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8F Economic Efficiency

11 Pages
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Department
Economics
Course Code
ECO101H1
Professor
Gustavo Indart

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ECONOMIC EFFICIENCY
Consumer and Producer Surplus
Consumer surplus: difference between the value that
consumers place on a product and the payment they
actually make to buy that product (area under the
demand curve and above the market price line)
Producer surplus: difference between price and
marginal cost (area above supply curve and below the
market price line)
Incidence (or Burden) of a Per Unit Tax
Buyers’ Share: difference between the pre-tax and post-tax price paid by Buyers
Buyers’ Share (BS) = P1 - P0
Sellers’ Share: difference between the pre-tax and post-tax price received by Sellers
Sellers’ Share (SS) = P0 - (P1 - Tax)
The tax revenue collected by the government (or total tax paid) is graphically the area with the
tax as the vertical dimension [P1 - (P1 - Tax)], which is the difference between the pre-tax and
the post-tax Supply curves at Q1.
The burden of a tax is distributed between consumers and sellers in a manner that depends on
the relative elasticities of supply and demand
When demand is inelastic relative to supply, consumers bear most of the burden of taxes
When supply is inelastic relative to demand, producers bear most of the burden
Per Unit Subsidies
A subsidy is the opposite of a tax in that the government gives a subsidy per unit rather than
takes a tax per unit. We can analyze a subsidy in a similar way, but with a shift down in Supply
by the amount of the subsidy rather than the shift up in Supply that occurs with a per unit tax.
Maximum Net Social Benefit: P = MC
Implies the output where the benefit to society of an additional unit of output equals the cost to
society of an additional unit of output.
Pareto Efficient Allocation (Pareto Optimality): P = MC
The allocation of resources where no person is worse off from trading and any additional trade
will make some person worse off
Efficiency Loss (Welfare or Deadweight Loss)
Measure efficiency loss of an output Qo by the difference between Price and Marginal Cost
between the output Qo and optimal output at P = MC. It is the difference between Demand and
Marginal Cost between given output and optimal output. This is equivalent to the net loss of
consumers’ surplus and producers’ surplus at the output relative to optimal output
Competition => Optimum Allocation (Allocation Efficiency, 0 Efficiency Loss)
Competitive market equilibrium implies that P = MC, which implies that competitive markets give
the optimal allocation of resources
Monopoly Regulation
Monopolies create efficiency loss by reducing output below competitive output and increasing
price above competitive price. Governments attempt to eliminate the efficiency loss caused by a
monopoly using two methods:
1) Marginal Cost Pricing (for ‘normal’ monopolies)
MC pricing results in 0 efficiency loss but still leaves the monopoly with an economic profit.

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Description
ECONOMIC EFFICIENCY Consumer and Producer Surplus Consumer surplus: difference between the value that consumers place on a product and the payment they actually make to buy that product (area under the demand curve and above the market price line) Producer surplus: difference between price and marginal cost (area above supply curve and below the market price line) Incidence (or Burden) of a Per Unit Tax Buyers’ Share: difference between the pre-tax and post-tax price paid by Buyers Buyers’ Share (BS) = P - 1 0 Sellers’ Share: difference between the pre-tax and post-tax price received by Sellers Sellers’ Share (SS) = P -0(P -1Tax) The tax revenue collected by the government (or total tax paid) is graphically the area with the tax as the vertical dimension [P - (P - Tax)], which is the difference between the pre-tax and 1 1 the post-tax Supply curves at Q1. The burden of a tax is distributed between consumers and sellers in a manner that depends on the relative elasticities of supply and demand When demand is inelastic relative to supply, consumers bear most of the burden of taxes When supply is inelastic relative to demand, producers bear most of the burden Per Unit Subsidies A subsidy is the opposite of a tax in that the government gives a subsidy per unit rather than takes a tax per unit. We can analyze a subsidy in a similar way, but with a shift down in Supply by the amount of the subsidy rather than the shift up in Supply that occurs with a per unit tax. Maximum Net Social Benefit: P = MC Implies the output where the benefit to society of an additional unit of output equals the cost to society of an additional unit of output. Pareto Efficient Allocation (Pareto Optimality): P = MC The allocation of resources where no person is worse off from trading and any additional trade will make some person worse off Efficiency Loss (Welfare or Deadweight Loss) Measure efficiency loss of an output Qo by the difference between Price and Marginal Cost between the output Qo and optimal output at P = MC. It is the difference between Demand and Marginal Cost between given output and optimal output. This is equivalent to the net loss of consumers’ surplus and producers’ surplus at the output relative to optimal output Competition => Optimum Allocation (Allocation Efficiency, 0 Efficiency Loss) Competitive market equilibrium implies that P = MC, which implies that competitive markets give the optimal allocation of resources Monopoly Regulation Monopolies create efficiency loss by reducing output below competitive output and increasing price above competitive price. Governments attempt to eliminate the efficiency loss caused by a monopoly using two methods: 1) Marginal Cost Pricing (for ‘normal’ monopolies) MC pricing results in 0 efficiency loss but still leaves the monopoly with an economic profit. 2) Average Cost Pricing (for natural monopolies) MC pricing is unattainable for a natural monopoly because there is an economic loss at the output where P = MC. AC pricing is the regulatory option in this case since the output where price equals average cost is the maximum output that would not entail economic loss for the monopoly. The monopoly makes 0 economic profit and there is efficiency loss at this output. Externalities Costs of a commodity other than the costs of the firms producing
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