chapter
four
Market Efficiency and Market Failure
Prepared by: Fernando & Yvonn Quijano
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien
After studying this chapter, you
should be able to:
1
New York City
… About one million of
New York City’s two million
apartments are subject to
rent control. The other
one million apartments
have their rents
determined in the market
by the demand and supply
for apartments.
LEARNING OBJECTIVES
CHAPTER 4: Market Efficiency and Market Failure
Should the Government
Control Apartment Rents?
2
3
4
5
Understand the concepts of
consumer surplus and producer
surplus.
Understand the concept of
economic efficiency, and use a
graph to illustrate how economic
efficiency is reduced when a
market is not in competitive
equilibrium.
Use demand and supply graphs to
analyze the economic impact of
price ceilings and price floors.
Identify examples of positive and
negative externalities and use
graphs to show how externalities
affect economic efficiency.
Analyze government policies to
achieve economic efficiency in a
market with an externality.
© 2007 Prentice Hall Business Publishing; Essentials of Economics R. Glenn Hubbard, Anthony Patrick O’Brien
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CHAPTER 4: Market Efficiency and Market Failure
Market Efficiency and Market Failure
Price ceiling A legally
determined maximum price that
sellers may charge.
Price floor A legally determined
minimum price that sellers may
receive.
© 2007 Prentice Hall Business Publishing; Essentials of Economics R. Glenn Hubbard, Anthony Patrick O’Brien
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CHAPTER 4: Market Efficiency and Market Failure
1 LEARNING OBJECTIVE
Consumer Surplus And Producer Surplus
Consumer Surplus
Marginal benefit The
additional benefit to a
consumer from consuming one
more unit of a good or service.
4-1
The Demand Curve is Also the
Marginal Benefit Curve
Consumer surplus The
difference between the highest
price a consumer is willing to
pay and the price the consumer
actually pays.
© 2007 Prentice Hall Business Publishing; Essentials of Economics R. Glenn Hubbard, Anthony Patrick O’Brien
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CHAPTER 4: Market Efficiency and Market Failure
Consumer Surplus and Producer Surplus
Consumer Surplus
4-2
Total Consumer Surplus in the
Market for Chai Tea
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CHAPTER 4: Market Efficiency and Market Failure
4-1
The Consumer Surplus from
Satellite Television
How much consumer
surplus will the owner of
this satellite dish receive?
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CHAPTER 4: Market Efficiency and Market Failure
Consumer Surplus and Producer Surplus
Producer Surplus
4-3
Producer Surplus
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.
© 2007 Prentice Hall Business Publishing; Essentials of Economics R. Glenn Hubbard, Anthony Patrick O’Brien
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CHAPTER 4: Market Efficiency and Market Failure
Consumer Surplus and Producer Surplus
What Consumer Surplus and Producer
Surplus Measure
Consumer surplus measures the benefit
to consumers from participating in a
market, and producer surplus measures
the benefit to producers from participating
in a market.
© 2007 Prentice Hall Business Publishing; Essentials of Economics R. Glenn Hubbard, Anthony Patrick O’Brien
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CHAPTER 4: Market Efficiency and Market Failure
2 LEARNING OBJECTIVE
The Efficiency of Competitive Markets
Marginal Benefit Equals Marginal Cost in Competitive
Equilibrium
4-4
Marginal Benefit Equals Marginal
Cost Only at Competitive
Equilibrium
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CHAPTER 4: Market Efficiency and Market Failure
The Efficiency of Competitive Markets
Economic Surplus
4-5
Economic Surplus Equals the
Sum of Consumer Surplus and
Producer Surplus
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CHAPTER 4: Market Efficiency and Market Failure
The Efficiency of Competitive Markets
Deadweight Loss
4-6
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.
© 2007 Prentice Hall Business Publishing; Essentials of Economics R. Glenn Hubbard, Anthony Patrick O’Brien
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CHAPTER 4: Market Efficiency and Market Failure
The Efficiency of Competitive Markets
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 where the sum of consumer surplus
and producer surplus is at a maximum.
© 2007 Prentice Hall Business Publishing; Essentials of Economics R. Glenn Hubbard, Anthony Patrick O’Brien
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CHAPTER 4: Market Efficiency and Market Failure
3 LEARNING OBJECTIVE
Government Intervention in the Market:
Price Floors And Price Ceilings
Price Floors: The Example of Agricultural Markets
4-7
The Economic Effect of a Price
Floor in the Wheat Market
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CHAPTER 4: Market Efficiency and Market Failure
4-2
Price Floors in Labor Markets:
The Minimum Wage
Many economists believe
there are better policies
than the minimum wage for
raising the incomes of lowskilled workers.
© 2007 Prentice Hall Business Publishing; Essentials of Economics R. Glenn Hubbard, Anthony Patrick O’Brien
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CHAPTER 4: Market Efficiency and Market Failure
Government Intervention In The Market:
Price Floors And Price Ceilings
Price Ceilings: The Example of Rent Controls
4-8
The Economic Effect
of a Rent Ceiling
Don’t Confuse “Scarcity” with a “Shortage.”
© 2007 Prentice Hall Business Publishing; Essentials of Economics R. Glenn Hubbard, Anthony Patrick O’Brien
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CHAPTER 4: Market Efficiency and Market Failure
4-1
3 LEARNING OBJECTIVE
What’s the Economic Effect of a “Black Market” for Apartments?
© 2007 Prentice Hall Business Publishing; Essentials of Economics R. Glenn Hubbard, Anthony Patrick O’Brien
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CHAPTER 4: Market Efficiency and Market Failure
Government Intervention In The Market:
Price Floors And Price Ceilings
The Results of Government Intervention:
Winners, Losers, and Inefficiency
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.
Positive and Normative Analysis of Price Ceilings
and Price Floors
Whether rent controls 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.
© 2007 Prentice Hall Business Publishing; Essentials of Economics R. Glenn Hubbard, Anthony Patrick O’Brien
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CHAPTER 4: Market Efficiency and Market Failure
4 LEARNING OBJECTIVE
Externalities and Efficiency
Externality A benefit or cost that affects someone who is not
directly involved in the production or consumption of a good or
service.
The Effect of Externalities
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,
including both the private benefit and any external benefit.
© 2007 Prentice Hall Business Publishing; Essentials of Economics R. Glenn Hubbard, Anthony Patrick O’Brien
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CHAPTER 4: Market Efficiency and Market Failure
Externalities and Efficiency
HOW A NEGATIVE EXTERNALITY IN PRODUCTION REDUCES ECONOMIC EFFICIENCY
4-9
The Effect of Pollution
on Economic Efficiency
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CHAPTER 4: Market Efficiency and Market Failure
Externalities and Efficiency
HOW A POSITIVE EXTERNALITY IN CONSUMPTION REDUCES ECONOMIC EFFICIENCY
4-10
The Effect of a Positive
Externality on Efficiency
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CHAPTER 4: Market Efficiency and Market Failure
Externalities and Efficiency
Externalities Can Result in Market Failure
Market failure Situations where 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.
© 2007 Prentice Hall Business Publishing; Essentials of Economics R. Glenn Hubbard, Anthony Patrick O’Brien
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CHAPTER 4: Market Efficiency and Market Failure
5 LEARNING OBJECTIVE
Government Solutions to Externalities
Government Solutions to Externalities
4-11
When There is a Negative
Externality, a Tax Can Bring
About the Efficient Level of
Output
© 2007 Prentice Hall Business Publishing; Essentials of Economics R. Glenn Hubbard, Anthony Patrick O’Brien
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CHAPTER 4: Market Efficiency and Market Failure
4-2
5 LEARNING OBJECTIVE
Using a Tax to Deal with a Negative Externality
© 2007 Prentice Hall Business Publishing; Essentials of Economics R. Glenn Hubbard, Anthony Patrick O’Brien
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CHAPTER 4: Market Efficiency and Market Failure
Government Solutions to Externalities
Government Solutions to Externalities
4-12
When There is a Positive
Externality, a Subsidy Can
Bring About the Efficient
Level of Output
Pigovian taxes and
subsidies Government
taxes and subsidies
intended to bring about an
efficient level of output in
the presence of
externalities.
© 2007 Prentice Hall Business Publishing; Essentials of Economics R. Glenn Hubbard, Anthony Patrick O’Brien
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CHAPTER 4: Market Efficiency and Market Failure
Government Solutions to Externalities
Command and Control versus Tradeable
Emissions Allowances
Command and control approach
Government-imposed quantitative limits on the
amount of pollution firms are allowed to
generate, or government-required installation
by firms of specific pollution control devices.
© 2007 Prentice Hall Business Publishing; Essentials of Economics R. Glenn Hubbard, Anthony Patrick O’Brien
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CHAPTER 4: Market Efficiency and Market Failure
4-5
Can Tradeable Permits Reduce Global
Warming?
Rapid growth in China
has led to rapid
increases in CO2
emissions.
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