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Lecture 3

# Economics 2150A/B Lecture Notes - Lecture 3: Lifesaving, Tax Incidence, Insulin

Department
Economics
Course Code
ECON 2150A/B
Professor
Kristin Denniston
Lecture
3

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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
oTS = 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…
oThese 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
oThe 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
oIn 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 QS = QD
In this graph, P* = 8 and Q* = 6, and they intersect at the equilibrium point, R
oWhere demand intersects supply, P = MC (R)
eg. at a quantity of 10 units, we are over-producing from a social standpoint
oThe MC is above the P, or willingness to pay for the unit
oTo 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)

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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
2
3
4
5
0
0
500
100
1200
The auction for the first ticket would have to start at 1200 to sell to the 5th buyer,
and then it would have to drop to 500 to get to the next buyer’s willingness to
pay. (A step function.)
oIf 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…
o1: 1200 - 300 = 900 (the consumer would be happy because they got a
good deal)
o2: 500 - 300 = 200
oThe 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
oP 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:
o1. 1800 – 100 = 1700 benefit
o2. 1800 – 1000 = 800
oTotal PS = 1700 + 800 = 2500
oNote: 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