market efficiency

• market efficiency is measured by examining total gains
• consumer surplus is the difference between price consumers are willing to pay for a good & the price they actually pay for that good
• consumer surplus = perceived value - price
• consumers pay market price
• consumer expenditure = p x q
• producer revenue = p x q
• producers actually receive market price
• total surplus = cs + ps
• producer surplus is the difference between price producers are willing to accept for a good & the price they actually receive for the good
• the free market equilibrium price and quantity produce largest possible total surplus
• free markets can generate inequality
• price floor

  • minimum price set by government
  • if minimum price is set higher than P*, it becomes new MP, quantity sold will be lower than free market outcome
  • benefits producers
  • producer surplus is larger & consumer surplus is smaller
  • reduction in surplus is deadweight loss
  • decreases market efficiency
• price ceiling

  • maximum price set by government
  • benefits consumers
  • consumer surplus is larger and producer surplus is smaller
  • reduction in deadweight loss
  • it is possible for some consumers to be left worse off
  • artificially low price created by price ceiling generates excess demand
• quota - a maximum quantity set by the government

  benefits producers

  producer surplus is larger & consumer surplus is smaller

  results in deadweight loss
• when the amount of the tax is fixed & does not change with the underlying price changed by producers, it is called a unit tax
• when the amount of the tax is a percentage of the price, is called value added tax or ad valorem tax
• consumers buy less because tax increases price
• the change in consumer price is called the consumer incidence of the tax
• the change in producer price is called the producer incidence of the tax
• tax amount = consumer incidence  + producer incidence

   
• tax causes producer price to decline, the consumer price to rise, & the quantity to fall
• tax revenue = tax x quantity sold
• producers receive lower price & sell less, producer surplus shrinks
• consumer surplus shrinks because consumers pay a higher price & buy less