Ch7 ppt (1)

Chapter 7: Welfare Economics

Overview

• Focuses on evaluating market efficiency and failures.

Chapter 7 Topic Outline

1. Evaluating Public Policy

2. Measuring Economic Surplus

3. Market Efficiency

4. Market Failure and Deadweight Loss

5. Beyond Economic Efficiency

Types of Economic Analysis

Positive Analysis

• Describes, explains, or predicts economic scenarios without value judgements.

• Example: Analyzing the consequences of raising the minimum wage.

Normative Analysis

• Prescribes what should happen based on personal values.

• Example: Debating whether the minimum wage should be raised and determining if it's worth enacting.

Economic Efficiency

• An outcome is economically efficient if it yields maximum economic surplus (the "economic pie").

• Key Concept: Economic Efficiency does not equal Equity.

  • Example: Uber increases economic surplus despite taxi drivers' losses; suggests efficient outcomes can make some better off while ignoring others.

Measuring Economic Surplus

Consumer Surplus

• Definition: Economic surplus derived from purchasing an item.

• Formula: Consumer Surplus = Marginal Benefit - Price.

  • Example: Willing to pay $40 for a sweater but only pay $35 leads to a consumer surplus of $5.

Producer Surplus

• Definition: Economic surplus derived from selling an item.

• Formula: Producer Surplus = Price - Marginal Cost.

  • Example: Charging $35 for tutoring services where the marginal cost was $25 gives a producer surplus of $10.

Total Economic Surplus

• Total economic surplus includes both consumer surplus and producer surplus.

  • Economic Surplus = Consumer Surplus + Producer Surplus.

• Example for Levi's Jeans: Economic surplus for 100th unit calculated as Marginal Benefit - Marginal Cost.

Market Failure

• When market forces fail to lead to efficient outcomes.

• Five Main Sources:

  1. Market Power

  2. Externalities

  3. Information Problems

  4. Irrationality

  5. Government Regulations

Deadweight Loss (DWL)

• Definition: Fall in economic surplus due to inefficiencies (underproduction/overproduction).

  • Example: Deadweight loss from not achieving the efficient quantity of goods produced.

• DWL Shape: Typically resembles an arrowhead pointing towards the efficient quantity.

Government Intervention

• Policy recommendations for addressing market failures can reduce or eliminate deadweight loss.

• Examples include taxing harmful products (cigarettes) or subsidizing beneficial ones (vaccines).

• However, government can also fail, leading to worse outcomes than market failures.

Critiques of Economic Efficiency

1. Distribution matters; equity considerations are pivotal.

2. Willingness to pay reflects ability to pay rather than just marginal benefit.

3. The means by which outcomes are achieved matter.

Example Case: The Ticket Dilemma

• Analysis of a single ticket's value between two individuals based on their respective willingness to pay leading to an economically efficient outcome.