CHAPTEREconomic Efficiency, Government4Price Setting, and TaxesChapterOutlineandLearningObjectives4.1ConsumerSurplusandProducer Surplus4.2The EfficiencyofCompetitive Markets4.3GovernmentIntervention inthe Market:Price FloorsandPrice Ceilings4.4TheEconomicImpactofTaxesAppendix:QuantitativeDemandand SupplyAnalysis
1 Chapter Outline and Learning Objectives 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 Impact of Taxes Appendix: Quantitative Demand and Supply Analysis CHAPTER 4 CHAPTER Economic Efficiency, Government Price Setting, and Taxes
Should the Government Control Apartment Rents?Rent control puts a legal limit on the rent that landlords can charge foran apartment.Sincerent-controlled rents are usuallyfar below market rents,itseems clear that this doesn't make landlords better off.Does it make tenants better off?Would you prefer tolookfor an apartment ina citywithorwithoutrentcontrol?@2015PearsonEducation,Inc
© 2015 Pearson Education, Inc. 2 Should the Government Control Apartment Rents? Rent control puts a legal limit on the rent that landlords can charge for an apartment. Since rent-controlled rents are usually far below market rents, it seems clear that this doesn’t make landlords better off. Does it make tenants better off? Would you prefer to look for an apartment in a city with or without rent control?
ConsumerSurplusandProducerSurplus4.1LEARNINGOBJECTIVEDistinguishbetweentheconceptsofconsumersurplusandproducersurplus@2015PearsonEducation,lnc3
LEARNING OBJECTIVE © 2015 Pearson Education, Inc. 3 Consumer Surplus and Producer Surplus 4.1 Distinguish between the concepts of consumer surplus and producer surplus
Consumerand Producer SurplusSurplus (noun):Something that remainsabovewhatisusedorneededEconomists use the idea of"surplus"to refer to the benefit that peoplederive from engaging in market transactionsConsumer surplus is the difference between the highest price aconsumer is willing to pay for a good or service and the actual pricethe consumerreceives.Producer surplus is thedifference between thelowest price afirm would be willing to accept for a good or service and theprice it actually receives.@2015PearsonEducation,Inc
© 2015 Pearson Education, Inc. 4 Consumer and Producer Surplus Surplus (noun): Something that remains above what is used or needed Economists use the idea of “surplus” to refer to the benefit that people derive from engaging in market transactions. Consumer surplus is the difference between the highest price a consumer is willing to pay for a good or service and the actual price the consumer receives. Producer surplus is the difference between the lowest price a firm would be willing to accept for a good or service and the price it actually receives
Deriving the Demand Curve for Chai TeaSuppose four peopleHighestPriceConsumerareeachinterestedinWillingto PayS6Theresabuying a cup of chaiPrice(dollars5Tomtea.percup)Theresa4Terri3Tim$6TomWecancharacterize5Territhem by the highest4pricetheyare willingtoTimpay.3MarketdemandcurveforchaiteaAt pricesabove $6,nochai tea will be sold.01234Quantity(cupsperday)Figure 4.1Deriving the demandAt $6, one cup will becurvefor chaiteasold, etc.@2015PearsonEducation,Inc?
© 2015 Pearson Education, Inc. 5 Deriving the Demand Curve for Chai Tea Suppose four people are each interested in buying a cup of chai tea. We can characterize them by the highest price they are willing to pay. At prices above $6, no chai tea will be sold. At $6, one cup will be sold, etc. Deriving the demand curve for chai tea Figure 4.1
HowMuch Benefit Will Chai TeaDrinkers Receive?How much benefit do theHighestPriceConsumerpotential tea consumersWillingto PayS6Theresaderive from this market?Price(dollars5Tompercup)Theresa4TerriThat depends on the3$6TimTompriceand theirmarginal5benefit, the additionalTerribenefit to a consumer4Timfrom consuming one3more unit of a good orservice.MarketdemandcurveforchaiteaIf the price is low, many of01234Quantitythe consumers benefit.(cupsperday)Figure 4.1Deriving the demandIf the price is high, few (ifcurve for chai teaany)oftheconsumersbenefit.62015PearsonEducation,Inc
© 2015 Pearson Education, Inc. 6 How Much Benefit Will Chai Tea Drinkers Receive? How much benefit do the potential tea consumers derive from this market? That depends on the price and their marginal benefit, the additional benefit to a consumer from consuming one more unit of a good or service. If the price is low, many of the consumers benefit. If the price is high, few (if any) of the consumers benefit. Deriving the demand curve for chai tea Figure 4.1
Consumer Surplusat a Priceof s3.50If the price of tea is $3.50 percup, Theresa, Tom, and TerriPrice(dollarsTheresa'spercup)consumersurpluswill buy a cup.$65Theresa was willing to payMarketprice$6.00; a cup of chai tea is"worth" $6.00 to her. She gotMarketdemandcurve for chaiteait for $3.50, so she derives anet benefit of023Quantity(cupsperday)$6.00 - $3.50 = $2.50(a)Consumersurpluswithamarketpriceofs3.50Area A represents this netbenefit, and is known asTheresa's consumer surplusFigure 4.2aMeasuring consumersurplusin the chai tea market.2015PearsonEducation,lnc
© 2015 Pearson Education, Inc. 7 Consumer Surplus at a Price of $3.50 If the price of tea is $3.50 per cup, Theresa, Tom, and Terri will buy a cup. Theresa was willing to pay $6.00; a cup of chai tea is “worth” $6.00 to her. She got it for $3.50, so she derives a net benefit of $6.00 – $3.50 = $2.50. Area A represents this net benefit, and is known as Theresa’s consumer surplus in the chai tea market. Measuring consumer surplus Figure 4.2a
Consumer Surplus at a Priceof s3.50-continuedTom and Terri also obtainconsumersurplus,equaltoPrice(dollarsTheresa'spercup)$1.50 (area B) and $0.50consumersurplusTom's$6(area C).consumersurplusTerri's5consumersurplusABMarketprice4CThe sum of the areas ofrectangles A, B, and C isMarketdemandcurve for chai teacalledtheconsumersurplusinthe chai tea market.O23Quantity(cups per day)(a)Consumersurpluswithamarketpriceofs3.50Thisareacanbe describedastheareabelowthedemandcurve, above the price thatFigure 4.2aconsumerspay.Measuring consumersurplus@2015PearsonEducation,Inc8
© 2015 Pearson Education, Inc. 8 Consumer Surplus at a Price of $3.50—continued Tom and Terri also obtain consumer surplus, equal to $1.50 (area B) and $0.50 (area C). The sum of the areas of rectangles A, B, and C is called the consumer surplus in the chai tea market. This area can be described as the area below the demand curve, above the price that consumers pay. Measuring consumer surplus Figure 4.2a
ConsumerSurplus IfPrice Fallsto 3.00If the price falls to $3.00.Theresa, Tom, and Terri eachPrice(dollarsTheresa'spercup)gain an additional $0.50 ofconsumersurplusTom'sS6consumersurplusconsumersurplus.Terri's5consumer surplusBTim's consumerCTim is indifferent betweensurplus (zero)Marketpricebuying the cup or not; his well-Marketdemandbeing is the same either way.curve for chaitea23Quantity(cups per day)(b) Consumer surplus with a market price of $3.00The overall consumer surplusremainstheareabelowthedemand curve, above the(new) price.Figure 4.2bMeasuring consumersurplus@2015PearsonEducation,Inc.9
© 2015 Pearson Education, Inc. 9 Consumer Surplus If Price Falls to $3.00 If the price falls to $3.00, Theresa, Tom, and Terri each gain an additional $0.50 of consumer surplus. Tim is indifferent between buying the cup or not; his wellbeing is the same either way. The overall consumer surplus remains the area below the demand curve, above the (new) price. Measuring consumer surplus Figure 4.2b
Total Consumer Surplus in the Market for Chai TeaThe market for chai tea islargerthan justourfourPrice(dollarsconsumers.per cup)Total consumer surplus inthemarketforchaiteaWithmany consumers,themarketdemandcurvelooks"normal": a straight line.$2.00Consumersurplus inthisDemandmarket is defined in just the015,000Quantity(cupspersame way: the area below theday)demandcurve,above price.Thegraphshowsconsumersurplus if price is $2.00Figure 4.3Total consumersurplus inthe marketforchaitea10@2015PearsonEducation,Inc
© 2015 Pearson Education, Inc. 10 Total Consumer Surplus in the Market for Chai Tea The market for chai tea is larger than just our four consumers. With many consumers, the market demand curve looks “normal”: a straight line. Consumer surplus in this market is defined in just the same way: the area below the demand curve, above price. The graph shows consumer surplus if price is $2.00. Total consumer surplus in the market for chai tea Figure 4.3