1. Efficiency and Deadweight Loss
AP Economics
Mr. Bernstein
Module 50:
Efficiency and Deadweight Loss
October 23, 2014

2. AP Economics Mr. Bernstein
Total Surplus
When markets reach equilibrium, Total Surplus is maximized
Distortions to competitive market outcomes(ie excise taxes) create Total Surplus that is not maximized and Deadweight Loss emerges

3. AP Economics Mr. Bernstein
Efficiency and Gains From Trade
When economists speak of efficiency, they are typically eluding to the ability of markets to produce outcomes that are most efficient to all other ways of organizing the exchange of goods
When a consumer makes a purchase from a producer, a trade has occurred and both sides gain
Gains are represented by Consumer and Producer Surplus, or Total Surplus

4. AP Economics Mr. Bernstein
Efficiency of Markets
No reallocation of consumption among consumers could increase consumer surplus
No reallocation of sales among producers could increase producer surplus
No change in the quantity traded could
increase total surplus
Once the market has reached equilibrium,
there is no other way to increase the gains
from trade. Any of these 3 possible
reallocations would reduce total surplus and
thus reduces efficiency.

5. AP Economics Mr. Bernstein
An Efficient Market
Allocates consumption of the good to the potential buyers who most value it, as indicated by the fact that they have the highest willingness to pay
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.
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 beneficial.
Insures 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. AP Economics Mr. Bernstein
Equity and Efficiency - Review
Societies may be concerned with Equity as well as Efficiency
Example: Handicapped Parking
Another example: Progressive tax rates

7. AP Economics Mr. Bernstein
The Effect of Taxes
Excise tax imposed on producers
Qt Q D
Dead Weight Loss P Q S1 S CS T D D T PS

8. AP Economics Mr. Bernstein
The Effect of Taxes on Total Surplus
Who pays the tax (tax incidence) depends on the price elasticities of demand and supply
Tax on sellers shifts the supply curve to the left
Tax on buyers shifts the demand curve to the left
Example: Gas tax can be imposed on producers or consumers
In either case, the tax leads to:
Decrease in quantity
Increase in price paid by consumers, but…
Decrease in price received by producers
A “wedge” between consumer and producer prices equal to the tax

9. AP Economics Mr. Bernstein
Elasticity and Tax Incidence
Relatively inelastic (steep) demand curve - consumers pay
Relatively elastic (flat) demand curve - producers pay
Relatively inelastic (steep ) supply curve – producers pay
Relatively elastic (flat) supply curve – consumers pay
On costs and benefits of taxes:
Tax revenue collected by the government is not a cost of the tax
It is a redistribution of surplus from consumers and producers to the government
The true cost of the tax is the inefficiency that it creates in the form of deadweight loss