Supply and Demand and Price
1. Name two types of market failure. Explain why each may cause market outcomes to be inefficient.
Market Power- In some markets, a single buyer or seller may be able to control the market prices. Market Power can cause inefficiency because it keeps the price and quantity away from the equilibrium of supply and demand.
Externalities- The impact of one person’s actions on the well-being of a bystander. Since buyers and sellers do not consider these side effects when deciding how much to consume and produce, the equilibrium in a market can be inefficient from the standpoint of society as a whole.
2. What happens to consumer and producer surplus when the sale of a good is taxed? How does the change in consumer and producer surplus compare to the tax revenue?
Consumer surplus is money buyers would be willing to spend to buy a good above what they must pay at the current price; and producer surplus is money the producers are making at the current price above what they would be willing to accept to still stay in the market. Imposing a tax distorts the interaction of demand and supply, with the effect of reducing both consumer surplus and producer surplus for the good. The addition of the tax will remove some consumer surplus and some producer surplus. Consumers are forced to pay more for the same good because the price has risen. Meanwhile, producers are losing out on potential profits because their revenue has not increased by as much as the price rise would suggest. On the other hand, tax revenue first rises with the size of the tax. Eventually, however, a larger tax reduces the tax revenue because it reduces the size of the market.
3. How do the elasticities of supply and demand affect the deadweight loss of a tax? Why does this effect occur?
Deadweight loss of a tax is a loss of economic well-being imposed by a tax. The loss occurs because taxation makes the taxed good or service less attractive, reducing individuals' desire to purchase that product.
Market Power- In some markets, a single buyer or seller may be able to control the market prices. Market Power can cause inefficiency because it keeps the price and quantity away from the equilibrium of supply and demand.
Externalities- The impact of one person’s actions on the well-being of a bystander. Since buyers and sellers do not consider these side effects when deciding how much to consume and produce, the equilibrium in a market can be inefficient from the standpoint of society as a whole.
2. What happens to consumer and producer surplus when the sale of a good is taxed? How does the change in consumer and producer surplus compare to the tax revenue?
Consumer surplus is money buyers would be willing to spend to buy a good above what they must pay at the current price; and producer surplus is money the producers are making at the current price above what they would be willing to accept to still stay in the market. Imposing a tax distorts the interaction of demand and supply, with the effect of reducing both consumer surplus and producer surplus for the good. The addition of the tax will remove some consumer surplus and some producer surplus. Consumers are forced to pay more for the same good because the price has risen. Meanwhile, producers are losing out on potential profits because their revenue has not increased by as much as the price rise would suggest. On the other hand, tax revenue first rises with the size of the tax. Eventually, however, a larger tax reduces the tax revenue because it reduces the size of the market.
3. How do the elasticities of supply and demand affect the deadweight loss of a tax? Why does this effect occur?
Deadweight loss of a tax is a loss of economic well-being imposed by a tax. The loss occurs because taxation makes the taxed good or service less attractive, reducing individuals' desire to purchase that product.