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Chapter 4: Economic Efficiency, Government Price setting, and taxes 4.1 Consumer Surplus and Producer Surplus  Consumers buy goods and producers sell goods as it makes them better off  How much better off? o Consumer surplus (CS)- difference between the highest price a consumer is willing to pay (WTP) for a good/service and the actual price the consumer pays o Producer surplus (PS): difference between the lowest price a firm would be willing to accept (WTA) for a good/service and the price it actually receives Figure 4.1 Deriving the demand curve for chai - Example: four people are interested in buying one cup of chai each - Each consumer has a different value for a cup of chai

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How much do the chai consumers benefit? o It depends on the price of chai and on the consumer’s marginal benefit o If the price is low, many consumers benefit o If the price is high, few if any consumers benefit

Figure 4.2 Measuring consumer surplus - Suppose P=$3.50 - Theresa, Tom and Terri will buy a cup - Theresa is willing to pay up to $6- she pays only $3.50, which results in a net benefit of $2.50 - Toms CS is $1.50 - Terri’s CS is $.50 - Market CS= A+B+C - Market CS is the area below the demand curve and above the price that consumers pay

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Suppose P=$3.00 instead o Theresa, Tom and Terri each gain an addition $.50 in CS o Tom is indifferent between buying the cup and now o Market CS increases by $1.50

Figure 4.3 Total consumer surplus in the market for chai - In reality, the market demand for chai tea consists of more than one four chai aficionados - CS is still the area below the demand curve, above price

How much better off are producers? - Producer surplus is the difference between the lowest price a firm would accept for a good or service and the price it actually receives - What is the lowest price a firm would accept for a good/service? - The minimum a firm would accept is the marginal cost of producing that good (additional cost of producing one more unit)

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The total producer surplus in the market for chai is the sum of all producer’s individual PS: area above the supply curve and below the market price ($2.00)

Example: The market for lemonade - Three potential consumers

Example: Suppose a frost in Florida reduces the size of the orange crop What is the effect on CS? It DECREASES because the price rises What is the effect on PS? It DECREASES because the price decreases What do consumer surplus and producer surplus measure? - Consumer surplus measures the net benefit (WTP less price) to consumers from the particulate a market - Producer surplus measures the net benefit (price WTA) received by producers from participating in a market

4.2 The efficiency of the Competitive market Two ways of thinking about efficiency in a market: - A market is efficient if o All trades take place where MB>=MC and no other trades take place o It maximizes the sum of CS and PS (total net benefit to consumers and firms) CS+PS=economic (total) surplus - Perfectly competitive markets are efficient Economic efficiency- a market outcome in which the marginal benefit to consumers of the last unity produced is equal to its marginal cost of production and in which the sum of consumer surplus and producer surplus I at a maximum ***************************GRAPH IN NOTES************************************* Deadweight loss (DWL)- the reduction in economic surplus resulting from a market not being in competitive equilibrium 4.3 Government intervention - Government policies to affect market price: price ceiling or price floor o Price Ceiling- legally determined max price that sellers can charge o Price floor-legally determined minimum price that sellers can receive  Examples: min wage, rent controls, agricultural price controls - Should the government control apt rents? o Rent control puts a legal limit on the rent that landlords can charge an apt o Since rent controlled rent are usually far below market rents, it’s obvious that landlords are not better off o Does it make tenants better? o Would you rather go apt hunting in a city with or w/o rent control? Example: market for wheat P=$6.50/bushel Q=2.0B bushels -

At Pf=$8.00: Qd=1.8B$2.50 (8 cents per gallon) - Sellers receive $2.48...