c h a p t e r f o u r © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. Prepared by: Fernando & Yvonn Quijano Economic Efficiency, Government Price Setting, and Taxes

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 4: Economic Efficiency, Government Price Setting, and Taxes 2 of 29 Economic Efficiency, Government Price Setting, and Taxes Price ceiling A legally determined maximum price that sellers may charge. Price floor A legally determined minimum price that sellers may receive.

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 4: Economic Efficiency, Government Price Setting, and Taxes 3 of 29 Consumer Surplus and Producer Surplus Consumer Surplus Total Consumer Surplus in the Market for Chai Tea

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 4: Economic Efficiency, Government Price Setting, and Taxes 4 of 29 Consumer Surplus and Producer Surplus Producer Surplus 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 Producer Surplus

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 4: Economic Efficiency, Government Price Setting, and Taxes 5 of 29 Consumer Surplus and Producer Surplus What Consumer Surplus and Producer Surplus Measure Consumer surplus measures the benefit to consumers from participating in a market, and producer surplus measures the benefit to producers from participating in a market.

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 4: Economic Efficiency, Government Price Setting, and Taxes 6 of 29 The Efficiency of Competitive Markets Economic Surplus Economic Surplus Equals the Sum of Consumer Surplus and Producer Surplus

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 4: Economic Efficiency, Government Price Setting, and Taxes 7 of 29 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.

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 4: Economic Efficiency, Government Price Setting, and Taxes 8 of 29 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.

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 4: Economic Efficiency, Government Price Setting, and Taxes 9 of 29 LEARNING OBJECTIVE The Economic Effect of a Price Floor in the Wheat Market Government Intervention in the Market: Price Floors And Price Ceilings Price Floors: The Example of Agricultural Markets

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 4: Economic Efficiency, Government Price Setting, and Taxes 10 of 29 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.

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 4: Economic Efficiency, Government Price Setting, and Taxes 11 of 29 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.”

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 4: Economic Efficiency, Government Price Setting, and Taxes 12 of 29 Government Intervention In The Market: Price Floors And Price Ceilings Black Markets Black markets Buying and selling at prices that violate government price regulations.

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 4: Economic Efficiency, Government Price Setting, and Taxes 13 of 29 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

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 4: Economic Efficiency, Government Price Setting, and Taxes 14 of 29 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.

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 4: Economic Efficiency, Government Price Setting, and Taxes 15 of 29 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

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 4: Economic Efficiency, Government Price Setting, and Taxes 16 of 29 When Do Consumers Pay All of a Sales Tax Increase? LEARNING OBJECTIVE 4

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 4: Economic Efficiency, Government Price Setting, and Taxes 17 of 29 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?

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 4: Economic Efficiency, Government Price Setting, and Taxes 18 of 29 Black market Consumer surplus Deadweight loss Economic efficiency Economic surplus Marginal benefit Marginal cost Price ceiling Price floor Producer surplus Tax incidence

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 4: Economic Efficiency, Government Price Setting, and Taxes 19 of 29 Appendix 4A: Quantitative Demand and Supply Analysis 4A-1 Graphing Supply and Demand Equations After statistically estimating supply and demand equations, we can use the equations to draw supply and demand curves. Q D = 3,000,000 – 1,000P Q S = – 450, ,300P Q D = Q S Demand and Supply Equations

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 4: Economic Efficiency, Government Price Setting, and Taxes 20 of 29 4A-2 Calculating the Economic Effect of Rent Controls CONSUMER SURPLUS PRODUCER SURPLUS DEADWEIGHT LOSS COMPETITIVE EQUILIBRIUM $1,125$865.50$0 RENT CONTROL $1,338.75$278$ Appendix 4A: Quantitative Demand and Supply Analysis Calculating Consumer Surplus and Producer Surplus