Transcript
PART 2 PRICE, QUANTITY,
AND EFFICIENCY
Prepared by Dr. Amy Peng
Ryerson University
© 2013 McGraw-Hill Ryerson Ltd.
Differentiate between demand side market failures and supply-side market failures.
Explain the origin of both consumer surplus and producer surplus, and explain how properly functioning markets maximize their sum, economic surplus, while optimally allocating resources.
Describe free riding and public goods, and illustrate why private firms cannot normally produce public goods.
Explain how positive and negative externalities cause underallocations and overallocations of resources.
© 2013 McGraw-Hill Ryerson Ltd.
Chapter 5
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A demand-side market failure
Demand curves do not reflect consumers’ full willingness to pay for a good or service.
A supply-side market failure
Supply curves do not reflect the full cost of producing a good or service.
© 2013 McGraw-Hill Ryerson Ltd.
Chapter 5, LO1
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Demand curve must reflect the consumers full willingness to pay
Supply curve must reflect all the costs of production
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Chapter 5, LO2
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Difference between what a consumer is willing to pay for a good and what the consumer actually pays
Extra benefit from paying less than the maximum price
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Chapter 5, LO2
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(1)
Person
(2)
Maximum Price Willing to Pay
(3)
Actual Price (Equilibrium Price)
(4)
Consumer Surplus
Bob
$13
$8
$5 (=$13-$8)
Barb
12
8
4 (=$12-$8)
Bill
11
8
3 (=$11-$8)
Bart
10
8
2 (=$10-$8)
Brent
9
8
1 (= $9-$8)
Betty
8
8
0 (= $8-$8)
© 2013 McGraw-Hill Ryerson Ltd.
Chapter 5, LO2
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D
Q1
P1
Consumer Surplus
Equilibrium Price
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Chapter 5, LO2
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Difference between the actual price a producer receives and the minimum price they would accept
Extra benefit from receiving a higher price
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Chapter 5, LO2
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(1)
Person
(2)
Minimum Acceptable Price
(3)
Actual Price (Equilibrium Price)
(4)
Producer Surplus
Carlos
$3
$8
$5 (=$8-$3)
Courtney
4
8
4 (=$8-$4)
Chuck
5
8
3 (=$8-$5)
Cindy
6
8
2 (=$8-$6)
Craig
7
8
1 (=$8-$7)
Chad
8
8
0 (=$8-$8)
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Chapter 5, LO2
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S
Q1
P1
Equilibrium price
Producer surplus
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Chapter 5, LO2
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S
Q1
P1
D
Consumer surplus
Producer surplus
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Chapter 5, LO2
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Quantity (bags)
Price (per bag)
c
S
Q1
Q2
D
b
d
a
e
Efficiency loss
from underproduction
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Chapter 5, LO2
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c
S
Q1
Q3
D
b
f
a
g
Quantity (bags)
Price (per bag)
Efficiency loss
from overproduction
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Chapter 5, LO2
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Private goods characteristics
Produced in the market by firms
Offered for sale
Rivalry
Excludability
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Chapter 5, LO3
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Public goods characteristics
Provided by government
Offered for free
Nonrivalry
Nonexcludability
Free-rider problem
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Chapter 5, LO3
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(1)
Quantity of Public Good
(2)
Adams’ Willingness to Pay (Price)
(3)
Benson’s Willingness to Pay (Price)
(4)
Collective Willingness
to Pay (Price)
1
$4
+
$5
=
$9
2
3
+
4
=
7
3
2
+
3
=
5
4
1
+
2
=
3
5
0
+
1
=
1
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Chapter 5, LO3
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Adams
Benson
D1
D2
Adams’ Demand
Benson’s Demand
$3 for 2 Items
$4 for 2 Items
$1 for 4 Items
$2 for 4 Items
Collective Demand and Supply
DC
S
Collective Demand
$7 for 2 Items
$3 for 4 Items
Connect the Dots
Optimal
Quantity
Collective
Willingness
To Pay
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Chapter 5, LO3
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Cost
Resources diverted from private good production
Private goods that will not be produced
Benefit
The extra satisfaction from the output of more public goods
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Chapter 5, LO3
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(1)
Plan
(2)
Total Cost of Project
(3)
Marginal Cost
(4)
Total Benefit
(5)
Marginal Benefit
(6)
Net Benefit
(4) – (2)
No new construction
$0
$0
$0
A: Widen existing highways
4
$4
5
$5
1
B: New 2-lane highways
10
6
13
8
3
C: New 4-lane highways
18
8
22
10
5
D: New 6-lane highways
28
10
26
3
-2
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Chapter 5, LO3
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Could be provided through the market system
Because of positive externalities the government provides them
Examples: education, streets, libraries
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Chapter 5, LO3
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Government
Taxes individuals and businesses
Takes the money and spends on production of public goods
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Chapter 5, LO3
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A cost or benefit accruing to a third party external to the transaction
Positive externalities
Too little is produced
Demand-side market failures
Negative externalities
Too much is produced
Supply side market failures
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Chapter 5, LO4
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(a)
Negative externalities
(b)
Positive externalities
0
D
S
St
Overallocation
Negative
Externalities
St
Underallocation
Positive
Externalities
Qo
Qo
Qe
Qe
P
P
0
Q
Q
D
Dt
a
c
z
x
b
y
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Chapter 5, LO4
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Correct negative externalities
Direct controls
Specific taxes
Correct positive externalities
Subsidies and government provision
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Chapter 5, LO4
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(a)
Negative Externalities
D
S
St
Overallocation
Negative
Externalities
Qo
Qe
P
0
Q
a
c
b
(b)
Correct externality with tax
D
S
St
Qo
Qe
P
0
Q
a
T
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Chapter 5, LO4
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(a)
Positive Externalities
0
St
Underallocation
Positive
Externalities
Qo
Qe
D
Dt
z
x
y
(b)
Correcting via a subsidy
to consumers
0
St
Qo
Qe
D
Dt
(c)
Correcting via a subsidy
to producers
0
S't
Qo
Qe
D
Subsidy
St
Subsidy
U
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Chapter 5, LO4
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0
Society’s Marginal Benefit and Marginal
Cost of Pollution Abatement (Dollars)
Q1
MB
MC
Socially
Optimal Amount
Of Pollution
Abatement
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Chapter 5, LO4
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Government can have a role in correcting externalities
Officials must correctly identify the existence and cause
Has to be done in the context of politics
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Chapter 5, LO4
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Problem
Resource Allocation Outcome
Ways to Correct
Negative externalities
(spillover costs)
Overproduction of output and therefore overallocation of resources
Private bargaining
Liability rules and lawsuits
Tax on producers
Direct controls
Market for externality rights
Positive externalities
(spillover benefits)
Underproduction of output and therefore underallocation of resources
Private bargaining
Subsidy to consumers
Subsidy to producers
Government provision
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Chapter 5, LO4
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Cap and trade
Sets a cap for the total amount of emissions
Assigns property rights to pollute
Rights can then be bought and sold
Carbon tax
Raises cost of polluting
Easier to enforce
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Chapter 5
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5.1 Market Failures in Competitive Markets
5.2 Efficiently Functioning Markets
5.3 Public Goods
5.4 Externalities
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Chapter 5
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