Thursday, September 29, 2016
Lecture 4: Economic Efficiency, Government Price Setting and Taxes
4.1 Consumer Surplus and Producer Surplus
Consumer Surplus - The difference between the highest price a consumer is willing to
pay for a good and the price the consumer actually pays.
Producer Surplus - The difference between the lowest price a ﬁrm would be willing to
accept for a good and the price it actually receives.
• Sellers are willing to supply an additional unit of a product only if the price is
equal to or greater than the additional cost of producing that unit.
Marginal Cost - additional cost of producing that unit in regards to the increase/
decrease in slope
Consumer Surplus (CS) = Highest price willing to pay - Cost of Item = Proﬁt (Beneﬁt)
= Total Beneﬁt received by consumers - Total Amount they pay
Producer Surplus (PS) = Price seller actually receives - the Marginal cost
Proﬁt (beneﬁt) = Total Amount received (Rx) - Cost of Production (Cx)
Economic Surplus = how well the market is surviving
= a measure of CS & PS
4.2 The Efﬁciency of Competitive Markets
Economic (Market) Efﬁciency - resources are used to generate the largest possible
surplus to consumers and producers
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Efﬁciency - 1. goods are being consumed by the buyers who value them the most
- 2. goods are being produced by the procedures with lowest cost
- 3. raising or lowering the quantity of a good would not increase total surplus
Requirement 1: Buyers who value the good most highly should get the good.
Value of Buyer = height to the demand curve (Marginal Beneﬁt)
Marginal Beneﬁt = total amount higher or lower than the point of equilibrium
Requirement 2: Producers with lowest cost will supply the good.
Producer with lowest cost = height to the supply curve (Marginal Cost)
Marginal Beneﬁt = total amount below or above the point of equilibrium
Requirement 3: Equilibrium quantity maximizes total surplus.
Market Equilibrium = Marginal Beneﬁt = Marginal Cost
= Demand = Supply
• A Market outcome in which:
• The Marginal Beneﬁt to consumers of the last unit produced = to its Marginal
Cost of Production
• The sum of consumer surplus and producer surplus is at a maximum (Maximum
Consumer Surplus + Maximum Producer Surplus)
4.3 Government Interventions in the Market
• Government wants to help, so they produce price ﬂoors and ceilings.
• Price Floor: minimum price seller can charge (e.g. minimum wage)
• Price Ceiling: maximum price seller can charge (e.g. rent control)
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Example: Employment (Wage in $/hr vs # of Unskilled workers)
Surplus (Qs > Qd) = Unemployment when wage is compared to the number of
At Competitive With Minimum Wage Changes (1) - (2)
Equilibrium (1) of $10.25 (2)
Consumer Surplus A+B+C A — (B+C)
Producer Surplus D+F B+D +B—F
Economic Surplus A+B+C+D+E A+B+D — (C+F)