Market Efficiency

Introducing Consumer & Producer Surplus

Consumer Surplus

The difference between what a consumer is prepared to pay and what they actually pay in the market.

• Area below the demand curve and above the price point
• Marginal Benefit: Extra benefit from consuming one extra unit of the good or services.

Producer Surplus

Difference between what a producer is willing to receive and what they actually receive in a market.

• Area above the supply curve and below the price point
• Marginal Cost: The extra opportunity cost of producing one more unit of a good or service.

Consumer Surplus + Producer Surplus = Total Surplus

Total Surplus

The measure of the net benefits to society from the production and consumption of the good.

• Allocated Efficiency is achieved

Deadweight Loss

The loss in Total Surplus that is avoidable.

We must maximise the quantity supplied and quantity demanded in a market - Using all resources optimally

• A desirable objective of an economic system is to maximize the well-being of society, and therefore to achieve this, we need to maximise total surplus.

Effect of Taxes/Subsidies/Ceilings/Floors on Efficiency

Efficiency

Producing the goods that producers want at the lowest possible price

Producing what society demands is called Allocative Efficiency

What is a Price Ceiling?

• It’s the highest price that a producer can charge on a good or service
• It is usually below the equilibrium price
• Intended to keep prices affordable for majority of the population

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• Needed for rationing process to regulate demand
• Could lead to black markets

What is a Price Floor?

• It’s the minimum price that a producer can charge on a good or service
• It is usually above the equilibrium price
• Designed to ensure that there is a minimum income received by producers

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• Informal illegal markets could result where workers are paid less than the minimum wage

The Steps for Success - Price Ceilings and Floors Diagrams

1. Original Price and Quantity
2. Implement Price Ceiling / Floor (Above or Below Equilibrium)
3. New Price and Quantity
4. Qd / Qs -> Shortage or Surplus
5. CS / PS / TS / DWL
6. Loss of Efficiency

What are Taxes?

They can be:

• Direct Taxes (Income Tax)
• Indirect Taxes
  • Consumers do not pay the tax directly, but are affected through changes in the price of the good or services.
    • Specific Tax: The tax is an fixed amount or is a set sum of money per unit
    • Ad Valorem Tax: Where the tax is a percentage of the value of the transaction, e.g GST

Tax Objectives:

• Aid in the redistribution of income
• To correct externalities
• To earn revenue

Impact of Taxes:

• Reduces quantity while increase price
• Tax incidence depends on the elasticity of the good/service
• Creates a DWL

The Steps for Success - Taxes Diagrams

1. Original Price / Quantity
2. Implement Government Policy (Tax)
3. New Price / Quantity
4. Tax Revenue
5. CS / PS / TS / DWL
6. Conclusion on Efficiency

What are Subsidies?

• Subsidies are payments by the government to a firm to reduce production costs and increase output

Subsidy Objectives:

• To encourage production of goods with positive externalities
• Allows the producer to export more
• Aid expansion of the firm

Impact of subsidies:

• DWL as part of government expenditure on the subsidy is not translated into either consumer or producer surplus