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total surplus
total net gain to consumers and producers from trading in a market
= CS + PS
there are gains from trade that exceed gains from self-sufficiency
want to maximize this in an efficient market
what characterizes an efficient market?
a market that, once it produces its gains from trade, has no way of making someone better off without making someone else worse off
3 approaches to attempt to increase total surplus
reallocating consumption among consumers
reallocating sales among sellers
change quantity traded
*none of these approaches work! once a market is in equilibrium, there is no way to increase gains w/o decreasing total surplus
reallocation of consumption among consumers
total surplus decreases if goods are taken away from those who value it more and given to those who value it less
reallocation of sales among sellers
total surplus decreases if sales are reallocated, since it increases total cost
changing quantity traded
total surplus decreases if transactions are forced or prevented
t or f: once a market is in eq., you can’t increase gains w/o decreasing total surplus
t
4 functions of an efficient market
allocates consumption of a good to the buyers who value it most (highest WTP)
allocates sales of a good to sellers who value the right to sell it the most (lowest seller’s cost)
ensures that every consumer who makes a purchase values the good more than every seller who makes a sale (transactions are mutually beneficial)
ensures that every potential buyer who doesn’t make a purchase values the good less than every potential seller who doesn’t make a sale (no missed mutually beneficial transactions)
3 caveats to consider about markets
efficiency ≠ fairness/equity (often in conflict, there’s a trade-off)
markets can be inefficient and not maximize total surplus
even when total surplus is maximized (efficient market), this doesn’t mean this is the best outcome for individual buyers and sellers
a. buyers will always want to pay a lower price
b. sellers will always want to sell at a higher price
regressive tax
rises less than in proportion to income; people with higher income pay a smaller % of their income than people with lower income
proportional tax
rises in proportion to income; all taxpayers pay the same percentage of income
progressive tax
rises more than in proportion to income; those with higher incomes pay a larger percent of their income than those with lower income
U.S. tax system
excise tax
tax on sales of a g/s; drives a wedge between price paid by consumers and price received by producers
consumers pay more, producers receive less
affects each group differently, but eq. outcome is the same regardless of who pays
on producers: they will increase S by wedge to receive more money → give tax to govt. and end up w/ original price
on consumers: they will decrease WTP by wedge, causing D to decrease
leads to distorted incentives + missed mutually beneficial transactions
wedge
equal to the size of the excise tax
tax incidence
distribution of the tax burden
depends on Es and Ed
when is an excise tax mainly paid by consumers?
demand is inelastic (low subs for consumers) and supply is elastic (many subs for producers)
burden mainly falls on consumers
when is an excise tax mainly paid by producers?
demand is elastic (many subs for consumers) and supply is inelastic (low subs for producers)
burden mainly falls on producers
revenue from an excise tax
area of rectangle with height = the tax wedge between supply and demand prices and width = quantity sold
costs of taxation
prevent mutually beneficial transactions from occuring
create inefficiency
deadweight loss from a tax
the value of forgone mutually beneficial transactions; inefficiency caused by an interference in a free market
the decrease in total surplus resulting from the tax minus tax revenue generated
triangle on graph (govt. revenue is the adjacent rectangle)
lump-sum tax
tax of a fixed amount paid by all taxpayers
might be unfair, but increases efficiency (doesn’t distort incentives due to equality)
administrative costs
of a tax, the resources used by the govt. to collect the tax and by taxpayers to pay (or evade) the tax, over and above the amount collected
total inefficiency caused by a tax
deadweight loss + administrative costs
examples of interferences in a free market
price controls: ceilings and floors
quantity controls: tariffs and quotas
govt. policy: taxes and subsidies
Note 
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