AP Economics
Mr. Bernstein
Module 50:
Efficiency and Deadweight Loss
October 2015
AP Economics
Mr. Bernstein
Total Surplus
• When markets reach equilibrium, Total Surplus is
maximized
• Distortions to competitive market outcomes(ie
excise taxes) create Total Surplus that is not
maximized and Deadweight Loss emerges
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AP Economics
Mr. Bernstein
Efficiency and Gains From Trade
• When economists speak of efficiency, they are
typically eluding to the ability of markets to
produce outcomes that are most efficient to all
other ways of organizing the exchange of goods
• When a consumer makes a purchase from a
producer, a trade has occurred and both sides gain
• Gains are represented by Consumer and Producer
Surplus, or Total Surplus
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AP Economics
Mr. Bernstein
Efficiency of Markets
• No reallocation of consumption among consumers could
increase consumer surplus
• No reallocation of sales among producers could increase
producer surplus
• No change in the quantity traded could
increase total surplus
• Once the market has reached equilibrium,
there is no other way to increase the gains
from trade. Any of these 3 possible
reallocations would reduce total surplus and
thus reduces efficiency.
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AP Economics
Mr. Bernstein
An Efficient Market
• Allocates consumption of the good to the potential buyers
who most value it, as indicated by the fact that they have the
highest willingness to pay
• Allocates sales to the potential sellers who most value the
right to sell the good, as indicated by the fact that they have
the lowest cost.
• Ensures that every consumer who makes a purchase values
the good more than every seller who makes a sale, so that all
transactions are mutually beneficial.
• Insures that every potential buyer who doesn’t make a
purchase values the good less than every potential seller who
doesn’t make a sale, so that no mutually beneficial
transactions are missed.
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AP Economics
Mr. Bernstein
Equity and Efficiency - Review
• Societies may be concerned with Equity as well as Efficiency
• Example: Handicapped Parking
• Another example: Progressive tax rates
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AP Economics
Mr. Bernstein
The Effect of Taxes
Dead Weight Loss
P
S1
S
CS
T
T
D
D
PS
D
Qt
Q
• Excise tax imposed on producers
Q
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AP Economics
Mr. Bernstein
The Effect of Taxes on Total Surplus
• Who pays the tax (tax incidence) depends on the price
elasticities of demand and supply
• Tax on sellers shifts the supply curve to the left
• Tax on buyers shifts the demand curve to the left
• Example: Gas tax can be imposed on producers or consumers
• In either case, the tax leads to:
•
•
•
•
Decrease in quantity
Increase in price paid by consumers, but…
Decrease in price received by producers
A “wedge” between consumer and producer prices equal to the tax
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AP Economics
Mr. Bernstein
Elasticity and Tax Incidence
•
•
•
•
•
Relatively inelastic (steep) demand curve - consumers pay
Relatively elastic (flat) demand curve - producers pay
Relatively inelastic (steep ) supply curve – producers pay
Relatively elastic (flat) supply curve – consumers pay
On costs and benefits of taxes:
• Tax revenue collected by the government is not a cost of the tax
• It is a redistribution of surplus from consumers and producers to the
government
• The true cost of the tax is the inefficiency that it creates in the form of
deadweight loss
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