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  1. Today • Economic Efficiency • Producer’s surplus • Perfect competition and economic efficiency • Return exams at end of class

  2. Economic Efficiency Reading: end of Chapter 21

  3. Definition • Economic Efficiency: When goods are produced in the least costly manner and distributed to those who value them most. • Requires: • Productive Efficiency • Allocative Efficiency

  4. Productive Efficiency • There is no way to re-direct production among firms to increase total output.

  5. Perfect Comp and Productive Efficiency • In LR firms produce at lowest possible LRAC. • There is no way to cut costs by changing plant size. • Since all firms take the same price, all firms have same MC (why?) • There is no way to re-direct production to other firms and get lower marginal costs. • Productive efficiency holds.

  6. Allocative Efficiency • Goods are consumed by those who most value them. • There is no alternative comb. of goods that could be produced that would increase society’s well-being.

  7. Measuring Allocative Efficiency • The sum of consumers’ surplus and producers’ surplus.

  8. Recall: Consumers’ Surplus • The difference between what a consumer is willing to pay & what he does pay. $/unit 8 A 6 B 4 D 2 units 1 3 4 5 2 6 7

  9. Producers’ Surplus-SR perspective • The difference between the amount of revenue the firm earns and the minimum amount necessary to get the firm to produce that quantity of the good in the short run. • PS = Revenue - total variable costs.

  10. Producers’ Surplus-Market • Selling 4 units @$6/unit. • Total revenue = B + C. • TVC for all firms is represented by the area under the SRS curve (why?) = C • B = producers’ surplus $/unit SRS 8 6 B 4 C D 2 units 1 3 4 5 2 6 7

  11. Allocative Efficiency • A + B = The sum of consumers’ and producers’ surplus. • Vertical distance between D and S is the difference between value to consumer and MC to producer. • What Q maximizes CS+PS? $/unit SRS 8 A 6 B 4 C D 2 units 1 3 4 5 2 6 7

  12. Allocative Efficiency & Perfect Competition • Perfectly competitive markets provide the allocatively efficient quantity of a good.

  13. Perfect Comp and Econ Efficiency • Conclusion: Perfectly competitive markets are economically efficient! • This is one reason why we use them as a benchmark for our study of other market structures.

  14. Excise Taxes and Allocative Efficiency • Assume the market for wheat is perfectly competitive. • Shade in the sum of consumers’ and producers’ surpluses for the competitive market equilibrium.

  15. Wheat Price/Gal. • Identify the market equilibrium price and quantity. • Shade in the CS + PS. S 1.25 1.00 0.75 D 4 5 6 Bushels of wheat

  16. Excise Tax • Add an excise tax of $0.50 per bushel to this market. • What happens to market price and quantity? • Shade in CS + PS in light of the tax. • Compare your answer to before the tax. Is it allocatively efficient to tax this industry?

  17. Excise tax on wheat-50¢ S’ Price/Gal. • Price paid by elevator is $1.25 • Price kept by farmer is $0.75. • What is quantity? • How is CS + PS affected? 0.50 S 1.25 1.00 0.75 D 4 5 6 Bushels of wheat

  18. Conclusions on Taxes & Efficiency • An excise tax cuts the quantity exchanged below the optimal level. • This reduces the surplus that consumers and producers receive. • Conclusion: Excise taxes reduce market efficiency.

  19. Next Time • Note: We are now one class period behind the syllabus. • April 2-4: Monopoly, Ch. 22 • April 9-11: Oligopoly and Monopolistic Competition, Ch. 23