Efficiency and Exchange

Objectives:
At the completion of this section, the student should

1. Understand and describe the importance

and determination of efficiency in the
Efficiency
market.
2. Graph and manipulate the graphs for
demand and supply descriptions of
governmental interventions in the
Subsidy
market.
Tax

Efficiency
Cannot help one without hurting another
If Marginal benefit > Marginal cost,
increase output

If Marginal benefit < Marginal cost,

decrease output

Efficiency<=>Marginal Benefit=Marginal Cost

In markets happens at D,S intersection

Efficiency is most output, given input

Equity is fairness

Efficiency, graphically
Consumer Surplus

S
Consumer Benefit

P1

Producer Cost

Producer Surplus
Producer Benefit &
Consumer Cost

Q1

Effect of Price too high on

Efficiency
Consumer Surplus
P

Deadweight
Loss

S
P1

Above equilibrium

Benefit > Cost, but units

Producer
Surplus

Not produced.
D

Cost

QD1
Cant get surplus on
units not produced.

QS1
Bene

Q
QS1 > QD1, = Excess Supply

Effect of Price too low on Efficiency

Dead Weight Loss
- Lost Consumer Surplus
- Lost Producer Surplus
Consumer Surplus

Low price converts some

producer surplus to
consumer surplus

P1

P2 (below market)

Producer Surplus

Q2

Q1

(Fewer Supplied
At lower price)

Effect of Subsidy on Efficiency

Dead weight loss =
Consumer Surplus

Cost of the subsidy

Added cost without more benefit.

S
P1
S, net of subsidy

= Q2 x per unit subsidy

D

Cost to society,
Paid to consumers.
Additional consumer surplus

Q1 Q2

Incidence of a Tax
Who physically pays the tax is not issue
Who has less value due to the tax is issue
If the demander is willing to pay a lot of
the tax (has LOW price elasticity),
consumer pays most of the tax
If supplier really wants to sell the product
(low supply elasticity), seller pays most of
the tax.

Effect of a Tax
on Efficiency

Tax

Added cost to Demander

Seller does not get to keep.
Seller keeps Price; Demander pays Price +
Tax.
Lower S is supplier,
Upper S faces Demander.
S + tax

Tax
Revenue

Consumer Surplus
P
S

Tax

P2+tx

Consumer Pays

Producer
Surplus

P1
P2

Producer Pays

D
Q2

Q1

Units not produced

are more valuable
than their cost.
That is, lost benefit
without saved cost.
Deadweight
Loss
Issues with tax:
1. Who pays?
Supplier (gets less)
Demander (pays more)
2. Dead Weight Loss.

Numeric Example of Tax Incidence

The effect of a tax on gasoline

Qs

Qd

Sold

Tx

P+tx

Qs

Qd

200

2.5

600

200

200

0.5

3.0

2.25

550

250

250

0.5

2.75

500

300

300

0.5

2.5

500

1.75

450

350

350

0.5

2.25

450

250

1.5

400

400

400

0.5

2.0

400

300

1.25

350

450

350

0.5

1.75

350

350

300

500

300

0.5

1.5

300

400

0.75

250

550

250

0.5

1.25

250

450

Sold

Cons Cst

Prod rev

Tx rev

200

500

400

100

250

562.50

437.50

125

300

600

450

150

350

612.50

437.50

175

300

450

300

150

250

312.50

187.50

125