Ch7 ppt (1)
Chapter 7: Welfare Economics
Overview
Focuses on evaluating market efficiency and failures.
Chapter 7 Topic Outline
Evaluating Public Policy
Measuring Economic Surplus
Market Efficiency
Market Failure and Deadweight Loss
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:
Market Power
Externalities
Information Problems
Irrationality
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
Distribution matters; equity considerations are pivotal.
Willingness to pay reflects ability to pay rather than just marginal benefit.
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.