (illegal markets) Black markets Buying and selling at prices that violate government price regulations.

What’s the Economic Effect of a “Black Market” for Apts.? LEARNING OBJECTIVE 3

Does Holiday Gift Giving Have a Deadweight Loss? Caution: Gift giving may lead to deadweight loss.

Government Intervention In The Market: Price Floors And Price Ceilings 4 The Results of Government Intervention: Winners, Losers, and Inefficiency ÜWhen 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.

Government Intervention In The Market: Price Floors And Price Ceilings 4 Positive and Normative Analysis of Price Ceilings and Price Floors ÜWhether rent controls 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.

The Economic Impact of Taxes LEARNING OBJECTIVE 4 The Effect of Taxes on Economic Efficiency The Effect of a Tax on the Market for Cigarettes

The Economic Impact of Taxes Tax Incidence: Who Actually Pays a Tax? Tax incidence The actual division of the burden of a tax between buyers and sellers in a market.

The Economic Impact of Taxes Tax Incidence: Who Actually Pays a Tax? The Incidence of a Tax on Gasoline DETERMINING TAX INCIDENCE ON A DEMAND AND SUPPLY GRAPH

When Do Consumers Pay All of a Sales Tax Increase? LEARNING OBJECTIVE 4

The Economic Impact Of Taxes Tax Incidence: Who Actually Pays a Tax? The Incidence of a Tax on Gasoline Paid by Buyers DOES IT MATTER WHETHER THE TAX IS ON BUYERS OR SELLERS?

Is the Burden of the Social Security Tax Really Shared Equally between Workers and Firms? How much FICA do you think this employee pays?

The Romance of Rent Control Figure 1: In (a), the elimination of rent control causes an increase from Q 1 to Q 2 in the quantity of apartments being rented. In (b) this causes the demand for currently non-rent- controlled apartments to shift to the left from D 1 to D 2. The equilibrium rent declines from $2,000 to $1,500.

4 Black market 4 Consumer surplus 4 Deadweight loss 4 Economic efficiency 4 Economic surplus 4 Marginal benefit 4 Marginal cost 4 Price ceiling 4 Price floor 4 Producer surplus 4 Tax incidence

Assignments to be completed before May 18: 4Read Ch. 5, and be able to answer ÜReview Questions: p. 166, ; p. 167, 2.1; p. 170, 4.2 & 4.3 (1 st edition: 1-6, 11 & 12 on p. 159) and ÜProblems and Applications: p. 166, 1.6; p. 168, 3.3; p. 167, 2.5; p. 170, 4.5(1 st edition: 1, 3, 7 & 17 on pp ).