1 chapter 7: efficiency and exchange market equilibrium and efficiency economic efficiency exists...
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1
Chapter 7: Efficiency and Exchange
Market Equilibrium and Efficiency
• Economic efficiency exists when no change could be made to benefit one party without harming the other– Sometimes called Pareto efficiency– Equilibrium price and quantity are efficient
• Prices above or below equilibrium are not
2
Price Below Equilibrium
• Suppose milk is $1 per gallon
2.50
Quantity (1,000s of gallons/day)
Pric
e ($
/gal
lon)
1 2 3 4 5
2.00
1.50
1.00
0.50
D
S
3
Price Below Equilibrium
• A buyer offers $1.25 per gallon
2.50
Quantity (1,000s of gallons/day)
Pric
e ($
/gal
lon)
1 2 3 4 5
2.00
1.50
1.00
0.50
D
S
1.25
4
Price above Equilibrium
2.50
Quantity (1,000s of gallons/day)1 2 3 4 5
2.00
1.50
1.00
0.50
D
S
1.75 Only equilibrium price is efficient
Pric
e ($
/gal
lon)
5
Efficiency Conditions
6
Heating Oil Market
D
S2.00
Quantity (1,000s of gallons/day)
Pric
e ($
/gal
lon)
1 2 3 4 5
1.60
1.20
1.00
.80
1.80
1.40
8
Producer surplus = $900/day
Consumer surplus = $900/day
7
Price Ceiling on Heating Oil
D
S
2.00
Quantity (1,000s of gallons/day)1 2 3 4 5
1.60
1.20
1.00
0.80
1.80
1.40
8
Consumer surplus = $900/ day
Producer surplus = $100/ day
Lost surplus = $800/ day
Pric
e ($
/gal
lon)
8
Price Subsidies for Bread
Quantity (millions of loaves/month)2 4 6
$3.00
$1.00
$4.00
8
$2.00
D
S
Price ($/loaf)
Consumer Surplus = $4 M/month
BUT…
S with subsidy
Consumer Surplus = $9 M/month
9
The Cost of the Subsidy
BUT … The government loses $1 on every loaf
Imports 6 million loaves for $2 per loaf Government losses are $6 million
The net benefit of the subsidy program Consumer surplus – government losses Net benefit = $3 million
10
Taxes on Sellers
• Tax program– Seller reports sales in units to government– Seller pays a fixed dollar amount per unit sold
• A tax on the seller shifts the supply curve up by the amount of the tax– Vertical interpretation of the supply curve
• For each level of output, seller charges his marginal cost PLUS the tax
11
Tax on Avocado Sellers
S + tax
2.50
3.50
2.5
6
Quantity (millions of pounds/month)
Pric
e ($
/pou
nd)
1 2 3 4 5
5
4
2
1D
S
3
12
Taxes and Perfectly Elastic Supply
Quantity (millions of cars/month)
Price ($/car)
D
S
2.0
$20,000
If supply is perfectly elastic, buyers pay all of the tax
1.9
S + $100$20,100
13
Tax on Avocado Sellers
6
Q
P
3
D
S
3
S + tax
3.50
6
2.5
1 DQ
P
After TaxConsumer surplus = $3.125 MProducer surplus = $3.125 M
Total surplus = $6.25 MLoss = $2.75 M
Before TaxConsumer surplus = $4.5 MProducer surplus = $4.5 M
14
Taxes and Price Elasticity of Demand
Q
P
19
2.40
1.40
S + T
D1
S
24
2.00
2.60
1.602.00
21
S + T
Q
D2
S
24
P
More Elastic Demand Less Elastic Demand
Consumers pay a smaller share of the tax when demand is more elastic
15
Taxes and Deadweight Loss
Q
P
19
2.40
1.40
S + T
D1
S
24
2.00
Deadweight loss
2.60
1.602.00
21
S + T
Q
D2
S
24
P Deadweight loss
More Elastic Demand Less Elastic Demand
Deadweight loss is larger when demand is relatively elastic
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