ECON1101: Microeconomics 1

Chapter 7: Efficiency
Pareto-efficiency
Pareto-efficiency occurs if there is no opportunity for exchange or trade that
will make at least one person better off without harming others.

Pareto-improving transaction
A Pareto-improving transaction is one that leaves at least one person
better off without harming others.

Market equilibrium
The market equilibrium is Pareto-efficient because it maximises total
economic surplus.

Efficiency is not equity

Efficiency is not necessarily equity because people may still lack basic
goods and service. However, it is important because it maximises total
economic surplus and allows other goals to be better pursued.

Inefficiencies
Price ceilings
Price ceilings set below the equilibrium price reduce total economic
surplus.

Price subsidies
Price subsidies increase consumer surplus at the expense of taxpayers and
reduce total economic surplus.

First-come, first-served policies

First-come, first-served policies may result in buyers with high reservation
prices missing out. Offering compensation in $1 that only those with the
lowest reservation prices miss out. A consequence of first-come, firstserved policies is ticket scalping, in which tickets are resold at a price
above their original face value.

Marginal cost pricing of public services

Public services should be priced at the marginal cost in order to maximise total
economic surplus.

Taxes
Who bears a tax?
If demand is more price inelastic than supply, the buyers will bear more of
a tax.

If supply is more price inelastic than demand, the sellers will bear more of
a tax.

Total economic surplus and tax revenue

Taxes reduce total economic surplus, which is partially offset by tax
revenue.

What is deadweight loss?

Deadweight loss is the reduction in total economic surplus that arises
when a market operates at some price and output combination other than
the one at which marginal benefit equals marginal cost.

Deadweight loss of taxes

The more price-inelasticity of supply or demand, the smaller the
deadweight loss of taxes.

Taxing overconsumed products

Taxes on overconsumed products (e.g. unenvironmentally-friendly
products) may actually increase total economic surplus.