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Lecture 3

Economics 2151B - Lecture 3.docx

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Economics 2150A/B
Kristin Denniston

Economics 2151B Monday January 13 Lecture 3 Homework 1 – Ch. 9 & 10 • To be posted today • Due Wednesday Jan. 22 at midnight (this has been extended from next Mon.) • Under ‘Tests and Quizzes’ on OWL Chapter 10 • We will be looking at public policies and asking how we can evaluate the effects of these policies on our market (particularly economic efficiency). Economic Efficiency: A result is economically efficient if: 1. It maximizes the total surplus (TS) in the market o TS = CS (consumer surplus) + PS (producer surplus) + Gov revenue  Consumer surplus is the benefit the consumer gets, producer surplus is the benefit the producer gets 2. The consumers who participate in the market are the ones who get the most benefit from that participation… o These consumers have the highest willingness to pay for the good …AND the producers are the ones with the lowest marginal cost of production. 3. Graphically, the efficient equilibrium will occur at a quantity where P = MC o The P represents a willingness to pay, and the MC represents the cost to society of producing that additional unit 4. Under perfect competition, the competitive market equilibrium is economically efficient. (It maximizes total surplus.) *We use these basic ideas to analyze different public policies. Figure 10.1 • Demand curve = marginal benefit to society, marginal value, or willingness to pay for the first unit o In order to sell the next good, we need to lower the price • Supply curve = marginal cost of production in terms of resources being devoted to the production of that unit • Competitive Equilibrium – where Q = Q S D • In this graph, P* = 8 and Q* = 6, and they intersect at the equilibrium point, R o Where demand intersects supply, P = MC (R) • eg. at a quantity of 10 units, we are over-producing from a social standpoint o The MC is above the P, or willingness to pay for the unit o To increase our benefit to society, we would want to decrease the production of these units until we reach the equilibrium point, R Consumer Surplus (discussed in ch. 5) • Represents the psychological benefit in monetary terms to consumers from consuming a good • CS = willingness to pay - P actually paid, summed up over all participating consumers in the market • Example: We will auction a Super Bowl ticket WTP 1 0 2 0 3 500 4 100 5 1200 • The auction for the first ticket would have to start at 1200 to sell to the 5 buyer, and then it would have to drop to 500 to get to the next buyer’s willingness to pay. (A step function.) o If we were to take this to the entire market, that step function would be in the form of a line • No one would be participating in the market at a price of $2000 (the market price), so the CS = 0 • If the price of a ticket was $300… o 1: 1200 - 300 = 900 (the consumer would be happy because they got a good deal) o 2: 500 - 300 = 200 o The CS would be 1100 • The CS is the area under the demand curve and above the price Producer Surplus • Represents the monetary benefit to producers for each unit sold in the market • It is the difference between the price they have received – MC of producing that unit o P receive – MC summed over all producers participating in the market • The graph would look like a step function in the opposite direction of the consumer surplus graph • Example: If the market price of a ticket was $1800: o 1. 1800 – 100 = 1700 benefit o 2. 1800 – 1000 = 800 o Total PS = 1700 + 800 = 2500 o Note: In this case GS = 0 because the government isn’t involved in this market (but usually they would be included) • Producers will keep producing as long as price is above marginal cost, until we reach the equilibrium • Total surplus is maximized at a competitive or free market equilibrium Excise Tax • A fixed tax per unit sold • Not the same as a sales tax o A sales tax is a percentage of sales (goes up with the size of your purchase), whereas an excise tax is fixed • Example: With every litre of gas sold, you pay 3 cents per litre • Consequences of imposing an excise tax: o An excise tax is added to the graph as a wedge, and the market will shrink by the size of this wedge • Figure 10.3 o At the equilibrium, there is no tax o The excise tax forms a wedge of $6 between demand and supply o The market equilibrium changes from 1 to 2 o The wedge can be represented as a shift downward in demand or as a shift back in supply o Originally we were selling 6 units at Q*, but because of the tax, we are selling fewer units at Q, 4 units sold (a shift back in supply) • Is the tax creating reduction in total surplus? o Excise tax creates a dead weight loss (DWL) to society o DWL = decrease in TS to society • How do we calculate the DWL? o DWL (lost total surplus) = TS before the policy change – TS after the policy change Before • TS = CS + PS + Gov. Revenue o = (A+B+C+E) + (G+F+H) + 0 (govt. not involved yet) o When the tax wedge is implemented, it is shifting the supply curve back because if suppliers are paying the tax, they must be paid an extra $6 in units sold in order to supply the good (because they have to pay the tax) o Before the tax we were at an equilibrium of 1, and after the tax we are at 2 • TS Afte= CS + PS + Gov. Revenue o = (A) + (H) + (tax wedge x # of units sold in the market) o = (A) + (H) + (B + C + G) o The price that consumers
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