chapter 4 part 2

Economic Concepts Overview

• This section covers producer and consumer surplus, their fluctuations, and the effects of government price controls.

Rent Control Effects

• Without rent control, rent can be $2,500/month, and 2,000,000 apartments are rented.

• Government-imposed rent ceiling of $1,500 leads to:

  • Supply decreases to 1,900,000 apartments.

  • Demand increases to 2,100,000 apartments.

  • Resulting in a shortage of 200,000 apartments.

Producer Surplus and Deadweight Loss

• Producer surplus can be visualized as the area of a triangle showing the profit transfer from landlords to consumers under price controls.

• Areas of deadweight loss (triangles labeled B and C) indicate economic surplus lost due to decreased rentals.

• Black markets may emerge where selling violates price regulations.

• Shift towards short-term rentals (e.g., Airbnb) allows some alleviation of deadweight loss, but buyers/sellers lose legal protections.

Government Price Controls

• Price controls can benefit some but harm others; typically induce economic inefficiency.

• Normative analysis questions whether price controls are good or bad—no absolute right/wrong answers; it relies on personal values and judgments.

Economic Effect of Taxes

• Taxes fund government activities; focus is on per unit taxes.

• Per Unit Taxes:

  • Example: US federal excise tax of $0.184/gallon for gasoline.

• Effect on cigarette market:

  • Without tax price equilibrium: $6/pack, 4,000,000,000 packs sold.

  • With $1 tax, the supply curve shifts, adjusting the equilibrium down to 3,700,000,000 packs at a higher consumer price of $6.90.

  • Producers receive $5.90 after tax.

• Government tax revenue comprises consumer and producer surplus losses converted to tax revenue and new deadweight loss.

Tax Efficiency

• Excess Burden: Refers to deadweight loss from a tax.

• Efficient taxes have a smaller excess burden relative to generated revenue.

  • Example: Gasoline tax shift from $2.50 to $2.58 increases financial burden on consumers, while sellers lose $0.02.

Tax Incidence

• Tax incidence defines who actually bears the burden of a tax, influenced by supply/demand curve slopes.

  • Steeper demand curve means consumers bear more burden; flatter means consumers shift less impact.

Consumer and Producer Surplus

• Consumer surplus is the difference between the highest price consumers are willing to pay and the actual price paid (illustrated as area A).

• Producer surplus is the lowest price sellers would accept versus price received (illustrated as area B).

• Economic surplus is measured by the sum of these surpluses.

Deadweight Loss

• Deadweight loss refers to the lost economic surplus due to non-competitive equilibrium, represented in diagrams as areas not covered under normal circumstances (e.g., areas C and E).

• Marginal benefit greater than marginal cost signifies inefficiency, reinforcing the equilibrium efficiency rule.

Binding Price Ceilings and Floors

• A binding price ceiling leads to producer surplus transfer to consumers (area C).

• Price floors can cause over-supplying, benefiting consumers by lowering prices below equilibrium.

Black Markets

• Black markets emerge when government controls prices, impacting surfaces negatively, with examples including rent controls.

• Normative statements regarding rent controls reflect personal values on market regulation and its outcomes.

Competitive Market Impacts

• Economists generally caution against excessive government interference due to its potential to diminish living standards.

• The imposition of price controls will always have winners and losers, leading to diminished economic efficiency overall.