ECONOMICS: Principles and Applications 3eHALL & LIEBERMAN© 2005 Thomson Business and Professional Publishing

Economic Efficiencyand the Role of Government

Figure 1 The Marginal Benefit from Guitar Lessons

1 2 3 4 5

$25$23$21$19$17

Demand

Flo

Flo (again)Joe

BoZoe

Price

Number of Lessons per Week

While the first lesson is worth $25 to some consumer (Flo) . . .

and the third is worth $21.

the second lesson is worth only $23 . . .

Figure 2 The Marginal Cost of Guitar Lessons

The smallest cost for this first lesson is $13 . . .

and $17 for the third.

but it's $15 for the second . . .

1 2 3 4 5

$21$19$17$15$13

McCollum

Supply

Martin (again)Gibson

Martin (again)Martin

Price

Number of Lessons per Week

Figure 3 Efficiency in the Market for Guitar Lessons

$25$23$21$19$17$15$13 Demand

1. Joe would pay as much as $23 for the second lesson . . .

Flo

FloJoe

McCollumMartin

Zoe

Supply

2. while Martin would offer it for as little as $15.

1 5

Martin

GibsonMartin

3. Four lessons is the equilibrium and the efficient quantity.

Price

Number of Lessons per Week2 3 4

Bo

Figure 4 Consumer Surplus in a Small and a Large Market for Guitar Lessons

1 2 3 4 5

$25$23$21$19$17

Demand

The total shaded area is market consumer surplus.

(a)

Price

Number of Lessons per Week

1. When market price is $19, someone (Flo) gets $6 in consumer surplus on the first lesson . . .

3. and someone (Flo again) gets $2 in consumer surplus on the third.

2. someone (Joe) gets $4 in consumer surplus on the second . . .

Assumed Market Price

Figure 4 Consumer Surplus in a Small and a Large Market for Guitar Lessons

4,000

$19Market Price

(b)

Price

Number of Lessons per Week

In a market with many buyers, market consumer surplus is the entire area under the demand curve and above the market price.

Demand

Figure 5 Producer Surplus from Selling Guitar Lessons

1 2 3 4

$21$19$17$15$13

Supply

(a)

Price

Number of Lessons per Week

The total shaded area is market producer surplus.

3. and someone (Gibson) gets $2 on the third.

1.When market price is $19, someone (Martin) gets $6 in producer surplus on the first lesson . . .

2. someone (Martin again) gets $4 in producer surplus on the second . . .

Assumed Market Price

5

Figure 5 Producer Surplus from Selling Guitar Lessons

4,000

$19

In a market with many sellers, market producer surplus is the entire area above the market supply curve and below the market price.

Price(b)

Number of Lessons per Week

Supply

Market Price

Figure 6 Total Net Benefits in a Competitive Market for Guitar Lessons

$19

4,000

S

D

Equilibrium Price

Price

Equilibrium Quantity

Figure 7 Why Price Ceilings and Price Floors Are Inefficient

$19

4,000

S

$15

6,0002,000

D

Price

1. A price ceiling of $15 . . .

3. It also decreases market quantity, taking away some consumer surplus

A

B D

EC

2. transfers surplus from producers to consumers.

4 . . . . and some producer surplus, which are not transferred to anyone.

$23

(a)

Figure 7 Why Price Ceilings and Price Floors Are Inefficient

3. It also decreases market quantity, taking away some consumer surplus

$19

4,000

S

$21

3,000

D

Price

1. A price floor of $21 . . .

A

BDE

C

2. transfers surplus from consumers to producers.

$17

5,000

4 . . . . and some producer surplus, which are not transferred to anyone.

Figure 8 Government Infrastructure and Output per Worker

LowQuality of Infrastructure

Medium High

Ave

rage

Out

put p

er W

orke

r

2,000

6,000

10,000

14,000

$18,000

Figure 9 The Welfare Loss from Monopoly1. A monopoly charges a higher price

than a competitive market . . .3. The result is a welfare loss . . .

4. from not producing the efficient quantity, at point E.

Number of Lessons per Week

Dollars

E

2,500

$22$19

4,000

DMR

MC

2. and produces a lower quantity.

Figure 10 Regulating a Natural Monopoly

B$15

$29

A

C

MC

$60

LRATC

50,000

DMR

85,000100,000 Number of

Households Served

Dollars

Unregulated monopoly

"Fair rate of return" production

F

Efficient production (requires subsidy)

Figure 11A Tax on Producers to Correct a Negative Externality

100 125

D

S

$1.00A

MSCC $0.50

B

(a)

Millions of Gallons per Period

Dollars

2. The efficient quantity is here . . .

3. but the equilibrium quantity is here.

4. In equilibrium, the welfare loss is triangle ABC.

1. This market has a negative externality of $0.50 per unit.

Figure 11A Tax on Producers to Correct a Negative Externality

100 125

D

$1.00

$0.50B

(b)

Millions of Gallons per Period

Dollars

$1.30

$0.80

SBefore Tax

SAfter Tax

6. shifts the supply curve upward . . .

7. and moves the equilibrium to the efficient quantity.

5. A tax per unit on producers, equal to the negative externality per unit,

A

(b)

Figure 12 A Subsidy for Consumers to Correct a Positive Externality

800,000 1,000,000

D

S

$100,000MSBC

A

$30,000

2. The equilibrium quantity is here . . .

3. but the efficient quantity is here.

4. In equilibrium, the welfare loss is triangle ABC.

(a)

Number of Degrees per Year

Dollars

1.This market has a positive externality of $30,000 per college degree.

B

Figure 12 A Subsidy for Consumers to Correct a Positive Externality

S

800,000 1,000,000

$100,000

B

A

$30,000

Number of Degrees per Year

Dollars

(b)

$114,000

$84,000DBefore Subsidy

DAfter Subsidy

6. shifts the demand curve upward . . .

5. A subsidy per unit for consumers equal to the positive externality per unit . . .

7. and moves the market to the efficient quantity

Figure 13 Pure Private, Pure Public, and Mixed Goods

More Nonexcludable

More Excludable

More Rival More Nonrival

Mixed Good

Pure Private Good Mixed Good

Pure Public Good

• food, clothing, housing

• sold-out movie• crowded

highway• newspaper

• software

• movie with empty seats

• uncrowded highway

• downloaded music file

• cable television

• urban park

• national defense, legal system

• police and fire protection• crowded

city streets• fish in international

waters