ECON 202 1nd Edition Lecture 17 Outline of Last Lecture I. Efficiency of Marketsa. Taxes and Efficiencyi. Tax IncidenceOutline of Current Lecture II. Efficiency of Marketsa. Tax Incidence and Efficiencyb. Elasticity and Deadweight LossIII. Market Inefficienciesa. Externalitiesi. Negative ExternalityCurrent LectureEfficiency of MarketsTax Incidence and EfficiencyExample: Excise tax collected from sellersPerfectly Elastic MarketBuyers pay the same price, so tax incidenceoccurs on the seller; sellers bear the entire taxburdenPerfectly Inelastic MarketThese notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute. PDS1S2Q*QATPB = P*PSPDS1S2Q*PS = P*PBSeller keeps the same price, so tax incidence occurs on the buyer; buyers bear the entire tax burdenWe can conclude that when demand is relatively more elastic than supply, sellers will bear moreof the tax burden and vice versa.Typically buyers and sellers share the tax burdenElasticity and Deadweight Loss (DWL)Example:Demand is very elasticDemand is very inelasticPDS1S2Q*QATP*DWLPDS1S2Q*P*QATDWLQDeadweight Loss is larger in the market with more elastic demand.Market InefficienciesMarket Failure – situation in which a market, left on its own, FAILS to allocate resources efficiently.1. Externalities – The Third Party Problem2. Public goodsExternalities – costs and benefits resulting from market activity that affect people other than buyers and sellers (third parties)Example: Flu Shot MarketSuppose the Marginal Internal Benefit for Joe is $25 and the Marginal Cost for a drug store is $28. Joe will not buy the flu shot because his benefit does not exceed the cost. However, the Marginal External Benefit (the benefit that third parties receive) is $4, so the social benefit of Joe getting his flu shot is $29, which does exceed the marginal cost, so society will be better off.Here the market fails, because there wouldn’t be enough flu shots provided because total marginal benefits outweigh the cost, but because some of that benefit is outside the market thetransaction doesn’t occur.Example: Negative Externality – an external cost paid by people other than the buyers and sellers in a market; results in OVERPRODUCTION of the good being producedPollution Market Example: Suppose for each unit of a good produced it generates $5 of water pollutionThe demand curve in this example is the socialbenefitS1 is the marginal internal cost of a customerbuying a unit of the good.S2 is the marginal social cost of a customer buying a unit of the good. The marginal social cost is themarginal internal cost + the marginal cost for thirdparties.This means that Q* is being produced instead of Qefficient, so there is an OVERPRODUCTION of
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