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Lecture 14

ECON 101 Lecture Notes - Lecture 14: Tax Wedge, Marginal Cost, Demand Curve
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Winter 2015
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Department
Economics
Course Code
ECON 101
Professor
Marina Adshade
Lecture
14

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ECON 101 - Lecture #14 - Producer Surplus, Market Efficiency, and Quantity of Tax
Producer Surplus
The difference between what a producer receives from trade and the minimum amount
the producer is willing to accept is called the producer surplus
Consider an imagined market, as presented in Table 1
Seller costs = the minimum price sellers are able to accept = marginal cost
function
Table 1. The seller costs of an imagined comic bookstore market.
Person Cost ($)
Andrew 5
Betty 15
Carlos 25
Donna 35
Englebert 45
If we analyze the table, we can conclude that
When price is greater than 45, five people will sell
When price is greater than 35 but under 45, four people will sell
When price is greater than 25 but under 35, three people will sell
When price is greater than 15, but under 25, two people will sell
When price is greater than 5, but under 15, one person will sell
When price is under 5, nobody will sell
With that, a graph could be produced, as presented by Figure 1
Figure 1. The graph of the marginal cost function for the imagined comic books market.
The marginal cost function is the same as supply curve
Only works if the market is perfectly competitive
On the other hand, marginal willingness to buy curve = marginal benefit curve =
demand curve
Using this graph, we could calculate producer surplus
At $32, what is producer surplus?

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Description
ECON 101 - Lecture #14 - Producer Surplus, Market Efficiency, and Quantity of Tax Producer Surplus ● The difference between what a producer receives from trade and the minimum amount the producer is willing to accept is called the producer surplus ● Consider an imagined market, as presented in Table 1 ○ Seller costs = the minimum price sellers are able to accept = marginal cost function Table 1. The seller costs of an imagined comic bookstore market. Person Cost ($) Andrew 5 Betty 15 Carlos 25 Donna 35 Englebert 45 ● If we analyze the table, we can conclude that ○ When price is greater than 45, five people will sell ○ When price is greater than 35 but under 45, four people will sell ○ When price is greater than 25 but under 35, three people will sell ○ When price is greater than 15, but under 25, two people will sell ○ When price is greater than 5, but under 15, one person will sell ○ When price is under 5, nobody will sell ● With that, a graph could be produced, as presented by Figure 1 Figure 1. The graph of the marginal cost function for the imagined comic books market. ● The marginal cost function is the same as supply curve ○ Only works if the market is perfectly competitive ○ On the other hand, marginal willingness to buy curve = marginal benefit curve = demand curve ● Using this graph, we could calculate producer surplus ● At $32, what is producer surplus? ○ At 32, three people are willing to sell (Andrew, Betty, and Carlos) ○ Andrew will gain $27 ○ Betty will gain $17 ○ Carlos will gain $7 ○ The total is $51 ● The area below the price and above the marginal cost curve is the producer surplus; the area below the marginal cost curve is the cost to the sellers. Adding those two areas together, we get total revenue ● If the price of a good increases, producer surplus typically increases for two reasons ○ Existing producers (who are in the market already at a lower price) obtain more profit ○ New producers enter the market and benefit from trade Market Efficiency ● Consumer surplus plus producer surplus equals total surplus ● The goal of economics is to try to maximize total surplus ○ Key Question: how do we achieve that? ● To answer that question, examine the supply and demand model ● To the left of equilibrium, marginal benefit (demand) is above marginal cost (supply), thereby quantity traded should increase to increase total gains ● The the right of equilibrium, marginal cost is above marginal benefit, thereby quantity traded should decrease ● Conclusion: the equilibrium maximizes total gains ● We say that equilibrium at perfectly competitive markets are efficient because they ○ Produce the quantity of goods that maximizes total surplus ○ Ensures that the goods produced are allocated to the consumers who value them most highly ○ Ensure that the goods are produced by the lowest cost producers ○ (Note that the first reason can only be true if the second and the third holds true) ● Efficiency might not be the only concern on policy makers
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