1. Chapter 5 Efficiency & Equity
Does the market achieve an efficient and fair use of resources?
Dr Ikhlaas Gurrib 1

2. P Q 6 D 5 Amount paid Consumer Surplus
Consumer surplus is the area below the demand curve and above the market price. P
Amount paid 6 D 5 Q

3. Total Benefits P
Total benefits = Consumer surplus + Amount paid 6 D 5 Q

4. How a change in Price affects consumer surplus
Supply
Initial
consumer
surplus C P1 B
Demand Q1 Q2
Quantity

5. How a change in Price affects consumer surplus
Supply S
Initial
consumer
surplus
Increase in consumer
surplus C P1 B P2 E D
Demand Q1 Q2
Quantity

6. Supply & Producer Surplus6
Cost of production = $20 5 Q

7. How a change in price affects producer surplus
Supply B P1 C
Initial
producer
surplus
Demand A Q1 Q2
Quantity

8. How a change in price affects producer surplus
Supply P2 B P1 C
Initial
producer
surplus D
Demand A Q1 Q2
Quantity

9. How a change in price affects producer surplus
Increase in producer
surplus
Supply D E P2 F B P1 C
Initial
producer
surplus D
Demand A Q1 Q2
Quantity

10. Economic well-being and total surplus=
Consumer Surplus
Producer Surplus + or
Total Surplus =
Total Benefits _
Total Costs

11. Total Surplus Price Supply Equilibrium price Demand Quantity
Equilibrium
quantity
Quantity

12. Total Surplus Consumer Surplus Producer Surplus Price Supply
Equilibrium
price
Producer Surplus
Demand
Equilibrium
quantity
Quantity

13. Sources of Inefficiency
Deadweight Loss
The decrease in total surplus that results from an inefficient allocation of resources 51

14. Under & Overproduction
Price
Deadweight
loss
Supply
underproduction
overproduction
Demand Qe
Quantity 8

15. Review
Gayle decides that she would pay as much as $3000 for a new laptop computer. She buys the computer and realises a consumer surplus of $700. How much did Gayle pay for her computer?
A. $700
B. $2300
C. $3000
D. $3700

16. Review
Michele is willing to pay $20 to see Legally Blonde for the fourth time. She finds a theatre showing Legally Blonde for $5. Michele’s consumer surplus is:
A. $5.
B. $15.
C. $20.
D. $25.

17. Review
The Health Ministry announces that eating chocolate improves your health. As a result, the equilibrium market price of chocolate __________, and producer surplus ___________. A. increases, increases B. increases, decreases C. decreases, decreases D. decreases, increases

18. Chapter 6 Markets in Action
The effects of
price restrictions
quantity restrictions
taxes 1

19. Price Controls These are price restrictions imposed on a market
Are usually enacted when policymakers believe the market price is unfair to buyers or sellers.
Result in government-created price ceilings and price floors. 3 3

20. Price Ceilings & Price Floors
A legally established maximum price at which a good can be sold.
Price Floor
A legally established minimum price at which a good can be sold. 4 4

21. Housing Markets and Rent Ceilings
Imagine that a tropical cyclone destroys much of the city’s homes
How would the housing market cope with such a devastating reduction in the supply of housing?

22. A Housing Market After a Cyclone
After the cyclone
SSA
900 SS
700
Should rents be capped at $500?
Rent (dollars per unit per month)
500 D
Quantity (thousands of units per month)

23. Housing Markets and Rent Ceilings
When a price ceiling is applied to a housing market, it is called a rent ceiling.
If the rent ceiling is set above the equilibrium rent, it has no effect.
But if the rent ceiling is set below the equilibrium rent, it has powerful effects.

24. A Rent Ceiling SSA Rent ceiling D Rent (dollars per unit per month)
900
700
Rent (dollars per unit per month)
500
Housing
shortage D
Quantity (thousands of units per month)

25. Housing Markets and Rent Ceilings
The time spent looking for someone with whom to do business is called search activity.
When a price is regulated and there is a shortage, search activity increases.
Search activity is costly. It uses time and other resources

26. A Rent Ceiling Maximum black market rent SSA Rent ceiling D
900
700
Rent (dollars per unit per month)
500
Housing
shortage D
Quantity (thousands of units per month)

27. A Rent Ceiling Deadweight loss SSA D Rent (dollars per unit per month)
900
Consumer
Surplus
700
Rent (dollars per unit per month)
Producer
Surplus
Rent
Ceiling
500 D
Quantity (thousands of units per month)

28. Minimum Wage and Unemployment6 SS
Unemployment
Wage Rate (dollars per hour) 5
Minimum
wage 4 3 DA
Quantity (millions of hours per year) 38

29. Other Price Floors
Price floors are common in agricultural markets e.g. minimum wool price
Price floors create surpluses because QS > QD.
Taxpayers fund the purchase of the surplus output
Price floors are also inefficient (they create a deadweight loss) and unfair
Dr Ikhlaas Gurrib 15 25

30. A Price Floor – Wool If government buys surplus Cost to taxpayers
Supply
Minimum
price
surplus
Price floor
Cost to taxpayers
Equilibrium
price
Demand Qd Qs
Quantity 8 23

31. Taxes
Governments levy taxes on goods and services to raise revenue for public purposes.
Taxes discourage market activity.
When a good is taxed, the quantity sold is smaller; the price is higher
A tax creates a wedge between buyer and seller 20 29

32. Taxes Tax incidence is the study of who bears the burden of a tax.
Taxes result in a change in the market equilibrium.
Buyers pay more and sellers receive less, regardless of whom the tax is levied on. 21 31

33. Taxes Taxes can be levied on buyers or sellers
A tax on sellers will decrease supply
A tax on buyers will decrease demand
Example: The govt wants to impose a new tax on chewing gum (Tax = $1.50)
Should the tax be imposed on buyers or sellers? 21 31

34. A Tax on Sellers
S + tax on sellers
5.00
4.00
3.00
1.00
Price paid
by buyers
$1.50 tax S
Price with
no tax
A tax on sellers shifts the S curve upward by the amount of the tax
Price (dollars per packet)
Price received
by sellers D
Quantity (millions of packets per year)

35. A Tax on Buyers A tax on buyers shifts the D curve downward
5.00
4.00
3.00
2.50
2.00
1.50
1.00
Price paid
by buyers S
D - tax on buyers
Price with
no tax
A tax on buyers
shifts the D
curve downward
by the size of
the tax
$1.50 tax
Price (dollars per packet)
Price received
by sellers D
Quantity (millions of packets per year)

36. The Incidence of Tax
In what proportions is the burden of the tax divided?
Who pays more of the tax – the buyer or the seller?
It depends on the elasticity of demand and supply
Dr Ikhlaas Gurrib 29 39

37. A Tax on Sellers – Inelastic D
S + tax on sellers
5.00
4.00
3.00
2.00
1.00 S B
The tax burden on the buyer is ___
The tax burden on the seller is ___
D is more ______ compared to S S
2.50
Price (dollars per packet) D
Quantity (millions of packets per year)

38. A Tax on Sellers – Elastic D
5.00
4.00
3.00
2.00
1.00
S + tax on sellers S
3.50
The tax burden on the buyer is ___
The tax burden on the seller is ___
D is more ______ compared to S B S
Price (dollars per packet) D
Quantity (millions of packets per year)

39. The Incidence of Tax
Who pays more of the tax – the buyer or the seller?
The incidence of a tax will fall more on the buyer when demand is more ____Inelastic____ compared to supply
The incidence of a tax will fall more on the seller when demand is more ____Elastic____ compared to supply 29 39

40. Tax Revenue & Elasticity
S + tax on sellers
5.00
4.00
3.00
2.00
1.00 S
Tax Revenue $
= size of T x Q
2.50
Price (dollars per packet) De Di
Quantity (millions of packets per year)

41. Taxes and Efficiency What about the efficiency of a tax?
How does a tax affect consumer & producer surplus?
Will total surplus increase or decrease?
Taxes increase the price paid by consumers, decrease the price received by sellers & decrease quantity sold

42. After a tax, consumers will pay more and consume less
Taxes and Efficiency
After a tax, consumers will pay more and consume less
Consumer surplus will decrease

43. A Tax on Sellers – Inelastic D
S + tax on sellers
5.00
4.00
3.00
2.00
1.00 S
Consumer surplus decreases
2.50
Price (dollars per packet) D
Quantity (millions of packets per year)

44. After a tax, producers will receive less and sell less
Taxes and Efficiency
After a tax, producers will receive less and sell less
Producer surplus will decrease

45. A Tax on Sellers – Inelastic D
S + tax on sellers
5.00
4.00
3.00
2.00
1.00 S
2.50
Price (dollars per packet)
Producer surplus decreases D
Quantity (millions of packets per year)

46. A Tax on Sellers – Inelastic D
S + tax on sellers
5.00
4.00
3.00
2.00
1.00 S
Deadweight loss
2.50
Price (dollars per packet)
Tax revenue D
Quantity (millions of packets per year)

47. Determinants of Deadweight Loss
The magnitude of the deadweight loss depends on the decline in market size as a result of the tax.
That, in turn, depends on the price elasticities of supply and demand.

48. Determinants of Deadweight Loss
The more elastic are demand and supply, the larger will be the decline in equilibrium quantity and the larger the deadweight loss.

49. In panel (a), the deadweight-loss triangle is large because demand is relatively elastic.
In panel (b), the deadweight-loss triangle is much smaller because demand is now relatively inelastic.

50. Assume tax revenue = $1 mill. while welfare loss = $ 0.1 mill
Should we have taxes?
Assume tax revenue = $1 mill. while welfare loss = $ 0.1 mill
The tax is beneficial if tax $ are spent to generate more than $1.1 million in benefits to the community
Does this always happen?

51. What goods should we tax? Objective should be to
Taxes
What goods should we tax?
Objective should be to
MAXIMISE TAX REVENUE and
MINIMISE the DEADWEIGHT LOSS
Therefore tax goods that are relatively INELASTIC

52. Review
Would a consumer prefer a tax to be placed on goods with elastic demand or inelastic demand?
Elastic D Why?
Consumer surplus would decrease most when a tax is placed on a good with INELASTIC demand

53. Review
A price ceiling set below equilibrium will cause greater shortages if a. both supply and demand are inelastic. b. both supply and demand are elastic. c. supply is elastic, but demand is inelastic. d. supply is inelastic, but demand is elastic.

54. A price floor set below the equilibrium price causes a. shortages.
Review
A price floor set below the equilibrium price causes
a. shortages.
b. surpluses.
c. excess supply.
d. none of the above.

55. Review
If the tax on cigarettes is increased by $1.00 per packet we should expect
a. the consumer to pay more of the tax the more elastic the demand for cigarettes.
b. the equilibrium price to be $1.00 higher if demand is perfectly elastic.
c. government revenue from the tax to increase if cigarette demand is relatively inelastic.
d. the suppliers to pay all of the tax if demand is completely inelastic.

56. Review
Assume that a tax is levied on a good and the government uses the funds to build statues of Kevin Rudd. In this case there would be:
A. a decrease in consumer surplus to consumers of the taxed good.
B. a decrease in producer surplus to producers of the taxed good.
C. a probable decrease in the welfare of society that exceeded the deadweight economic loss from the tax.
D. All of the above would occur.