Chapter 9

1. Chapter 9 The Analysis of Competitive Markets

2. Q: Rent Control • Chuncheon City decided to control rent around KNU campus for students. • Are KNU students going to be better off? Chapter 9

3. Consumer and Producer Surplus • Consumer surplus is the total benefit or value that consumers receive beyond what they pay for the good. Chapter 9

4. Consumer and Producer Surplus • Producer surplus is the total benefit or revenue that producers receive beyond what it cost to produce a good. Chapter 9

5. S 9 Consumer Surplus 5 Producer Surplus 3 D Consumer and Producer Surplus Price Between 0 and Q0 consumer A receives a net gain from buying the product-- consumer surplus Between 0 and Q0 producers receive a net gain from selling each product-- producer surplus. Q0 QS QD Quantity Chapter 9

6. Consumer and Producer Surplus • To determine the welfare effect of a governmental policy we can measure the gain or loss in consumer and producer surplus. • Welfare Effects Chapter 9

7. S B P0 A C Pmax D Q1 Q0 Q2 Price Control and Surplus Changes Price Chapter 9 Quantity

8. Price controls and Welfare Effects • The total loss is equal to area B + C. • The deadweight loss is the inefficiency of the price controls – the total loss in surplus (consumer plus producer) • If demand is sufficiently inelastic, losses to consumers may be fairly large Chapter 9

9. D S P0 C Pmax Q1 Q2 Price Controls With Inelastic Demand Price B With inelastic demand, triangle B can be larger than rectangle A and consumers suffer net losses from price controls. A Quantity Chapter 9

10. The Efficiency ofa Competitive Market • In the evaluation of markets, we often talk about whether it reaches economic efficiency • Policies such as price controls that cause dead weight losses in society are said to impose an efficiency cost on the economy Chapter 9

11. The Efficiency ofa Competitive Market • If efficiency is the goal, then you can argue leaving markets alone is the answer • However, sometimes market failures occur Chapter 9

12. Types of Market Failures • Externalities • Costs or benefits that do not show up as part of the market price (e.g. pollution) • Costs or benefits are external to the market • Lack of Information • Imperfect information prevents consumers from making utility-maximizing decisions. • Government intervention may be desirable in these cases Chapter 9

13. The Efficiency of a Competitive Market • Other than market failures, unregulated competitive markets lead to economic efficiency • What if the market is constrained to a price higher than the economically efficient equilibrium price? Chapter 9

14. S Pmin B P0 A C D Q0 Q1 Q2 Price Control and Surplus Changes Price Quantity Chapter 9

15. The Efficiency of a Competitive Market • Deadweight loss triangles, B and C, give a good estimate of efficiency cost of policies that force price above or below market clearing price. • Measuring effects of government price controls on the economy can be estimated by measuring these two triangles Chapter 9

16. Minimum Wages • Wage is set higher than market clearing wage • Decreased quantity of workers demanded • Those workers hired receive higher wages • Unemployment results since not everyone who wants to work at the new wage can Chapter 9

17. S wmin w0 C Unemployment D L1 L0 L2 The Minimum Wage w A B L Chapter 9

18. Price Supports • Much of agricultural policy is based on a system of price supports. • Government can also increase prices through restricting production, directly or through incentives to producers Chapter 9

19. Price Supports • What are the impacts on consumers, producers and the federal budget? Chapter 9

20. Price Supports • Government may be able to “dump” some of the goods in the foreign markets • Total welfare effect of policy CS + PS – Govt. cost = D – (Q2-Q1)PS • Society is worse off over all • Less costly to simply give farmers the money Chapter 9

21. S Qg Ps D P0 D + Qg E D Q1 Q0 Q2 Price Supports Price To maintain a price Ps the government buys quantity Qg . A B Net Loss to society is E + B Quantity Chapter 9

22. Production Quotas • The government can also cause the price of a good to rise by reducing supply. • Limitations of taxi medallions in New York City • Limitation of required liquor licenses for restaurants Chapter 9

23. S’ S PS P0 C D Q1 Q0 Supply Restrictions Price A B Quantity Chapter 9

24. Import Quotas and Tariffs • Many countries use import quotas and tariffs to keep the domestic price of a product above world levels • Import quotas: Limit on the quantity of a good that can be imported • Tariff: Tax on an imported good • This allows domestic producers to enjoy higher profits • Costs to consumers is high Chapter 9

25. S P0 A B C PW Imports D QS Q0 QD Import Tariff To Eliminate Imports Price Quantity Chapter 9

26. The Impact of a Tax or Subsidy • The government wants to impose a $1.00 tax on movies. It can do it two ways • Make the producers pay $1.00 for each movie ticket they sell • Make consumers pay $1.00 when they buy each movie • In which option are consumers paying more? Chapter 9

27. The Impact of a Tax or Subsidy • The burden of a tax (or the benefit of a subsidy) falls partly on the consumer and partly on the producer. • How the burden is split between the parties depends on the relative elasticities of demand and supply. Chapter 9

28. The Effects of a Specific Tax • For simplicity we will consider a specific tax on a good • For our example, consider a specific tax of $t per widget sold Chapter 9

29. S Pbprice buyers pay Tax = $1.00 P0 C PS price producers get D Q1 Q0 Incidence of a Specific Tax Price B A D Quantity Chapter 9

30. Incidence of a Specific Tax • In the previous example, the tax was shared almost equally by consumers and producers • If demand is relatively inelastic, however, burden of tax will fall mostly on buyers • If supply is relatively inelastic, the burden of tax will fall mostly on sellers Chapter 9

31. D S Pb S t Pb P0 P0 PS t D PS Q1 Q0 Q1 Q0 Impact of Elasticities on Tax Burdens Burden on Buyer Burden on Seller Price Price Quantity Quantity