PPT - Market Efficiency

Explain the concepts of consumer surplus, producer surplus, total surplus and deadweight loss

• Efficiency is the production of goods that society wants at the lowest possible price.

The consumer surplus ($CS$)

• Consumer Surplus is the difference between what a consumer is prepared to pay and what they actually pay in the market #testanswer
• Marginal Benefit is the extra benefit from consuming one extra unit of the good or service
• The demand curve is what the consumer is actually willing and able to pay
• However, they could actually pay something lower; the difference would be the consumer surplus
  

The producer surplus ($PS$)

• This is related to the amount the producer is willing to receive.
  • Formally, the difference between what a producer is willing to receive and what they actually receive in a market #testanswer
  • Marginal cost is the extra opportunity cost of producing one more unit of a good or service
• The same concept as consumer surplus; the difference is producer surplus
  
• Combining both diagrams, total surplus is the measure of the net benefits to society from the production and consumption of the good #testanswer
  • This is equal to the $PS+CS$
  • Allocative efficiency is achieved

Discuss how over and underproduction in a market can create deadweight loss ($DWL$)

• Deadweight loss is a loss in total surplus that is avoidable #testanswer
  • The situations we have to deal with are where price is above and below the equilibrium
  • A diagram for above; it is important to note that $PS$ is not a triangle, but instead the area above the supply curve below P1
  • And another, for below
• Also, when quantity is above and below the equilibrium. Dunno if the second one is correct yet.

Demonstrate and explain the effects of a tax and subsidy on a market

Tax

• Why do governments tax if it introduces inefficiency?
  • Can aid in the redistribution of income
  • To correct externalities
  • To earn revenue
• Impact of tax
  • Reduces quantity while increasing price
  • Tax incidence depends on the elasticity of the good/service
  • Creates a DWL
    To explain either,

1. Original P/Qty
2. Implement government policy
3. New price/quantity
4. Tax Revenue
5. CS/PS/TS/DWL
6. Conclusion on efficiency

• Direct tax
  • e.g. income tax
• Indirect tax
  • Consumers do not pay the tax directly, but are affected through changes in the price of the good or service
    • Specific tax: the tax is a fixed amount or is a set sum of money per unit
    • Ad Valorem tax: Where the tax is a percentage of the value of the good or service, e.g. GST

Subsidies

• A payment by the government to a firm to reduce production costs and increase output #testanswer
• The aim is to encourage production of goods with positive externalities
  • Allow the producer to export more
  • Aid expansion of the firm
• Impact of subsidies
  • DWL as part of government expenditure on the subsidy is not translated into either consumer of producer surplus

• **Case Study: CORN

Demonstrate and explain the effects of a price ceiling and price floor on a market

Price Ceilings

• Price Ceilings are the highest price that a producer can charge on a good
• Is usually below the equilibrium price
• Intended to keep prices affordable for majority of the population
• Need for rationing process to regulate demand, but this could lead to a black market

Price Floors

• Minimum Price that a producer can charge on a good
• Is usually above the equilibrium price
• Designed to ensure that there is a minimum income received by producers
• However, this could result in informal illegal markets where workers are paid less than the minimum wage.

To explain either,

1. Original Pe and Qe
2. Implement price ceiling or floor
3. New price and Quantity
4. Compare Qs and Qd $\rightarrow$ shortage/surplus
5. CS/PS/TS/DWL
   • Talk about changes in CS/PS/TS, then talk about loss in efficiency i.e DWL.