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3 Online Efficient Market 12 16 13
3 Online Efficient Market 12 16 13
3 Online Efficient Market 12 16 13
$4
3
D
8 10
efficient markets
P
6
$5
$30
D
6
efficient markets
In effect, each maximum price could be extracted from the consumer for each added quantity by
walking the consumer down their demand curve. This activity is surely not preferred by the
consumer, but consumers are willing to play-along in the sense that they are not being asked to pay
more than their maximum price for each added quantity. Consumers are just not receiving any
break or surplus value in the sense that they pay less than their maximum price for any quantity.
Consumer surplus considers the difference between what consumers actually pay and what their
maximum payment would be. This difference is a surplus because it reflects a gain in welfare for
the consumer. If Mary is willing to pay $3 for another bagel but only pays $2 her surplus is $1.
Since total expenditure equals price times quantity, the area under the demand curve up to the total
quantity purchased equals total expenditures extracted when maximum prices are charged.
D
Q
In practice, however, sellers rarely have the ability to price each added quantity at a different
(maximum) price.
So, the next step is to contrast the above case with the more common case whereby only one price
per unit is charged.
efficient markets
Consumer Surplus is defined as the difference between what consumers are at most willing to
pay and what they actually pay for goods and services. Lets evaluate consumer surplus at
quantity d.
CS
a
what
they
pay
0
efficient markets
Consumer Surplus rises (falls) as price falls (rises) thus demonstrating that consumers
are better-off (higher welfare) with lower prices.
P
P
CS
CS
P
what
they
pay
P
what they pay
D
Q
efficient markets
D
Q
A
P1
P2
C
Q1
D
Q2
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P
$5
3
8
10 Q
efficient markets
In effect, producers could charge each minimum price for each possible quantity by walking up
the supply curve.
The area under the supply curve then represents the minimum payment sellers are willing to take.
efficient markets
P
S
$5
B
6
Producer surplus then is A, the difference between what they receive (A+B) and the
minimum they would take (B).
efficient markets
CS
P
CS
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10
Consumer
surplus
Pe
Producer
surplus
C
0
Qe
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Multiple Choice
1. Which of the following best explains the source of consumer surplus for good A?
a. Many consumers would be willing to pay more than the market price for good A.
b. Many consumers pay prices that are greater than the equilibrium price of good A.
c. Many consumers think the market price of good A is greater than its cost.
d. Many consumers think the price elasticity of demand for good A is unit elastic.
2. Suppose a market now has a large increase in the number of sellers of groceries, ceteris paribus. Which of the
following would you predict would also arise following the change in market price?
a. consumer surplus will remain the same.
b. consumer surplus will increase.
c. it is not possible to predict the change in consumer surplus.
d. consumer surplus will decrease
3. Suppose a market now has a large increase in the number of demanders of groceries, ceteris paribus. Which of the
following would you predict would also arise following the change in market price?
a. producer surplus will remain the same.
b. producer surplus will increase.
c. it is not possible to predict the change in producer surplus.
d. producer surplus will decrease
4. Suppose that in the wine market, consumer surplus equals $500 and producer surplus equals $400. Which of the
following is correct?
a. total surplus equals $100
b. total surplus equals $20,000
c. total surplus equals $500
d. total surplus equals $900
5. Suppose that in the wine market, consumer surplus equals $5,000 and producer surplus equals $3,000. Suppose
that in the beer market, consumer surplus equals $1,000 and producer surplus equals $8,000. Which of the following
is correct?
a. total surplus is highest in the wine market
b. total surplus is highest in the beer market
c. total surplus is equal in the two markets
d. we cannot cross-compare in the two markets.
efficient markets
12
Pe
Pc
D
Qe
efficient markets
Q
13
Pf
Pe
Qe
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Q
14
Shortages are Symptoms of Price Ceilings & Surpluses are Symptoms of Price Floors.
Pe
D
Q
Qe=Qs=Qd
15
A price ceiling such as Pc mandates that prices may go no higher than Pc.
But, at Pc, quantity demanded exceeds quantity supply, and thus a shortage arises.
In other words, a law mandating a price
ceiling is a law that indirectly mandates a
shortage.
Notice the shortage grows as the price
ceiling is set farther away from Pe.
Pe
Pc
D
Q1
Q2
shortage
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16
A price floor such as Pf is a law mandating that prices may go no lower than Pf.
But, at Pf, quantity supplied exceeds quantity demanded, and thus a surplus arises.
D
Q1
Q2
surplus
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17
$10
5
D
Q1
Q2
Costs are more difficult to assess and require a command of supply and demand analysis.
Consider a price ceiling of $5 per pizza, when equilibrium is $10 (see nearby graph).
The price ceiling creates a shortage of distance Q1Q2 because quantity demanded Q2 exceeds
quantity supplied Q1.
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18
$10
5
D
Q1
Q2
The price ceiling may also cause sellers to choose who receives available pizzas, and who do not, on
the basis of race, gender, or some other characteristic.
Sellers may also choose to provide on the basis who pays the highest bribes.
The point here is that sellers must decide on some basis who receives available pizzas.
This issue, however, does not come up when prices are allowed to equilibrate because a shortage
never arises at the equilibrium price.
efficient markets
19
A long-standing price ceiling is also likely to foster an exodus out of the market by suppliers.
Suppliers do not like to have their hands tied
behind their backs by price ceilings and, over
time, suppliers will leave this market for markets
without price ceilings.
Suppliers leaving this market causes the supply
curve to shift left from S to S.
Notice, that as the supply curve shifts leftward,
the shortage grows to distance Q3Q2.
$11
$10
5
D
Q3 Q1
Q2
Also, the price will jump to $11, a price above the initial equilibrium of $10, when the price
ceiling is lifted. (However, over time the price will eventually fall back to $10 if no other changes in
the market have taken place).
The point here is that shortages will tend to grow over time and (in the short run) equilibrium prices
will rise over time, as long as price ceilings remain in place.
How Goods & Services are Rationed When Prices are not Allowed to Reach Equilibrium. This was
explained above in reference to how sellers must determine who receives the available pizzas and who
do not when the price ceiling results in a shortage. Sellers may decide to allocate available pizzas
based on eye colors of consumers, or national origin, gender, zip code or hair color. They could also
choose randomly or on the basis of which consumers offer the best bribes.
efficient markets
20
A minimum wage law is a price floor because it mandates that employers must pay workers at least
the defined minimum. The nearby chart shows a minimum wage at $7 per hour, although the
private market sets $5 as equilibrium wage.
A minimum wage of $7 per hour creates unemployment
because it causes a surplus of labor.
At $7 per hour, quantity demanded (by employers) of labor
is Q1, quantity supplied (by workers) is Q2, and thus
distance Q1Q2 is the surplus, or unemployment.
wage
$7
$5
Q1
Q2
workers
Unemployment
(surplus)
21
Workers, Consumers and Owners Bear the Economic Incidence of Minimum Wage Laws. Minimum
wage laws create unemployment and have the potential for raising prices and output levels. These
effects carry the potential for passing on costs of minimum wage laws to different parties. A minimum
wage law raises the costs of production to sellers and thus causes the supply curve to shift left, as
shown in the nearby chart.
S (initial)
P
P
D
efficient markets
Q Q
milk shakes
22
6. Suppose a minimum wage is set a level above the equilibrium wage. Which of the following describes the
unemployment created associated with movement along the demand curve for labor?
a. workers who used to work, but are laid off
b. individuals who did not previously seek work, but now do at the higher wage
c. none of the above
d. all of the above
7. Suppose a minimum wage is set a level above the equilibrium wage. Which of the following describes the
unemployment created associated with movement along the supply curve of labor?
a. workers who used to work, but no longer can find employment
b. individuals who did not previously seek work, but now do at the higher wage
c. none of the above
d. all of the above
8. Suppose a price ceiling is set above equilibrium price in the apple market. Which best describes what will
happen?
a. a shortage will develop
b. a surplus will develop
c. the market will stay at equilibrium
d. both a shortage and a surplus will develop
9. Suppose a price ceiling is set below the equilibrium price in the apple market. Which of the following best
describes what will happen?
a. a shortage will develop
b. a surplus will develop
c. the market will stay at equilibrium
d. both a shortage and a surplus will develop
10. Increases in both the supply and demand for caviar will:
(a) affect price in an indeterminate way and increase the quantity exchanged.
(b) increase price and increase the quantity exchanged.
(c) affect quantity in an indeterminate way while reducing the price.
(d) decrease price and decrease the quantity exchanged.
(e) affect price in an indeterminate way and decrease the quantity exchanged.
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PRICE
$10
9
8
7
6
5
4
QU.
SUPPLIED
600 units
500
400
300
200
100
0
QU.
DEMANDED
50 units
100
200
300
400
700
900
11. Suppose a price ceiling is set where price may not go any higher than $8 per unit. Which of the following is true?
a. There will be a shortage of 200 units
b. There will be a surplus of 200 units
c. There will be shortage of 600 units
d. There will be no shortage or surplus
12. Suppose a price floor is set where price may not go any lower than $8 per unit. Which of the following is true?
a. There will be a shortage of 200 units
b. There will be shortage of 600 units
c. There will be a surplus of 200 units
d. There will be a surplus of 600 units e. There will no shortage or surplus
13. Suppose a price ceiling is set where price may not go any higher than $7 per unit. Which of the following is true?
a. There will be a shortage of 200 units
b. There will be shortage of 600 units
c. There will be a surplus of 200 units
d. There will be a surplus of 600 units e. There will no shortage or surplus
14. Suppose new suppliers enter this market and provide at each price an additional 200 units; e.g., at price $10,
quantity supplied becomes 800 units, at price $9 quantity supplied becomes 700 units, etc. Which is true?
a. There will be a shortage of 600 units if there is a price ceiling set at $5
b. There will be shortage of 200 units if there is a price ceiling set at $6
c. There will be a surplus of 200 units if there is price ceiling set at $9
d. There will be no shortage or surplus at a price of $6
e. none of these is true
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efficient markets
15. Use the graph on the right for the following question. If price falls
from Pa to Pb, which of the following is correct?
a. consumer surplus falls from 1+2+3 to 1+2
b. consumer surplus rises from 1+4 to 4+6
c. consumer surplus rises from 1 to 1+2+3
d. consumer surplus rises from 1 to 1+2+4
e. consumer surplus does not change
16. Use the graph on the right for the following question. Which of the
following is correct?
a. total expenditure is 3+5 when the price is Pb
b. total expenditure is 1+2+3 when the price is Pa
c. total expenditure is 3+5+6 when the price is Pb
d. total expenditure is 4+5 when the price is Pb
e. none of the above is correct
17. Use the graph below. What is the change in producer surplus as price
falls from P2 to P1?
a. from D+E to A+B
b. from A+B to D + E
c. from A + D to A
d. from B+E to B
e. none of these
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efficient markets
26
Negative externalities arise when there is a divergence between private costs and social costs. Private
costs are costs occurred by private parties. Private costs include only those paid by the producer and
therefore do not necessarily include the costs of all resources used in production. In the previous
example, a toy factory that does not pay for the noise pollution it inflicts on nearby homeowners only
consider their private costs of production (i.e., labor, tools, electricity, rent, etc.)
Social costs are those incurred by private parties in addition to any other costs borne by other members
of society. In our factory example, the difference between private and social costs is the discomfort that
the factory imposes on homeowners. The negative externality is this difference between private and
social costs and explains why it is sometimes referred to as an external cost.
$
Pe
P1
social costs
private costs
a
c
D
Qe Q1
toys
Markets will produce too much at Q1 and charge too little with P1. An efficient outcome would be
to produce less at Qe and charge a higher price at Pe.
27
efficient markets
Positive externalities arise when there is a divergence between private benefits and social benefits.
Positive externalities thus occur whenever markets fail to allocate on the basis of full social benefits.
Immunization against communicable diseases is a common example of a good that produces positive
externalities individuals who do not consume the good benefit because inoculations decrease the
number of individuals who may transmit diseases.
Markets do not take account of the benefits that flow to those who are not inoculated. However, those
benefits, which are external to the market exchange, are part of the benefits that society receives when
resources are allocated to immunization. Private producers do not normally care about non-paying
customers and thus will ignore external benefits to their production thus resulting in too little
production from the point of view of society.
$
c
Pe
P1
social costs
b
social benefits
private benefits
Q1 Qe
inoculations
Markets will produce too little at Q1 and charge too little with P1. An efficient outcome would be to
produce more at Qe and charge a higher price at Pe.
28
efficient markets
True-False
18. Negative Externalities arise whenever markets fail to allocate resources on the basis of full social cost.
19. Too many resources are allocated in markets with positive externalities.
20. Social costs are larger than private costs in markets characterized by negative externalities.
Multiple Choice
21. Which of the following is most likely to be associated with a positive externality?
a. air pollution
b. water pollution
c. inoculations for transmittable diseases
d. congestion on a crowded highway
22. When there is a divergence between social and private costs, which of the following arises?
a. positive externality
b. negative externality
c. public good
d. social good
23. Which of the following is said to occur when a market characterized by social benefits being larger than
private benefits?
a. positive externality
b. negative externality
c. Pareto equilibrium
d. Giffin good
efficient markets
29
Key Concepts
Total Welfare
Consumer Surplus
Maximum Price Consumers Willing to Pay
Producer Surplus
Minimum Prices Sellers are Willing to Accept
Do Not Confuse Consumer Surplus /Producer Surplus with Market Surplus
Walking Consumers Down a Demand Curve
Consumer Surplus Rises (Falls) with Lower (Higher) Prices
Producer Surplus Rises (Falls) as Price Rises (Falls)
Total Expenditure
Total Surplus at Market Equilibrium
Equilibrium as an Efficient Point in a Market
Price Ceiling vs. Price Floor
Shortages as Symptoms of Price Ceilings
Surpluses as Symptoms of Price Floors
Resource Misallocation (Inefficient Resource Allocation)
Deadweight Loss
Law of Unintended Consequences
Costs and Benefits of Price Ceilings/Floors
Minimum Wage Laws
2 Types of Unemployment Created by Minimum Wage Laws
Negative Externalities and Positive Externalities: When Markets are not Efficient
Private Costs vs. Social Costs; Private Benefits vs. Social Benefits.
Resource Misallocation Under Externalities
efficient markets
30
1A
2B
3B
4D
5B
6A
7B
8C
9A
10A
11D
12C
13E
14D
15D
16A
17C.
18T
19F
20T
21C
22B
23A
efficient markets
31