Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 1 of 33 © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. Consumer surplus The difference between the highest price a consumer is willing to pay and the price the consumer actually pays. Marginal benefit The additional benefit to a consumer from consuming one more unit of a good or service. Consumer Surplus and Producer Surplus Consumer Surplus Learning Objective 4.1

Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 2 of 33 © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. Learning Objective 4.1 Consumer Surplus and Producer Surplus Consumer Surplus FIGURE 4-1 Deriving the Demand Curve for Chai Tea

Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 3 of 33 © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. Consumer Surplus and Producer Surplus Consumer Surplus FIGURE 4-2 Measuring Consumer Surplus Learning Objective 4.1

Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 4 of 33 © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. Consumer Surplus and Producer Surplus FIGURE 4-3 Total Consumer Surplus in the Market for Chai Tea Learning Objective 4.1 Consumer Surplus

Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 5 of 33 © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. The Consumer Surplus from Satellite Television Consumer surplus allows us to measure the benefit consumers receive in excess of the price they paid to purchase a product. Making the Connection Learning Objective 4.1

Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 6 of 33 © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. Consumer Surplus and 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 Learning Objective 4.1

Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 7 of 33 © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. Producer Surplus FIGURE 4-4 Calculating Producer Surplus Learning Objective 4.1 Consumer Surplus and Producer Surplus

Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 8 of 33 © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. Learning Objective 4.1 Consumer surplus measures the net benefit to consumers from participating in a market rather than the total benefit. The net benefit equals the total benefit received by consumers minus the total amount they must pay to buy the good. Producer surplus measures the net benefit received by producers from participating in a market. Producer surplus is the total amount firms receive from consumers minus the cost of producing the good. What Consumer Surplus and Producer Surplus Measure Consumer Surplus and Producer Surplus

Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 9 of 33 © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. The Efficiency of Competitive Markets FIGURE 4-5 Marginal Benefit Equals Marginal Cost Only at Competitive Equilibrium Marginal Benefit Equals Marginal Cost in Competitive Equilibrium Learning Objective 4.2

Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 10 of 33 © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. Economic surplus The sum of consumer surplus and producer surplus. Economic Surplus Equals the Sum of Consumer Surplus and Producer Surplus The economic surplus in a market is the sum of the blue area, representing consumer surplus, and the red area, representing producer surplus. Figure 4.6 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 in which the sum of consumer surplus and producer surplus is at a maximum. Equilibrium in a competitive market results in the greatest amount of economic surplus, or total net benefit to society, from the production of a good or service.

Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 11 of 33 © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. The Efficiency of Competitive Markets FIGURE 4-7 When a Market Is Not in Equilibrium There is a Deadweight Loss Deadweight Loss Deadweight loss The reduction in economic surplus resulting from a market not being in competitive equilibrium. Learning Objective 4.2

Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 12 of 33 © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. The Efficiency of Competitive Markets 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 in which the sum of consumer surplus and producer surplus is at a maximum. Economic Surplus and Economic Efficiency Learning Objective 4.2

Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 13 of 33 © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. Price ceiling A legally determined maximum price that sellers may charge. Price floor A legally determined minimum price that sellers may receive. Economic Efficiency, Government Price Setting, and Taxes

Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 14 of 33 © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. Government Intervention in the Market: Price Floors And Price Ceilings FIGURE 4-8 The Economic Effect of a Price Floor in the Wheat Market Price Floors: Government Policy in Agricultural Markets Learning Objective 4.3

Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 15 of 33 © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. Price Floors in Labor Markets: The Debate Over Minimum Wage Policy Making the Connection Learning Objective 4.3

Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 16 of 33 © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. Government Intervention in the Market: Price Floors And Price Ceilings FIGURE 4-9 The Economic Effect of a Rent Ceiling Price Ceilings: Government Rent Control Policy in Housing Markets Don’t Let This Happen to YOU! Don’t Confuse “Scarcity” with a “Shortage” Learning Objective 4.3

Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 17 of 33 © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. Government Intervention in the Market: Price Floors And Price Ceilings The Results of Government Price Controls: Winners, Losers, and Inefficiency When the government imposes price floors or price ceilings, three important results occur: Learning Objective 4.3 Some people win. Some people lose. There is a loss of economic efficiency.

Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 18 of 33 © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. Government Intervention in the Market: Price Floors And Price Ceilings Positive and Normative Analysis of Price Ceilings and Price Floors Whether rent controls or federal farm programs 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. Learning Objective 4.3

Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 19 of 33 © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. The Economic Impact of Taxes The Effect of Taxes on Economic Efficiency FIGURE 4-10 The Effect of a Tax on the Market for Cigarettes Learning Objective 4.4

Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 20 of 33 © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 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. Learning Objective 4.4

Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 21 of 33 © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. The Economic Impact of Taxes Tax Incidence: Who Actually Pays a Tax? Determining Tax Incidence on a Demand and Supply Graph FIGURE 4-11 The Incidence of a Tax on Gasoline Learning Objective 4.4

Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 22 of 33 © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. The Economic Impact of Taxes Tax Incidence: Who Actually Pays a Tax? Does It Matter Whether the Tax Is on Buyers or Sellers? FIGURE 4-12 The Incidence of a Tax on Gasoline Paid by Buyers Learning Objective 4.4

Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 23 of 33 © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. Solved Problem 4-4 When Do Consumers Pay All of a Sales Tax Increase? Learning Objective 4.4

Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 24 of 33 © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. Is the Burden of the Social Security Tax Really Shared Equally between Workers and Firms? Making the Connection Learning Objective 4.4

Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 25 of 33 © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. Consumer surplus Deadweight loss Economic efficiency Economic surplus Marginal benefit Marginal cost Price ceiling Price floor Producer surplus Tax incidence K e y T e r m s