Chapter
4
Market Efficiency
and Market Failure
Prepared by:
Fernando & Yvonn Quijano
© 2009 Prentice Hall Business Publishing Essentials of Economics Hubbard/O’Brien, 2e.
Market Efficiency and Market Failure
Chapter 4: Economic Efficiency,
Government Price Setting, and Taxes
Price ceiling A legally
determined maximum price
that sellers may charge.
Price floor A legally
determined minimum price
that sellers may receive.
Externality A benefit or cost that
affects someone who is not directly
involved in the production or
consumption of a good or service.
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Learning Objective 4.1
Consumer Surplus and Producer Surplus
4.1
Chapter 4: Economic Efficiency,
Government Price Setting, and Taxes
Consumer Surplus
Consumer surplus
The difference between the
highest price a consumer is
willing to pay and the price the
consumer actually pays.
Marginal benefit
The additional benefit to a
consumer from consuming one
more unit of a good or service.
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Learning Objective 4.1
Consumer Surplus and Producer Surplus
Consumer Surplus
FIGURE 4-3
Chapter 4: Economic Efficiency,
Government Price Setting, and Taxes
Total Consumer Surplus
in the Market for Chai Tea
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Learning Objective 4.1
Chapter 4: Economic Efficiency,
Government Price Setting, and Taxes
Making The Consumer Surplus from
the
Satellite Television
Connection
Consumer surplus allows us to measure the benefit consumers
receive in excess of the price they paid to purchase a product.
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Learning Objective 4.1
Consumer Surplus and Producer Surplus
Producer Surplus
Chapter 4: Economic Efficiency,
Government Price Setting, and Taxes
Marginal cost The additional
cost to a firm of producing one
more unit of a good or service.
Producer surplus The difference
between the lowest price a firm
would have been willing to accept
and the price it actually receives.
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Learning Objective 4.1
Consumer Surplus and Producer Surplus
Producer Surplus
FIGURE 4-4
Chapter 4: Economic Efficiency,
Government Price Setting, and Taxes
Calculating Producer Surplus
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Learning Objective 4.1
Consumer Surplus and Producer Surplus
Chapter 4: Economic Efficiency,
Government Price Setting, and Taxes
What Consumer Surplus and Producer Surplus Measure
Consumer surplus measures the net benefit to consumers from
participating in a market rather than the total benefit. The net
benefit equals the total benefit received by consumers minus the
total amount they must pay to buy the good.
Similarly, producer surplus measures the net benefit received by
producers from participating in a market, or the total amount firms
receive from consumers minus the cost of producing the good.
© 2009 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
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Learning Objective 4.2
The Efficiency of Competitive Markets
Marginal Benefit Equals Marginal Cost in Competitive
Equilibrium
FIGURE 4-5
Chapter 4: Economic Efficiency,
Government Price Setting, and Taxes
Marginal Benefit Equals Marginal Cost
Only at Competitive Equilibrium
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Learning Objective 4.2
The Efficiency of Competitive Markets
Economic Surplus
Economic surplus The sum of
consumer surplus and producer surplus.
Chapter 4: Economic Efficiency,
Government Price Setting, and Taxes
FIGURE 4-6
Economic Surplus
Equals the Sum of
Consumer Surplus
and Producer Surplus
© 2009 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
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Learning Objective 4.2
The Efficiency of Competitive Markets
Deadweight Loss
FIGURE 4-7
Chapter 4: Economic Efficiency,
Government Price Setting, and Taxes
When a Market Is Not in
Equilibrium There is a
Deadweight Loss
Deadweight loss The reduction in economic surplus
resulting from a market not being in competitive equilibrium.
© 2009 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
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Learning Objective 4.2
The Efficiency of Competitive Markets
Chapter 4: Economic Efficiency,
Government Price Setting, and Taxes
Economic Surplus and Economic Efficiency
Economic efficiency
A market outcome in which the
marginal benefit to consumers of
the last unit produced is equal to
its marginal cost of production,
and in which the sum of
consumer surplus and producer
surplus is at a maximum.
© 2009 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
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Learning Objective 4.3
Government Intervention in the Market:
Price Floors And Price Ceilings
Price Floors: Government Policy in Agricultural Markets
Chapter 4: Economic Efficiency,
Government Price Setting, and Taxes
FIGURE 4-8
The Economic Effect
of a Price Floor in the
Wheat Market
© 2009 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
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Learning Objective 4.3
Chapter 4: Economic Efficiency,
Government Price Setting, and Taxes
Making Price Floors in Labor Markets: The
the
Debate Over Minimum Wage Policy
Connection
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Learning Objective 4.3
Government Intervention in the Market:
Price Floors And Price Ceilings
Price Ceilings: Government Rent Control Policy in
Housing Markets
Chapter 4: Economic Efficiency,
Government Price Setting, and Taxes
FIGURE 4-9
The Economic Effect of
a Rent Ceiling
Don’t Let This Happen to YOU!
Don’t Confuse “Scarcity” with a “Shortage”
© 2009 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
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Learning Objective 4.3
Government Intervention in the Market:
Price Floors And Price Ceilings
Chapter 4: Economic Efficiency,
Government Price Setting, and Taxes
Black Markets
Black markets A market in
which buying and selling take
place at prices that violate
government price regulations.
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Learning Objective 4.3
Solved Problem
4-3
Chapter 4: Economic Efficiency,
Government Price Setting, and Taxes
What’s the Economic Effect of a
“Black Market” for Apartments?
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Learning Objective 4.3
Government Intervention in the Market:
Price Floors And Price Ceilings
The Results of Government Price Controls: Winners, Losers,
and Inefficiency
Chapter 4: Economic Efficiency,
Government Price Setting, and Taxes
When the government imposes price floors or
price ceilings, three important results occur:
• Some people win.
• Some people lose.
• There is a loss of economic efficiency.
© 2009 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
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Learning Objective 4.3
Government Intervention in the Market:
Price Floors And Price Ceilings
Chapter 4: Economic Efficiency,
Government Price Setting, and Taxes
Positive and Normative Analysis of Price Ceilings
and Price Floors
Whether rent controls or federal farm
programs are desirable or undesirable is a
normative question.
Whether the gains to the winners more than
make up for the losses to the losers and for
the decline in economic efficiency is a matter
of judgment and not strictly an economic
question.
© 2009 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
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Learning Objective 4.4
Externalities and Economic Efficiency
The Effect of Externalities
Chapter 4: Economic Efficiency,
Government Price Setting, and Taxes
Private cost The cost borne by the producer
of a good or service.
Social cost The total cost of producing a
good, including both the private cost and any
external cost.
Private benefit The benefit received by the
consumer of a good or service.
Social benefit The total benefit from
consuming a good or service, including both
the private benefit and any external benefit.
© 2009 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
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Learning Objective 4.4
Externalities and Economic Efficiency
The Effect of Externalities
How a Negative Externality in Production Reduces
Economic Efficiency
Chapter 4: Economic Efficiency,
Government Price Setting, and Taxes
FIGURE 4-10
The Effect of Pollution
on Economic Efficiency
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Learning Objective 4.4
Externalities and Economic Efficiency
The Effect of Externalities
How a Positive Externality in Consumption Reduces
Economic Efficiency
Chapter 4: Economic Efficiency,
Government Price Setting, and Taxes
FIGURE 4-11
The Effect of a Positive
Externality on Efficiency
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Learning Objective 4.4
Externalities and Economic Efficiency
Externalities May Result in Market Failure
Chapter 4: Economic Efficiency,
Government Price Setting, and Taxes
Market failure A situation in which the
market fails to produce the efficient
level of output.
What Causes Externalities?
Property rights The rights individuals
or businesses have to the exclusive
use of their property, including the
right to buy or sell it.
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Learning Objective 4.5
Government Policies to Deal with Externalities
Chapter 4: Economic Efficiency,
Government Price Setting, and Taxes
FIGURE 4.12
When There Is a
Negative Externality, a
Tax Can Bring about the
Efficient Level of Output
© 2009 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
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Learning Objective 4.5
Solved Problem
4-5
Chapter 4: Economic Efficiency,
Government Price Setting, and Taxes
Using a Tax to Deal with
a Negative Externality
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Learning Objective 4.5
Government Policies to Deal with Externalities
FIGURE 4-13
Chapter 4: Economic Efficiency,
Government Price Setting, and Taxes
When There Is a Positive
Externality, a Subsidy Can
Bring about the Efficient
Level of Output
© 2009 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
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Learning Objective 4.5
Government Policies to Deal with Externalities
Chapter 4: Economic Efficiency,
Government Price Setting, and Taxes
Pigovian taxes and subsidies Government
taxes and subsidies intended to bring about an
efficient level of output in the presence of
externalities.
Command and Control versus Tradable Emissions Allowances
Command and control approach An approach
that involves the government imposing
quantitative limits on the amount of pollution
firms are allowed to emit or requiring firms to
install specific pollution control devices.
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