Microeconomics: Economic Efficiency, Government Price Setting, and Taxes

Chapter Outline

• 4.1 Consumer Surplus and Producer Surplus
• 4.2 The Efficiency of Competitive Markets
• 4.3 Government Intervention in the Market: Price Floors and Price Ceilings
• 4.4 The Economic Effect of Taxes

Key Concepts

Consumer Surplus and Producer Surplus

• Consumer Surplus: Difference between the highest price a consumer is willing to pay and the actual price paid.
• Producer Surplus: Difference between the lowest price a firm would accept and the price it actually receives.
• Surplus: Refers to the benefit derived from market transactions.

Examples

• Chai Tea Market:
  • Example illustrating consumer surplus, where price changes affect the consumer benefits.
  • Graphical representation of consumer surplus as the area below the demand curve and above the price.
• Uber Services:
  • Analysis of consumer surplus derived from Uber rides using the demand curve and price data.

Efficiency of Competitive Markets

• Economic Efficiency:
  • Market is efficient if all trades occur where marginal benefit exceeds marginal cost.
  • Efficiency also implies maximizing the sum of consumer surplus and producer surplus (economic surplus).
• Competitive Equilibrium:
  • Occurs where marginal benefit equals marginal cost; ensures maximum economic efficiency and no deadweight loss.

Government Intervention: Price Floors and Ceilings

• Price Ceiling: Maximum price sellers can charge; may lead to shortages.
• Price Floor: Minimum price sellers can receive; may lead to surpluses.
• Effects:
  • Rent control leads to apartment shortages; minimum wage affects employment levels.
  • Price controls can create deadweight loss, reducing economic efficiency.

Real-World Implications

• Labor Markets:
  • Minimum wage argues both for raising low-skilled worker incomes and causing employment decreases.
• Rent Control:
  • Deadweight loss from reduced rents leads to shortages and potential black markets.

Economic Effect of Taxes

• Per-Unit Taxes:
  • Assessed as a specific amount per unit sold, such as excise taxes on gasoline.
  • Taxes shift supply curves up, changing equilibrium prices and quantities.
• Tax Incidence:
  • Describes who bears the burden of a tax; determined by demand and supply curve slopes.
  • Legal obligation to pay tax does not necessarily reflect who bears its burden.

Figures and Applications

• Chai Tea Market & Uber Analysis: Demonstrate consumer surplus calculations.
• Competitive Equilibrium: Illustrate economic surplus maximization.
• Price Floors & Ceilings: Show how impositions affect market equilibrium and generate deadweight loss.
• Tax Effects:
  • Cigarette market example shows tax shifting supply curves and affecting equilibrium.
  • Gasoline market example demonstrates tax incidence between buyers and sellers.

Concluding Notes

• Market efficiency and economic surplus are maximized at competitive equilibrium.
• Government interventions such as price controls and taxes impact economic efficiency and surplus distribution.
• Understanding tax incidence is critical for evaluating economic policies and their real-world implications.