© 2009 Prentice Hall Business Publishing Essentials of Economics Hubbard/OBrien, 2e. Fernando & Yvonn Quijano Prepared by: Chapter 4 Market Efficiency and Market Failure

Chapter 4: Economic Efficiency,Government Price Setting, and Taxes 2 of 35 © 2009 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e. Price ceiling A legally determined maximum price that sellers may charge. Price floor A legally determined minimum price that sellers may receive. Market Efficiency and Market Failure Externality A benefit or cost that affects someone who is not directly involved in the production or consumption of a good or service.

Chapter 4: Economic Efficiency,Government Price Setting, and Taxes 3 of 35 © 2009 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e. Consumer surplus The difference between the highest price a consumer is willing to pay and the price the consumer actually pays. Marginal benefit The additional benefit to a consumer from consuming one more unit of a good or service. 4.1 Consumer Surplus and Producer Surplus Consumer Surplus Learning Objective 4.1

Chapter 4: Economic Efficiency,Government Price Setting, and Taxes 4 of 35 © 2009 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e. Consumer Surplus and Producer Surplus FIGURE 4-3 Total Consumer Surplus in the Market for Chai Tea Learning Objective 4.1 Consumer Surplus

Chapter 4: Economic Efficiency,Government Price Setting, and Taxes 5 of 35 © 2009 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e. The Consumer Surplus from Satellite Television Consumer surplus allows us to measure the benefit consumers receive in excess of the price they paid to purchase a product. Making the Connection Learning Objective 4.1

Chapter 4: Economic Efficiency,Government Price Setting, and Taxes 6 of 35 © 2009 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e. Consumer Surplus and Producer Surplus Producer surplus The difference between the lowest price a firm would have been willing to accept and the price it actually receives. Marginal cost The additional cost to a firm of producing one more unit of a good or service. Producer Surplus Learning Objective 4.1

Chapter 4: Economic Efficiency,Government Price Setting, and Taxes 7 of 35 © 2009 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e. Producer Surplus FIGURE 4-4 Calculating Producer Surplus Learning Objective 4.1 Consumer Surplus and Producer Surplus

Chapter 4: Economic Efficiency,Government Price Setting, and Taxes 8 of 35 © 2009 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e. Learning Objective 4.1 Consumer surplus measures the net benefit to consumers from participating in a market rather than the total benefit. The net benefit equals the total benefit received by consumers minus the total amount they must pay to buy the good. Similarly, producer surplus measures the net benefit received by producers from participating in a market, or the total amount firms receive from consumers minus the cost of producing the good. What Consumer Surplus and Producer Surplus Measure Consumer Surplus and Producer Surplus

Chapter 4: Economic Efficiency,Government Price Setting, and Taxes 9 of 35 © 2009 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e. The Efficiency of Competitive Markets FIGURE 4-5 Marginal Benefit Equals Marginal Cost Only at Competitive Equilibrium Marginal Benefit Equals Marginal Cost in Competitive Equilibrium Learning Objective 4.2

Chapter 4: Economic Efficiency,Government Price Setting, and Taxes 10 of 35 © 2009 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e. The Efficiency of Competitive Markets FIGURE 4-6 Economic Surplus Equals the Sum of Consumer Surplus and Producer Surplus Economic Surplus Learning Objective 4.2 Economic surplus The sum of consumer surplus and producer surplus.

Chapter 4: Economic Efficiency,Government Price Setting, and Taxes 11 of 35 © 2009 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e. The Efficiency of Competitive Markets FIGURE 4-7 When a Market Is Not in Equilibrium There is a Deadweight Loss Deadweight Loss Deadweight loss The reduction in economic surplus resulting from a market not being in competitive equilibrium. Learning Objective 4.2

Chapter 4: Economic Efficiency,Government Price Setting, and Taxes 12 of 35 © 2009 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e. The Efficiency of Competitive Markets Economic efficiency A market outcome in which the marginal benefit to consumers of the last unit produced is equal to its marginal cost of production, and in which the sum of consumer surplus and producer surplus is at a maximum. Economic Surplus and Economic Efficiency Learning Objective 4.2

Chapter 4: Economic Efficiency,Government Price Setting, and Taxes 13 of 35 © 2009 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e. Government Intervention in the Market: Price Floors And Price Ceilings FIGURE 4-8 The Economic Effect of a Price Floor in the Wheat Market Price Floors: Government Policy in Agricultural Markets Learning Objective 4.3

Chapter 4: Economic Efficiency,Government Price Setting, and Taxes 14 of 35 © 2009 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e. Price Floors in Labor Markets: The Debate Over Minimum Wage Policy Making the Connection Learning Objective 4.3

Chapter 4: Economic Efficiency,Government Price Setting, and Taxes 15 of 35 © 2009 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e. Government Intervention in the Market: Price Floors And Price Ceilings FIGURE 4-9 The Economic Effect of a Rent Ceiling Price Ceilings: Government Rent Control Policy in Housing Markets Dont Let This Happen to YOU! Dont Confuse Scarcity with a Shortage Learning Objective 4.3

Chapter 4: Economic Efficiency,Government Price Setting, and Taxes 16 of 35 © 2009 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e. Government Intervention in the Market: Price Floors And Price Ceilings Black Markets Black markets A market in which buying and selling take place at prices that violate government price regulations. Learning Objective 4.3

Chapter 4: Economic Efficiency,Government Price Setting, and Taxes 17 of 35 © 2009 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e. Solved Problem 4-3 Whats the Economic Effect of a Black Market for Apartments? Learning Objective 4.3

Chapter 4: Economic Efficiency,Government Price Setting, and Taxes 18 of 35 © 2009 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e. Government Intervention in the Market: Price Floors And Price Ceilings The Results of Government Price Controls: Winners, Losers, and Inefficiency When the government imposes price floors or price ceilings, three important results occur: Learning Objective 4.3 Some people win. Some people lose. There is a loss of economic efficiency.

Chapter 4: Economic Efficiency,Government Price Setting, and Taxes 19 of 35 © 2009 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e. Government Intervention in the Market: Price Floors And Price Ceilings Positive and Normative Analysis of Price Ceilings and Price Floors Whether rent controls or federal farm programs are desirable or undesirable is a normative question. Whether the gains to the winners more than make up for the losses to the losers and for the decline in economic efficiency is a matter of judgment and not strictly an economic question. Learning Objective 4.3

Chapter 4: Economic Efficiency,Government Price Setting, and Taxes 20 of 35 © 2009 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e. Learning Objective 4.4 Private cost The cost borne by the producer of a good or service. Social cost The total cost of producing a good, including both the private cost and any external cost. Private benefit The benefit received by the consumer of a good or service. Social benefit The total benefit from consuming a good or service, including both the private benefit and any external benefit. Externalities and Economic Efficiency The Effect of Externalities

Chapter 4: Economic Efficiency,Government Price Setting, and Taxes 21 of 35 © 2009 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e. Learning Objective 4.4 Externalities and Economic Efficiency The Effect of Externalities FIGURE 4-10 The Effect of Pollution on Economic Efficiency How a Negative Externality in Production Reduces Economic Efficiency

Chapter 4: Economic Efficiency,Government Price Setting, and Taxes 22 of 35 © 2009 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e. Learning Objective 4.4 Externalities and Economic Efficiency The Effect of Externalities How a Positive Externality in Consumption Reduces Economic Efficiency FIGURE 4-11 The Effect of a Positive Externality on Efficiency

Chapter 4: Economic Efficiency,Government Price Setting, and Taxes 23 of 35 © 2009 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e. Learning Objective 4.4 Externalities and Economic Efficiency Externalities May Result in Market Failure Market failure A situation in which the market fails to produce the efficient level of output. What Causes Externalities? Property rights The rights individuals or businesses have to the exclusive use of their property, including the right to buy or sell it.

Chapter 4: Economic Efficiency,Government Price Setting, and Taxes 24 of 35 © 2009 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e. Government Policies to Deal with Externalities Learning Objective 4.5 FIGURE 4.12 When There Is a Negative Externality, a Tax Can Bring about the Efficient Level of Output

Chapter 4: Economic Efficiency,Government Price Setting, and Taxes 25 of 35 © 2009 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e. Solved Problem 4-5 Using a Tax to Deal with a Negative Externality Learning Objective 4.5

Chapter 4: Economic Efficiency,Government Price Setting, and Taxes 26 of 35 © 2009 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e. Government Policies to Deal with Externalities Learning Objective 4.5 FIGURE 4-13 When There Is a Positive Externality, a Subsidy Can Bring about the Efficient Level of Output

Chapter 4: Economic Efficiency,Government Price Setting, and Taxes 27 of 35 © 2009 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e. Learning Objective 4.5 Pigovian taxes and subsidies Government taxes and subsidies intended to bring about an efficient level of output in the presence of externalities. Command and Control versus Tradable Emissions Allowances Command and control approach An approach that involves the government imposing quantitative limits on the amount of pollution firms are allowed to emit or requiring firms to install specific pollution control devices. Government Policies to Deal with Externalities