Transcript Supply and Demand: Applications and Extensions

The Pizza Demand Curve
• The demand for frozen pizzas
reflects the law of diminishing
marginal utility.
• Because marginal utility (MU)
falls with increased consumption,
$3.50
so does a consumer’s maximum
willingness to pay -- marginal
$3.00
benefit (MB).
• A consumer will purchase Price =$2.50
$2.50
until
MB = Price . . .
so at $2.50 $2.00
they would purchase 3 frozen
pizzas and receive a consumer
surplus shown by the shaded
area (above the price line and
below the demand curve).
MB4
MU4
< MBbecause
< MB <MB
< MU < MU <MU
3
2
1
3
2
1
John’s demand curve
for frozen pizza
MB
1
MB
MB
2
3
MB
4
d = MB
Frozen
pizzas
per week
1 2 3 4
Consumer Surplus
The total difference between what a
consumer is willing to pay and how much they
actually have to pay.
Producer Surplus
The total difference between what a supplier
is willing to provide a good or service and how
much they actually get for it.
What Consumer Surplus and Producer Surplus Measure
Consumer surplus measures the net benefit to consumers from
participating in a market rather than the total benefit.
Consumer surplus in a market is equal to the total benefit
received by consumers minus the total amount they must pay to
buy the good or service.
Similarly, producer surplus measures the net benefit received by
producers from participating in a market.
Producer surplus in a market is equal to the total amount firms
receive from consumers minus the cost of producing the good or
service.
Producer and Consumer Surplus
Marginal Cost to Producer equals
Marginal Benefit to Consumers
P
$10
9
8
7
6
5
4
3
2
1
Consumer surplus =
area of blue triangle =
½($5)(5) = $12.5
S
Producer surplus =
area of red triangle =
½($5)(5) = $12.5
CS
PS
D
0 1 2 3 4 5 6 7 8
Q
The combination of
producer and consumer
surplus is maximized at
market equilibrium
Inefficiency
P
$10
9
8
7
6
5
4
3
2
1
At Q = 3, consumers want
more, and producers want
to supply more
S
At Q = 8, consumers want
less and producers are
willing to supply less.
CS
PS
Only at equilibrium are
producer and consumer
surplus maximized.
D
0 1 2 3 4 5 6 7 8
Q
Deadweight loss is the reduction in economic surplus resulting from a
market not being in competitive equilibrium.
Economic surplus is maximized when a market is in competitive equilibrium.
When a market is not in equilibrium, there is a deadweight loss.
When the price of chai tea is $2.20 instead of $2.00, consumer surplus declines from
an amount equal to the sum of areas A, B, and C to just area A.
Producer surplus increases from the sum of areas D and E to the sum of areas B
and D.
At competitive equilibrium, there is no deadweight loss.
At a price of $2.20, there is a deadweight loss equal to the sum of areas C and E.
Consumer Surplus
Price
5
4
3
2
1
2nd
3rd
4th
1st
Quantity
1
2
3
4
5
If the selling price is 3, the consumer
surplus for the 1st item is 5-3=2, plus
4-3=1 for the 2nd and 3-3=0 for the 3rd,
or 3
Government Intervention in
the Market:
Price Controls
1. Price Floors
• Price floor is a legally established minimum
price that buyers must pay.
• It stops the price from dropping down to
equilibrium level.
• Example: minimum wage
• The direct effect of a price floor above the
equilibrium price is a surplus: quantity
supplied exceeds quantity demanded.
The Impact of a Price Floor
Price
• A price floor like P1 sets a
price above market equilibrium
P1
causing quantity supplied QD …
S
Surplus
Price
floor
to exceed quantity demanded QS
P0
…
resulting in a surplus.
•Non-price factors will become
more important than prices in
determining where scarce
goods go.
D
QD
QS
Quantity
Minimum Wage Effects
• Direct effect:
• Reduces employment of low-skilled labor.
• Indirect effects:
• Reduction in non-wage component of
compensation.
• Less on-the-job training.
• May encourage students to drop out of
school
• A higher minimum wage does little to help
the poor.
Employment and the Minimum Wage
• If a price (wage) of $4.00
could bring equilibrium.
Price
(wage)
Excess
supply
• A minimum wage (price floor) $ 5.15
of $5.15 would increase the
earnings of those who stayed
employed (E1), but would reduce
the employment of others.
$ 4.00
S
Minimum
wage level
• Those who lose their job (E0
to E1) would be pushed into
either unemployment or some
other less preferred form of
employment.
D
E1
E0
Quantity
(employment)
2. Price Ceilings
• Price ceiling is a legally established
maximum price that sellers may charge.
• It stops the price from rising to the
equilibrium level.
• Example: rent control
• The direct effect of a price ceiling is a
shortage: quantity demanded exceeds
quantity supplied.
The Impact of a Price Ceiling
Price
(rent)
• In the rental housing
market the price (rent) P0
would bring the quantity
of rental units demanded
into balance with the
quantity supplied.
• A price ceiling like P1sets a
price below equilibrium …
quantity demanded QD …
exceeds quantity supplied QS
…
resulting in a shortage.
S
Rental housing
market
P0
Price
ceiling
P1
Shortage
D
QS
QD
Quantity of
housing units
Effects of Rent Control
• The future supply of housing will decline.
• The quality of housing will deteriorate.
• Non-price methods of rationing will
increase in importance.
• Long-term renters will benefit at the
expense of newcomers.
The Impact of a Tax
Tax Incidence
• Who pays a tax is called the incidence.
Buyer
Seller
Impact of a Tax Imposed on Sellers
Price
• If in the used car market a price
of $7,000 would bring the
quantity of used cars demanded
into balance with the quantity
supplied.
• When a $1,000 tax is imposed on
sellers of used cars, the supply
curve shifts vertically by the
amount of the tax.
• The new price for used cars is
$7,400 … sellers netting $6,400
($7,400 - $1000 tax).
• Consumers end up paying $7,400
instead of $7,000 and bear $400
of the tax burden.
• Sellers end up receiving $6,400
(after taxes) instead of $7000 and
bear $600 of the tax burden.
S plus tax
S
$7,400
$7,000
$1000 tax
$6,400
D
500
750
# of used cars
per month
(in thousands)
Impact of a Tax Imposed on Buyers
Price
• In the same used car market:
• When a $1,000 tax is imposed on
buyers of used cars, the demand
curve shifts vertically by the
amount of the tax.
S
$7,400
$7,000
• The new price for used cars is
$6,400 … buyers then pay taxes
$6,400
of $1000 making the total $7,400.
• Consumers end up paying $7,400
(after taxes) instead of $7,000 and
bear $400 of the tax burden.
• Sellers end up receiving $6,400
instead of $7000 and bear $600
of the tax burden.
$1000 tax
D
D minus tax
500
750
# of used cars
per month
(in thousands)
Elasticity and
Incidence of a Tax
• The actual burden of a tax depends on the
elasticity of supply and demand.
• As supply becomes more inelastic,
then more of the burden will fall on sellers.
• As demand becomes more inelastic,
then more of the burden will fall on buyers.
Tax Burden and Elasticity
• Consider the market for Gasoline
and Luxury Boats individually.
• We begin in equilibrium.
• If we impose a $.20 tax on gasoline
suppliers, the supply curve moves
vertically the amount of the tax.
Price goes up $.15 and output falls
by 6 million gallons per week.
• If we impose a $25K tax on Luxury
Boat suppliers, the supply curve
moves vertically the amount of
the tax. Price goes up by $5K and
output falls by 5 thousand units.
• In the gas market, the demand is
relatively more inelastic than its
supply; hence, buyers bear a larger
share of the burden of the tax.
• In the luxury boats market, the
supply curve is relatively more
inelastic than its demand; hence,
sellers bear a larger share of the
tax burden.
Price
Gasoline
market
S plus tax
$1.65
$1.60
$1.55
$1.50
$1.45
S
D
Quantity
(millions
of gallons)
194 200
Price
(thousand $)
S plus tax
S
110
Luxury boat
market
100
90
D
80
Quantity
5
10
15
(thousands
20 of boats)
1.
Which of the following is a major disadvantage of setting
the price of a good below equilibrium and using waiting in line
rather than price to ration the good?
a.
Compared to price rationing, waiting in line is unfair since
it is easier for those with higher incomes to wait in line.
b.
Waiting in line imposes a cost on the consumer; paying
higher prices does not.
c.
Both waiting in line and higher prices are costly to
consumers, but unlike the payment of a higher price, waiting in
line does not provide suppliers with an incentive to expand future
output.
d.
Waiting in line benefits consumers at the expense of
producers.
2.
When a price floor is above the equilibrium price,
a.
quantity demanded will exceed quantity supplied,
so there will be a shortage.
b.
quantity supplied will exceed quantity demanded,
so there will be a surplus.
c.
the market will be in equilibrium.
d.
This is a trick question because price floors are
generally set below the equilibrium price.
3. Rent control applies to about two-thirds of the private
rental housing in New York City. Economic theory suggests
that the below-equilibrium prices established by rent controls
would
a.create a surplus of rental housing.
b.promote a rapid increase in the future supply of housing.
c. result in poor service and quality deterioration of many
rental units.
d.lead to a reduction in housing discrimination against
minorities.
4. Which of the following is the most likely result of an
increase in the minimum wage?
a.an increase in the employment of unskilled workers
b.a decrease in the number of workers seeking minimum
wage jobs
c. an increase in the demand for unskilled workers
d.a decrease in the employment of unskilled workers
5.
The benefit of a subsidy will go primarily to sellers
when the
a.
demand for the product is highly inelastic and
supply is relatively elastic.
b.
demand for the product is highly elastic and
the supply is relatively inelastic.
c.
subsidy is legally (statutorily) granted to the
seller of the product.
d.
subsidy is legally (statutorily) granted to the
buyer of the product.
6.
If there was an increase in the excise tax imposed
on beer suppliers, what would be the effect on the
equilibrium price and quantity of beer?
a.
price increases; quantity decreases
b.
price decreases; quantity decreases
c.
price increases; quantity increases
d.
price decreases; quantity increases
7.
The more elastic the supply of a product, the more
likely it is that the
a.
burden of a tax on the product will fall on sellers.
b.
burden of a tax on the product will fall on buyers.
c.
burden of a tax on the product will fall equally on
both buyers and sellers.
d.
deadweight loss of the tax will be smaller.