Transcript Chapter 9

Chapter 9
• Use tools of competitive markets to
analyze effects of government
intervention.
• Tools (See Figure 9.1):
• Consumer Surplus = CS:
– Difference between willingness to pay
and market price.
– Area above price line but below
demand curve.
• Producer Surplus = PS:
– Difference between willingness to
supply and market price.
– Area below price line but above supply
curve.
Welfare Effects
• Overall effects of government
policies:
– Welfare Effects: Gains/losses in
produce and consumer surplus caused
by government intervention.
• Effect of Price Ceiling (Pmax): see
CS/PS both before and after ceiling;
–
–
–
–
See Figure 9.2.
CS won and lost
PS won and lost
Deadweight Loss: See loss that “goes”
to noone.
– Importance of elasticity: Figure 9.3.
Economic Efficiency
• Economic Efficiency:
– Maximization of aggregate PS and CS.
– Can use economic efficiency as gauge
to evaluate a market.
• Government intervention reduces
economic efficiency.
– So why intervene?
• To make necessary goods more affordable.
• To reduce consumption of “bad” goods.
• To reduce impact of market failure.
Market Failure
• Market Failure: when market
fails to generate an efficient
outcome.
• Two common causes:
– 1) Externalities : when costs not
fully borne by producer; benefits
not fully borne by consumer.
• Examples: pollution; education.
– 2) Lack of information.
• Example: child care; bank loans
– One solution to lack of information
with bank loans is truth in lending
laws.
Price Floors
(Minimum Prices)
• Price floor:
– Examples:
• Wmin
• Agricultural price supports
– Alters market outcome if
Pmin > P*.
• See Figure 9.7:
– See change in CS and PS.
– Deadweight loss.
Impact of a Tax
• Key Point: What is impact of tax
on final price? NOT true that final
price = initial price plus the tax.
• Example: per unit tax (excise tax);
– See Qsold, Pb, Ps, and t.
– Note: Pb – Ps = tax.
– See Figure 9.17.
• Burden of tax:
– shared by sellers and buyers;
– how shared determined by relative
elasticities of S and D.
– Pass-through fraction = Es/(Es-Ed)
• Tells fraction of tax “passed thru” to
buyers in form of higher prices.
– In general: a tax falls mostly on buyer
if Ed/Es is small and mostly on the
seller if Ed/Es is large.
Show Tax w/Algebra
(Example 9.6)
• Terms:
– Pb : price paid by buyers
– Ps : price received by sellers
– Po : no-tax price
• Example:
Qd = 150 – 50Pb
Qs = 60 + 40Ps
t = 0.50; Pb – Ps = 0.50.
• Approach: Replace Pb with
Ps+0.50; set Qd=Qs and then solve
for Ps; Then solve for Pb and Q.
– See difference if there had been no tax.
– Buyers’ tax burden = Pb – P0.
– Sellers’ burden = P0 – Ps.
Exercise: Tax
• Given S & D of wickets:
Qs = -800 + 15P
Qd = 3200 – 25P
• 1. What is market equilibrium price
and quantity?
• 2. Now impose per unit tax of $20
on consumers. What is new Pb, Ps,
quantity, and tax revenue. Answer
with algebra and graph.
• 3. Show es in CS, and PS, and the
deadweight loss.
• 4. In general, how do es in Pb, Ps
relate to S & D elasticities? Explain.
Subsidy
(See Figure 9.19)
• Treat subsidy like negative tax.
• With subsidy: sellers’ price exceeds
the buyers’ price and difference
between the two is the subsidy.
• Approach:
– Start at equilibrium P and Q; impose
subsidy.
– Find Q that makes Ps – Pb = S.
– Result is higher quantity sold (opposite
of effect of tax).
• General rule: the benefit of a
subsidy accrues mostly to buyers if
Ed/Es is small and mostly to sellers if
Ed/Es is large..