ECON 010 CHAPTER 4 A price ceiling is a legally determined maximum price that sellers may charge. o o E.g.

E.g. rent control Markets for farm products such as milk, government has been setting price floors above equilibrium market price since the 1930s. Government also intervenes in markets by imposing taxes. Consumer surplus is the difference between the highest price a consumer is willing to pay for a good or service and the price the consumer actually pays. o It measures the dollar benefit consumers receive from buying goods or services in a particular market. Producer surplus measures the dollar benefit firms receive from selling goods or services in a particular market. Economic surplus in a market is the sum of consumer surplus plus producer surplus. When the government imposes a price ceiling or a price floor, the amount of economic surplus in a market is reduced. o Price ceilings and price floors reduce the total benefit to consumers and firms from buying and selling in a market Demand curves show the willingness of consumers to purchase a product at different prices. o o Consumers are willing to purchase a product up to the point where the marginal benefit of consuming a product is equal to its price. The marginal benefit is the additional benefit to a consumer from consuming one more unit of a good or service. Supply curves show the willingness of firms to supply a product at different prices. o o Firms will supply an additional unit of a product only if they receive a price equal to the additional cost of producing that unit. Marginal cost is the additional cost to a firm of producing one more unit of a good or service. Producer surplus is the different between the lowest price a firm would be willing to accept for a good or service and the price it actually receives. Consumer surplus measures the net benefit to consumers from participating in a market rather than the total benefit. o Consumer surplus in a market is equal to the total benefit received by consumers minus the total amount they must pay to buy the good or service. A price floor is a legally determined minimum price that sellers may receive.

Producer surplus in a market is equal to the total amount firms receive from consumers minus the cost of producing the good or service.

Equilibrium in a competitive market results in the economically efficient level of output, where marginal benefit equals marginal cost. Economic surplus in a market is the sum of consumer surplus and producer surplus. o In a competitive market, with many buyers and sellers and no government restrictions, economic surplus is at a maximum when the market is in equilibrium.

Deadweight loss is the reduction in economic surplus resulting from a market not being in competitive equilibrium. Equilibrium in a competitive market results in the greatest amount of economic surplus, or total net benefit to society, from the production of a good or service. Economic efficiency is 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.

Price floors: o o Government policy in agricultural markets Labor markets; debate over minimum wage policy Government rent control policy in housing markets

Price ceilings: o A black market is a market in which buying and selling take place at prices that violate government price regulations. When a government taxes a good or service, less of that good or service will be produced and consumed. The true burden of a tax is not just the amount consumers and producers pay the government but also includes the deadweight loss. The deadweight loss from a tax is referred to as the excess burden of the tax. A tax is efficient if it imposes a small excess burden relative to the tax revenue it raises. Tax incidence is the actual division of the burden of a tax between buyers and sellers in a market.

Summary: Although most prices are determined by demand and supply in markets, the government sometimes imposes price ceilings and price floors. A price ceiling is a legally determined maximum price that sellers may charge. A price floor is a legally determined minimum price that sellers may receive. Economists analyze the effects of price ceiling and price floors using consumer surplus and producer

surplus. Marginal benefit is the additional benefit to a consumer from consuming one more unit of a good or service. The demand curve is also a marginal benefit curve. Consumer surplus is the difference between the highest price a consumer is willing to pay for a good or service and the price the consumer actually pays. The total amount of a consumer surplus in a market is equal to the area below the demand curve and above the market price. Market cost is the additional cost to a firm of producing one more unit of a good or service. The supply curve is also a marginal cost curve. Producer surplus is the difference between the lowest price a firm is willing to accept for a good or service and the price it actually receives. The total amount of producer surplus in a market is equal to the area above the supply curve and below the market price. Equilibrium in a competitive market is economically efficient. Economic surplus is the sum of consumer surplus and producer surplus. Economic efficiency is a market outcome in which the marginal benefit to consumers from the last unit produced is equal to the marginal cost of production and where the sum of consumer surplus and producer surplus is at a maximum. When the market price is above or below the equilibrium price, there is a reduction in economic surplus. The reduction in economic surplus resulting from a market not being in competitive equilibrium is called the deadweight loss. Producers or consumers who are dissatisfied with the market outcome can attempt to convince the government to impose price floors or ceilings. Price floors usually increase producer surplus, decrease consumer surplus, and cause a deadweight loss. Price ceilings usually increase consumer surplus, decrease producer surplus, and cause a deadweight loss. The results of the government imposing price ceilings and price floors are that some people win, some people lose, and a loss of economic efficiency occurs. Price ceilings and price floors can lead to a black market, where buying and selling take place at prices that violate government price regulations. Positive analysis is concerned with what is, and normative analysis is concerned with what should be. Positive analysis shows that price ceilings and price floors cause deadweight losses. Whether these policies are desirable or undesirable, though, is a normative question.