1. © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e. Fernando & Yvonn Quijano Prepared by: Chapter 4 Economic Efficiency, Government Price Setting, and Taxes

2. 2 of 29 © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e. Should the Government Control Apartment Rents? 4.1Understand the concepts of consumer surplus and producer surplus. 4.2Understand the concept of economic efficiency. 4.3Understand the economic effect of government imposed price ceilings and price floors. 4.4Analyze the economic impact of taxes. APPENDIX Use quantitative demand and supply analysis. Learning Objectives New York City has two million apartments, about one million of which are subject to rent control. The other one million apartments have their rents determined in the market by the demand and supply for apartments.

3. Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 3 of 33 © 2008 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. Economic Efficiency, Government Price Setting, and Taxes

4. Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 4 of 33 © 2008 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. Consumer Surplus and Producer Surplus Consumer Surplus Learning Objective 4.1

5. Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 5 of 33 © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e. Learning Objective 4.1 Consumer Surplus and Producer Surplus Consumer Surplus FIGURE 4-1 Deriving the Demand Curve for Chai Tea

6. Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 6 of 33 © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e. Consumer Surplus and Producer Surplus Consumer Surplus FIGURE 4-2 Measuring Consumer Surplus Learning Objective 4.1

7. Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 7 of 33 © 2008 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

8. Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 8 of 33 © 2008 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

9. Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 9 of 33 © 2008 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

10. Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 10 of 33 © 2008 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

11. Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 11 of 33 © 2008 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

12. Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 12 of 33 © 2008 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

13. Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 13 of 33 © 2008 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.

14. Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 14 of 33 © 2008 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

15. Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 15 of 33 © 2008 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

16. Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 16 of 33 © 2008 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

17. Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 17 of 33 © 2008 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

18. Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 18 of 33 © 2008 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

19. Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 19 of 33 © 2008 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

20. Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 20 of 33 © 2008 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

21. Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 21 of 33 © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e. Does Holiday Gift Giving Have a Deadweight Loss? Making the Connection Gift giving may lead to deadweight loss. Learning Objective 4.3

22. Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 22 of 33 © 2008 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.

23. Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 23 of 33 © 2008 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

24. Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 24 of 33 © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e. The Economic Impact of Taxes The Effect of Taxes on Economic Efficiency FIGURE 4-10 The Effect of a Tax on the Market for Cigarettes Learning Objective 4.4

25. Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 25 of 33 © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e. The Economic Impact of Taxes Tax Incidence: Who Actually Pays a Tax? Tax incidence The actual division of the burden of a tax between buyers and sellers in a market. Learning Objective 4.4

26. Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 26 of 33 © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e. The Economic Impact of Taxes Tax Incidence: Who Actually Pays a Tax? Determining Tax Incidence on a Demand and Supply Graph FIGURE 4-11 The Incidence of a Tax on Gasoline Learning Objective 4.4

27. Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 27 of 33 © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e. Solved Problem 4-4 When Do Consumers Pay All of a Sales Tax Increase? Learning Objective 4.4

28. Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 28 of 33 © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e. The Economic Impact of Taxes Tax Incidence: Who Actually Pays a Tax? Does It Matter Whether the Tax Is on Buyers or Sellers? FIGURE 4-12 The Incidence of a Tax on Gasoline Paid by Buyers Learning Objective 4.4

29. Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 29 of 33 © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e. Is the Burden of the Social Security Tax Really Shared Equally between Workers and Firms? Making the Connection Learning Objective 4.4

30. Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 30 of 33 © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e. An Inside LOOK Is Rent Control a Lifeline or Stranglehold? The Landlords: Two Sides of a Coin

31. Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 31 of 33 © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e. Black market Consumer surplus Deadweight loss Economic efficiency Economic surplus Marginal benefit Marginal cost Price ceiling Price floor Producer surplus Tax incidence K e y T e r m s

32. Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 32 of 33 © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e. Quantitative Demand and Supply Analysis Q D = 0 = 3,000,000 – 1,000P Q S = 0 = –450,000 + 1,300P Q D = Q S Demand and Supply Equations FIGURE 4A-1 Graphing Supply and Demand Equations Appendix and:

33. Chapter 4: Economic Efficiency, Government Price Setting, and Taxes 33 of 33 © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e. Quantitative Demand and Supply Analysis Calculating Consumer Surplus and Producer Surplus FIGURE 4A-2 Calculating the Economic Effect of Rent Controls Appendix CONSUMER SURPLUSPRODUCER SURPLUSDEADWEIGHT LOSS COMPETITIVE EQUILIBRIUM$1,125$865.50$0 RENT CONTROL$1,338.75$278$373.75