Transcript Ch9
Chapter 9: Applying the Competitive Model • So far we learned how the equilibrium (P*, Q*) is reached. • In this chapter, we learn that at equilibrium, how welfare is distributed among market participants. • Economists use “surplus” to mean “welfare.” Consumer Welfare • Demand curve = consumer’s marginal willingness to pay or the maximum amount of money consumer will spend for an extra unit of good. • Consumer surplus: The maximum amount of money a consumer is willing to pay minus actual amount of payment. This is the difference between area under the demand curve and the total payment. Measured in dollars. Maximum prices (r) consumer will pay, actual price (p), and consumer’s surplus Price Price r1 r1 r2 r2 r3 r3 p r4 r5 r6 1 2 3 4 5 r4 r5 r6 6 1 Quantity 2 3 4 5 6 Quantity Approximating a continuous demand Price Price p p x Quantity x Quantity Is the Concept of Consumer Surplus Intuitively Acceptable? • Suppose one bottle of coke costs 100 yen. And you consume 10 bottles per month. • Now, Coca Cola company has raised the price of coke to 120 yen. • QUESTION: How much do you lose as a consumer per month? 20 yen x 10 bottles? Or smaller than this? • Is it reasonable to expect that given a change in price, a change in consumer surplus is larger, the more inelastic the demand curve is? Change in consumer’s surplus Producer Welfare • Supply Curve = how much producers wish to supply at each price. • Supply curve measures at least how much producer needs to receive for each additional unit of the good or service supplied. • Producer Surplus: Actual revenue minus the minimum revenue the producer has to receive. • What is the area under the supply curve? Producer Surplus and Profit A) PS = R – VC π = R – C = R – VC – FC = PS – FC B) Integration Q* PS MC (q)dq [VC(q) FC]Q0 * 0 VC (Q*) FC 0 FC VC (Q*) C) In the long-run, there is no fixed cost, then PS=π. Competition Maximizes Welfare! Social welfare = CS + PS Analyzing effects of policies • Welfare measures are helpful in studying the impacts of government policies or other events that may shift the competitive equilibrium. Welfare Effect of Specific Tax Restriction on the Number of Cabs (1) Number of cabs is restricted to be n2. (2) Because of a high demand, each cab works a longer hours, i.e., q2> q1 , which increases the MC. (3) Thus, the supply curve (S2) has an up-ward slope. Restriction on the Number of Cabs Price Support Policy (1) The government sets the support price and force consumers to pay for the price. (2) Because the support price is high, there will be an excess supply, which will be purchased by the government. (3) The excess supply will simply be stored or used as food aid. Consumers buy at the support price The excess supply: the government buys at the support price Price Support Policy Alternative Price Support (Deficiency Payment) (1) The government sets the support price but allow consumers to pay at a market price, i.e., p2. • ?? (2) The government pays the deficiency to producers. (3) Because the support price is higher than the competitive price, the quantity produced is larger than the competitive quantity. • ?? Alternative Price Support (Deficiency Payment) Price Ceiling 9.6: Comparing Both Types of Policies: Imports • Types of policies used by governments: – Allow free trade – Ban all imports – Set a positive quota – Set a tariff Loss from Eliminating Free Trade Effect of a Tariff or Quota