Economics 101: Principles of Economics

1. Economics 101: Principles of Economics • Queries?

2. Producer Surplus • Producer Surplus = amount a seller actually receives – minimum amount WTS at • Quantifies the net benefit for seller of a change in price • Approach (1): note the overall increase in PS • Approach (2): Two steps Price Supply P2 C P1 B 1. Same qty. sold at higher price A 2. Advantageous to sell more now Q1 Q2 Quantity

3. Price S CS P* PS D Q* Quantity Are Free Markets Efficient? • Total Surplus = CS + PS = total net gain to market participants • Changes in Total Surplus help identify gain/loss as a result of govt policies (taxes, subsidies, etc.) or changes in market structure (monopoly, oligopoly, etc.) • Efficient level of Output = when MB = MC or TS is greatest • Free competitive markets achieve this, others don’t • An inefficient allocation does not achieve highest TS • If output is expanded beyond Q*, then MB < MC and net gain from those units is negative (thus, lower TS) • Free markets allocate goods such that buyers who value good most & sellers who can produce at lowest cost are the ones in the market! • Laissez-faire approach is efficient  • Violations: market power & externalities

4. Deadweight Loss of Excise Tax • Economic incidence unaffected by legal incidence Price • How much does CS fall? • (b + c) • How much does PS fall? • (d + e) • Tax revenue? • (b + d) S a b c tax e d f D Quantity • Deadweight Loss? • (c + e) • Why? • Higher price to buyer gives incentive to consume less & lower price for seller gives incentive to produce less  market shrinks

5. Deadweight Loss of Price Ceiling • Price Ceiling • e.g., rent control • creates an Excess Demand Rent / unit • How much does Total Surplus fall? • Deadweight Loss = fall in Total Surplus • DWL = measure of aggregate loss in well-being of all market participants • Some units for which MB > MC don’t get produced • Consumers gain area X, lose area Y S Y Z Price ceiling X D • Producers lose area (X + Z) Apartments • TS = Deadweight Loss = Y + Z • DWL > 0 doesn’t imply everyone is worse off. Producers lose, consumers may gain (getting the lower rent) or lose (not find apt) • Public Policy, whom do you value more?

6. Determinants of Deadweight Loss S2+tax S1+tax • Size of the DWL is determined by the elasticities of supply & demand Price S2 S1 • The greater the elasticities of supply & demand, the greater the DWL due to a tax • The Laffer curve • Overall, his theoretical possibility did not pan out • 1980-84, income  4% ( taxes), but tax rev  9% • But true for richest individuals • Also may work in other countries tax D Quantity

7. International Trade • Growing importance in the US economy • In 1960, trade was < 5% of GNP • By 1998, trade was > 10% of GNP • Comparative advantage story didn’t explain how the gains from trade were distributed Japanese Car Market Price Sdomestic CS Pworld • Pre-trade situation is as usual PJapan PS • Assume Japan is a price-taker • Will Japan export or import cars? • PJAPAN vs. PWORLD Ddomestic • Export the excess supply Quantity • Who benefits? • Domestic producers gain • Domestic consumers lose • Net change in welfare? Total surplus?

8. International Trade • Effects of a Tariff ? • Not an issue for exporter • Domestic buyers/sellers • Government revenue • Deadweight Loss • Arguments by opponents • Unilateral vs Multilateral trade Price Sdomestic a • NAFTA & GATT (multilateral) Pworld + tariff b c d e f Pworld g Imports fall Ddomestic Quantity