1. Economic Efficiency and the Competitive Ideal
Chapter 14
Economic Efficiency and
the Competitive Ideal
ECONOMICS: Principles and Applications, 4e
HALL & LIEBERMAN, © 2008 Thomson South-Western

2. Economic Efficiency Is achieved when Pareto improvement
Cannot rearrange the production or allocation of goods
to make one person better off
without making anybody else worse off
Pareto improvement
At least one person is better off, and no one is harmed

3. Economic Efficiency Economic efficiency Side payment
achieved when every possible Pareto improvement is exploited.
Side payment
action will benefit one group and harm another

4. Economic Efficiency Greater total gains than total losses Side payment
Transferred from the gainers to the losers
Pareto improvement

5. Competitive Markets and Economic Efficiency
Demand curve
The maximum price someone would be willing to pay for each unit
Value of the last unit of the good consumed
Supply curve
The minimum price a seller must get in order to supply that unit
Additional cost of each unit of the good supplied

6. Reinterpreting the Demand Curve
Figure 1 The Value of Another Guitar Lesson
While the first lesson is worth $25 to some consumer (Flo) . . .
Price
Number of Lessons per Week
$25
Flo
Joe
$23
the second lesson is worth only $
$21
Flo (again)
$19 Bo
Zoe
and the third is worth $21.
$17
Demand 1 2 3 4 5

7. Reinterpreting the Supply Curve
Figure 2 The Cost of Another Guitar Lesson
Price
Number of Lessons per Week
Supply
The smallest cost for this first lesson is $
$21
McCollum
$19
Martin (again)
$17
Gibson
but it's $15 for the second . . .
$15
Martin (again)
$13
Martin
and $17 for the third. 1 2 3 4 5

8. The Efficient Quantity of a Good
Whenever the demand curve is higher than the supply curve
the value of one more unit to some consumer is greater than its additional cost to some producer
Efficient quantity of a good
Market demand curve and market supply curve intersect
Automatically achieved in perfect competition at equilibrium

9. The Efficient Quantity of a Good
Figure 3 Efficiency In The Market For Guitar Lessons
1. Joe would pay as much as $23 for the second lesson . . .
Price
Number of Lessons per Week
$25
Flo
Supply
Joe
$23
Flo
$21
McCollum Bo
$19
Martin
$17
Zoe
Gibson
3. Four lessons is the equilibrium and the efficient quantity.
$15
Martin
$13
Martin
Demand
2. while Martin would offer it for as little as $15. 1 2 3 4 5

10. Measuring Market Gains
Consumer surplus - difference between
Value of a unit of a good to the buyer
And what the buyer actually pays for it
Market consumer surplus
Total consumer surplus enjoyed by all consumers in a market.
Total area under the demand curve, above the market price

11. Consumer surplus
Figure 4a Consumer Surplus in a Small Market for Guitar Lessons
Price
Number of Lessons per Week
1. When market price is $19, someone (Flo) gets $6 in consumer surplus on the first lesson . . .
2. someone (Joe) gets $4 in consumer surplus on the second . . .
$25
$23
3. and someone (Flo again) gets $2 in consumer surplus on the third.
$21
$19
$17
Demand
Assumed Market Price
The total shaded area is market consumer surplus. 1 2 3 4 5

12. Consumer surplus
Figure 4b Consumer Surplus in a Large Market for Guitar Lessons
Price
Number of Lessons per Week
In a market with many buyers, market consumer surplus is the entire area under the demand curve and above the market price.
$19
Market
Price
Demand
4,000

13. Measuring Market Gains
Producer surplus - difference between
Price the seller gets
And the additional cost of providing it
Market producer surplus
Total producer surplus enjoyed by all sellers in a market.
Total area above the supply curve, below the market price

14. Producer surplus
Figure 5a Producer Surplus from Selling Guitar Lessons
Price
Number of Lessons per Week
1.When market price is $19, someone (Martin) gets $6 in producer surplus on the first lesson . . .
Supply
$21
2. someone (Martin again) gets $4 in producer surplus on the second . . .
$19
$17
$15
$13
3. and someone (Gibson) gets $2 on the third.
Assumed Market Price
The total shaded area is market producer surplus. 1 2 3 4 5

15. Producer surplus
Figure 5b Producer Surplus from Selling Guitar Lessons
Price
Number of Lessons per Week
Supply
Market Price
$19
In a market with many sellers, market producer surplus is the entire area above the market supply curve and below the market price.
4,000

16. Total Benefits and Efficiency
Sum of consumer surplus and producer surplus
Efficient market
Total benefits are maximized
Equilibrium quantity
Maximizes total benefits

17. Total Benefits and Efficiency
Figure 6 Total Benefits in a Competitive Market for Guitar Lessons
Price S
Equilibrium Price
$19 D
Number of Lessons per Week
4,000
Equilibrium Quantity

18. Inefficiency and Deadweight Loss
Price ceiling
May benefit consumers as a group
Reduces total net benefits in the market
Price floor
May benefit producers as a group
Deadweight loss
The loss of potential benefits due to a deviation from the efficient outcome

19. Price Ceiling Figure 7 The Inefficiency of a Price Ceiling
1. A price ceiling of $
2. transfers surplus from producers to consumers.
Price
deadweight
loss S
$23 C
3. It also decreases market quantity, taking away some consumer surplus
$19 B
$15 D A
and some producer surplus, neither of which are transferred to anyone.
Number of Lessons
per Week
2,000
4,000
6,000

20. Price Floor Figure 8 The Inefficiency of a Price Floor
1. A price floor of $
2. transfers surplus from consumers to producers.
Price
deadweight
loss S H
$21
3. It also decreases market quantity, taking away some consumer surplus G
$19
$17 F D
and some producer surplus, neither of which are transferred to anyone.
3,000
4,000
5,000

21. Monopoly and Market Power
Monopoly and imperfectly competitive markets
Firms charge a single price on all units
P>MC
Price is too high
Output is too low
Inefficient

22. Monopoly and Market Power
Figure 9 The Deadweight Loss from Monopoly
Dollars
Perfectly Competitive
Market
Dollars
Monopoly Market $8 D $8 D MR
consumer
surplus 5 F S
consumer
surplus
300,000
deadweight
loss S
producer
surplus 3 E
500,000 E
500,000
producer
surplus

23. Taxes and Deadweight Losses
Imposing a tax on an efficient market
Creates a deadweight loss
The loss in benefits to buyers and sellers is greater than the gain in revenue to the government
Taxes create smaller deadweight loss
when they are imposed on markets in which demand or supply is relatively inelastic

24. Deadweight Loss From an Excise Tax
Figure 10 The Deadweight Loss from an Excise Tax
Price
per
Ticket
Millions of Tickets per Year
Consumer Surplus D
SAfter Tax
Deadweight Loss
$340 B S1
7.5
Government Tax Revenue
300 A 10
280
Producer Surplus

25. A Tax on Land Figure 11 A Tax on Land Monthly Rent per Acre
Number of Acres
3,000,000 S D
Dafter Tax
Government Revenue
$800 A
600 B