Policy Analysis - Economics
Transcript Policy Analysis - Economics
• Welfare Analysis
– Consumer surplus
– Producer surplus
• Welfare consequences of minimum wage
• Wage subsidy as alternative to minimum
• Tortillas as a Cautionary Tale
• A situation is economically inefficient if there is
some way to change it so that so that someone
gains while no one else loses.
• A change is a Pareto improvement if at least one
person gains and no one loses
• A change is economically efficient if the winners
could compensate the losers by enough to make
the change a Pareto improvement.
“Willingness to Pay” = Consumer Benefit
“Willingness to Sell” =Opportunity Cost
Consumer Surplus -- Difference
between Willingness to Pay and Price
Paid by Buyer
Consumer Surplus Is Triangle Below Demand,
Above Market Price.
Producer Surplus- Difference Between
Opportunity Cost and Selling Price
Consumer and Producer Surplus - Market
Impact of Price Floor on Efficiency
A -- New CS
A+B+E -- Old CS
B+C+D -- New PS
C+F+D -- Old PS
Market clearing price
E+F is deadweight loss associated with the price floor.
Impact of Price Ceiling on Efficiency
A+B+C -- New CS
A+B+E -- Old CS
D -- New PS
C+D+F -- Old PS
Market Clearing Price
E+F is the Deadweight Loss Associated with Price Ceiling
• Market Equilibrium is Efficient. No
• Price controls create a deadweight loss
• Also, there are costs associated with
rationing mechanisms, black markets etc.
Impact of $12 Minimum Wage
$2 Wage Subsidy
• If demand is elastic,
• Benefits accrue to
workers who stay
• Costs borne by
• Wage subsidy
• Benefits shared by
• Subsidy funded from
Subsidy Benefits Employers and Workers
Impact of Subsidy on Efficiency
A+B+F+E = CS after Subsidy
A+B = CS before Subsidy
B+C+F+G = PS after Subsidy
F+G= PS before Subsidy
B+C+D+E+F = Subsidy
D=Deadweight Loss from Subsidy
Pre Subsidy Price
Pre Subsidy Q
On New Year’s Day 1999, Mexico ended price
controls on tortillas. The price stood at 3 pesos
per kilo (31 cents for 2.2 pound stack). Some
shops immediately raised their prices by 50%. In
1998, the government phased out subsidies to the
tortilla industry that helped keep prices down.
The tortilla subsidy was replaced with programs
such as one that gives the 1.2 million poorest
Mexicans free tortillas each day.
Source: Smith, James, Los Angeles Times, Jan 7, 1999
• What does the price increase suggest about
the elasticity of demand for tortillas?
• How does the impact of a subsidy to
consumers differ from the impact of a
subsidy to producers?
• What are the advantages of price controls
as compared with subsidies?
Elasticity of Demand for
Kilos of tortillas
Subsidy to Producers
Subsidy to Consumers
If All Consumers Received Subsidy:
• If all consumers receive the subsidy, output
• Price producers receive is same in two cases
• Price consumers pay is same in two cases
Disadvantages of Subsidies
• Control of subsidies by local bureaucrats
created opportunties to exploit subsidies for
political ends. Price controls anonymous.
• Consumers not eligible for subsidies, but
still relatively poor will pay a higher price
• Impact of price controls and of subsidies
depends on elasticity of demand (and
• Price floors lead to surpluses. Price ceilings
• Price controls lead to a deadweight loss.