Chapter 4 - Economic Efficiency, Government Price Setting, and Taxes

4.1 Consumer Surplus and Producer Surplus 4.2 The Efficiency of Competitive Markets 4.3 Government Intervention in the Market: Price Floors and Price Ceilings 4.4 The Economic Effect of Taxes

What do the situations in Venezuela and U.S. taxi markets have in common?

Both involve governments trying to alter prices.

What is surplus in economics?

The benefit people derive from engaging in market transactions.

What is consumer surplus?

The difference between the highest price a consumer is willing to pay and the actual price paid.

What is producer surplus?

The difference between the lowest price a firm is willing to accept and the price it actually receives.

What is marginal benefit?

The additional benefit to a consumer from consuming one more unit of a good or service.

What area on a graph represents consumer surplus?

The area below the demand curve and above the price consumers pay.

If the price of chai tea falls from $3.50 to $3.00 what happens to consumer surplus?

Each buyer gains an additional $0.50 of surplus.

What did economists find when studying Uber rides in major U.S. cities?

Consumers gained large amounts of consumer surplus from Uber services.

What is marginal cost?

The change in a firm’s total cost from producing one more unit of a good or service.

What area on a graph represents producer surplus?

The area above the supply curve and below the market price.

What does consumer surplus measure?

The net benefit to consumers from participating in a market.

What does producer surplus measure?

The net benefit producers receive from participating in a market.

When is a market efficient?

When it maximizes the sum of consumer surplus and producer surplus (economic surplus).

What is economic surplus?

The sum of consumer surplus and producer surplus.

What happens if quantity is below equilibrium?

Value to consumers exceeds cost to producers meaning not enough is produced.

What happens if quantity is above equilibrium?

Cost to producers exceeds value to consumers meaning too much is produced.

When does deadweight loss occur?

When the market is not in competitive equilibrium.

What is deadweight loss?

The reduction in economic surplus from inefficiency.

What is a price ceiling?

A legally determined maximum price (e.g. rent control).

What is a price floor?

A legally determined minimum price (e.g. minimum wage

What happens when the government sets a price floor above equilibrium?

Fewer units are traded

Why is the minimum wage debated?

Supporters say it raises incomes opponents say it reduces jobs.

What did natural experiments on minimum wage (e.g. New Jersey vs. Pennsylvania) show?

Sometimes employment rises instead of falling after wage increases.

What happens with rent ceilings (rent control)?

Shortages occur because demand exceeds supply reducing efficiency.

What alternative markets arise under rent ceilings?

Landlords may use short-term rentals (like Airbnb) to avoid controls.

What happened to sanitizer prices during Covid-19?

Prices rose sharply benefiting sellers but limiting access to consumers willing to pay.

What do price gouging laws do?

Prevent high prices during emergencies but cause shortages.

Do price controls create winners or losers?

Yes but they always reduce efficiency.

Is judging price controls positive or normative?

Normative (based on values and judgments).

What do taxes do in markets?

Shift the supply curve up

What happens to lost surplus when a tax is imposed?

Part becomes government revenue part becomes deadweight loss.

What is tax incidence?

The actual division of the tax burden between buyers and sellers.

Does who legally pays the tax determine incidence?

No it depends on supply and demand responsiveness.

If demand is steep (inelastic) who bears most of the tax?

Buyers.

If demand is shallow (elastic) who bears most of the tax?

Sellers.

Who usually bears most of the gasoline tax?

Consumers.

Who legally splits payroll taxes like Social Security?

Employers and workers.

Who actually bears most of the payroll tax burden?

Workers because labor supply is less responsive to wage changes.