Chapter 10: Economic Efficiency

Transcription

1 Chapter 10: Economic Technological Allocative Scale Economic Measurement Consumer Surplus Producer Surplus Total Surplus Perfect Competition Government Intervention Ceiling Price Support Price Subsidy and Taxes Trade Restrictions Spillover Loss Allocation Problem Acreage Controls Target Pricing Outline and Conceptual Inquiries Economic- Criteria Favorable Features of Perfect Competition Are you a capitalist? Unfavorable Features of Perfect Competition Are you a socialist? Measuring Economic

2 Consumers Live for Consumer Surplus Are you willing to pay more for the pizza than it cost? Application: The Minimum Legal Drinking Age and Public Health Producers Produce for Producer Surplus Total Surplus and Economic Are free markets free of inefficiency? Government Intervention and Deadweight Loss Problems with Ceiling Prices Is allowing the poor to have affordable housing desirable? Do you enjoy waiting in lines? Application: Long-Run Relation between the Black and Legal Foreign Exchange Markets Problems with Support Prices Is having an abundance of food desirable? Price Subsidies Tax Who pays taxes? Application: Cigarette Taxation Trade Restrictions Why the big fuss over free trade, anyway? Application: African Famine, Made in Europe Spillover Loss Do two wrongs make things worse? Summary 1. A firm is economic efficient when it is technologically, allocatively, and scale-efficient. Technological efficiency is when a firm is using the current technology in its production process. Allocative efficiency is when a firm employing the least-cost combination of inputs for a given level of output. Scale efficiency occurs where output price is equal to the marginal cost of production. 2. A perfectly competitive market meets all three of the criteria for economic efficiency. This results in consumer preferences being reflected in the market, with no governmental agency required to determine the equilibrium level of demand and supply. 3. Unfavorable features of perfect competition are the consequence of missing markets. This results in the perfectly competitive market not efficiently supplying public goods and not accounting for externalities. 4. A measure of market economic efficiency is the total surplus, composed of consumer plus producer surplus. Consumer surplus is the net benefit a consumer receives from a commodity, and producer surplus is pure profit plus total fixed cost. A perfectly competitive market maximizes this total surplus. There is no deadweight loss.

3 5. A government-imposed market ceiling price is inefficient in that it creates deadweight loss, requires some type of a commodity allocation system, and results in the creation of a black market. 6. A government imposed support price is inefficient in that it results in deadweight loss and production surpluses. In agriculture, acreage controls have and are currently being used to reduce production surpluses. 7. Government subsidies result in market inefficiencies in the form of deadweight loss. The adjustment process when these subsidies are removed can be severe on an economy. 8. A commodity tax can be in the form of an output or sales tax. The amount of a commodity tax borne by consumers versus firms depends on the elasticities of demand and supply. In the extreme, a perfectly elastic supply curve will result in all of the tax passed onto consumers. 9. Trade restrictions in the form of quotas and tariffs will result in market inefficiencies. Deadweight loss from these restrictions exists in the form of reducing consumer surplus. 10. A price distortion in one market may have spillover efficiency losses in another related market if this other market is also affected by some price distortion. Key Concepts black market ceiling price commodity tax consumer sovereignty consumer surplus (CS) deadweight loss excess burden firm economic efficiency producer surplus quota scale efficiency subsidy support price tariff Key Equations CS(Q) = U(Q) pq Consumer surplus measures the difference between the total benefits from the consumption of a commodity and the expenditure on the commodity. PS(Q) = π + TFC Producer surplus is pure profit plus total fixed cost.

4 TEST YOURSELF Multiple Choice 1. Which of the following is not a criterion for firm economic efficiency? a. Allocative efficiency b. Scale efficiency c. Cost efficiency d. Technological efficiency. 2. Scale efficiency occurs where a. p = SAVC b. p = SMC c. p = SATC d. p = MR. 3. You are willing to pay $50 for a new pair of jeans. When you arrive at the store, you find that the price of jeans is on sale for $42. Your consumer surplus is equal to a. $42 b. $92 c. $8 d. $4. 4. Suppose the market demand for hotdogs is Q D = 6 p. If the price is $2, consumer surplus is then equal to a. $8 b. $16 c. $18 d. $ If the supply of bananas increases, consumer surplus will a. Rise b. Fall c. Remain unchanged d. Rise, fall or remain unchanged depending on the elasticities of supply and demand. 6. A perfectly competitive firm sells 10 units of output at a price of $15. Total fixed cost for the firm is $35 and total variable cost is $80. The firm s producer surplus is equal to a. $35 b. $115 c. $70 d. $45.

5 7. If the demand for hotdogs falls, producer surplus will a. Rise b. Fall c. Remain unchanged d. Rise, fall, or remain unchanged, depending on the elasticities of supply and demand. 8. At the market equilibrium price, a. Marginal consumer surplus is positive and marginal producer surplus is negative b. Marginal consumer surplus is zero and marginal producer surplus is positive c. Marginal consumer surplus is negative and marginal producer surplus is zero d. Marginal consumer surplus is zero and marginal producer surplus is zero. 9. Consider the following graph: p 6 A 5 4 B D G C E G H F Q S Q D Q Total surplus is equal to a. $15 b. $12 c. $24 d. $ Consider the graph in Problem 9. Assume that the market is initially in equilibrium and the government places a price ceiling in the market at p C = 2.5. Which of the following will not occur? a. Producer surplus will fall by areas D and E b. There will be a shortage equal to 7.5. c. There will be a deadweight loss equal to C + E d. Consumer surplus will increase by areas D, E, H and F. 11. Consider the graph in Problem 9. Which of the following statements is true? a. A price ceiling of 2.5 and a support price of 5 will have equal deadweight losses b. A support price of 5 will lead to a surplus c. Total surplus at the market equilibrium is equal to A + B + C + D + E + F + G + H d. A support price of 5 will cause consumer surplus to equal areas A and B.

6 12. Suppose a firm s short-run marginal cost curve can be represented by SMC = 5 + 3Q. If the price of the product is $11, then producer surplus will be equal to a. $6 b. $8 c. $12 d. $ Suppose the market equilibrium price of a veggie burger is $8. If the government places a price ceiling of $10 on each burger sold a. Consumer surplus will rise b. Market quantity of burgers is unchanged c. A shortage of burger results d. A surplus of burgers results. 14. If supply is relatively elastic and demand is relatively inelastic, a sales tax on a commodity will cause a. Consumers to bear a larger proportion of the tax b. Sellers to bear a larger proportion of the tax c. Consumers and sellers to share the tax burden equally d. Whoever pays the tax to bear the tax burden. 15. If demand is perfectly inelastic, an output tax on a commodity will a. Increase consumer surplus b. Be shifted entirely to the sellers c. Not create a deadweight loss d. Be efficient. 16. Until recently, Isoland has maintained a policy of a closed economy, with no international trade. Suppose in the market for biofuel, the domestic equilibrium price is $2 per liter, while the world price is $1. If Isoland allows trade in the market for biofuel, a. It will export biofuel b. Domestic consumer surplus will fall c. Domestic producer surplus will rise d. Total surplus will rise. 17. A tax on imported goods is a(n) a. Output tax b. Tariff c. Quota d. Input tax.

7 18. Consider the following graph: p Q S Q D Q Suppose the world price of a commodity is $6. If a $4 tariff is placed on the commodity, the deadweight loss from the tariff will be equal to a. $6 b. $8 c. $14 d. $ Consider the graph in Problem 18. Which of the following statements is not true? a. The $4 tariff will generate $12 in government revenue b. The $4 tariff will result in imports falling to 3 c. The $4 tariff will increase domestic production by 6 d. Without a tariff, imports are equal to Consider the graph in Problem 18. Suppose the government decides to use an import quota equal to 3 instead of the $4 tariff. This will a. Cause a smaller decline in domestic consumer surplus b. Create a larger deadweight loss c. Cause a decline in domestic producer surplus d. Result in the price remaining at $6.

8 Short Answer 1. List the criteria associated with firm economic efficiency. Explain how a perfectly competitive market meets these criteria. 2. What is consumer sovereignty? Suppose it is determined that eating an apple a day will help individuals to live longer. Explain how consumer sovereignty will result in an increase in the amount of apple production. 3. Describe the unfavorable features associated with perfect competition and possible solutions? 4. Provide an example that describes the meaning of consumer surplus. 5. Graphically explain why marginal consumer surplus is equal to zero for the last unit consumed. 6. Graphically explain why a price ceiling leads to a deadweight loss. 7. Suppose the government places a binding price ceiling on gasoline. What will occur? How will the market allocate gasoline? 8. Graphically illustrate the market for bottled water. Suppose the government places a binding price ceiling on bottled water. Illustrate the black-market demand and supply that may result. What will be the black-market price? How much will be traded? What happens to consumer and producer surplus as a result of the black market? 9. Graphically illustrate the domestic market for cotton. Assume that the equilibrium price is $5 per bushel. If the world price is greater than $5 per bushel, will this country wish to export or import cotton? Show the resulting effects of trade on consumer surplus, producer surplus, and total surplus. 10. What is the difference between a tariff and a quota? Suppose you are asked to advise a government considering the use of one of these policies to reduce imports. If you must choose one, which will you suggest if you are concerned about the possible loss in domestic surplus? 11. The government of Justus has imposed trade restrictions on imported beef to protect domestic ranchers. To protect consumers, the government has placed a price ceiling on domestic beef. Graphically explain how these policies create a spillover efficiency loss.

9 Problems 1. Consider the market demand curve Q D = 120 6p. Calculate consumer surplus when p = 10 and Suppose a producer has SMC = 2 + Q. Calculate producer surplus when p = 10 and Suppose the market demand and supply for apples can be represented by Q D = 35 5p and Q S = p. a. Solve for the market equilibrium price and quantity. b. Solve for consumer, producer, and total surplus. 4. Refer to Problem 3. Suppose the government places a price ceiling of $2.5 per bushel. Calculate the change in consumer and producer surplus along with the deadweight loss. 5. Refer to Problems 3 and 4. The government is now concerned about the incomes of apple farmers and has eliminated the price ceiling on apples. In its place, the government has created a support price of $3.50 per bushel. From the initial equilibrium, calculate the change in consumer and producer surplus, the quantity of apples produced and purchased, the price paid by consumers, the cost of the program, and the deadweight loss. 6. Refer to Problem 3. The government is concerned about the amount of apple consumption and has decided to place a output tax of $1 per bushel. a. Calculate the price paid by buyers, the price received by sellers, and the amount of apples sold after the tax is put into place. b. From the initial equilibrium, calculate the change in consumer and producer surplus, along with the tax revenue collected. c. From the initial equilibrium, calculate the deadweight loss from the tax. 7. Suppose the domestic demand and supply functions for blouses are Q D = 50 2p and Q S = 10 + p. a. Determine the domestic equilibrium price and quantity. What is the value of total surplus? b. Suppose the world price for blouses is $15. How many blouses will be purchased by domestic consumers and how many blouses will be provided by domestic producers and imported? c. Calculate consumer and producer surplus after the introduction of trade. What happens to total surplus? 8. Refer to Problem 7. Suppose the government imposes a tariff of $1 per blouse imported. a. How many blouses will be purchased by domestic consumers? How many blouses will be produced domestically and imported? b. Determine consumer and producer surplus, along with the deadweight loss. c. Instead of using a tariff, suppose the government uses a quota equal to the amount imported under the $1 tariff. Does your answer to b change? Explain.