Download Lecture 5 - Cal Poly Pomona

EC 201
Cal Poly Pomona
Dr. Bresnock
Lecture 5 Market Efficiency and Inefficiency
Graph 1
Market Equilibrium and Adjustment to a Surplus
Graph 2
Market Equilibrium and Adjustment to a Shortage
EC 201
Dr. Bresnock
Lecture 5
Price Controls -- one form of government intervention in markets. There are two types of price
controls, PC.
1)
Price Ceilings -- For an effective price ceiling to work, it is set so that the market price will not
rise above PC.
Graph 3
Price Ceiling vs Market Equilibrium (Ex. Rent control)
Price Ceilings:
Quantitative Effects
(a)
Shortage at PC
(b)
Misallocation of Resources = Too Little Offered = QE - QS
(c)
↓TR to Seller --
Price Ceilings:
TR @ Eq. = PE x QE
- TR @ PC = PC x QS
Unintended Consequences
(a)
↓ Quality – deterioration of units, lack of upkeep
(b)
↑ Search Costs – other charges
(c)
↓ Gains from Trade = Deadweight Loss
(d)
Resources do not Flow to Highest Valued Uses – the QS units may flow to high or low
valued uses
(e)
Conversion to Condo
(f)
↓ Incentive to Build New Apartments
(g)
↑ Illegal Activity -- bribery
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EC 201
Dr. Bresnock
2)
Lecture 5
Price Floor -- For an effective price floor to work, it is set so that the market price will not fall
below PC .
Graph 4
Price Floor vs Market Equilibrium (Ex. Agricultural price supports, U.S. and EU)
Price Floors -- Quantitative Effects
(a)
Surplus at PC
(b)
Misallocation of Resources = Too Much Offered
(c)
↑ TR to Seller = TR @ PC = PC x QS
- TR @ Eq. = PE x QE
Price Floors -- Unintended Consequences
(a)
↑ Quality -- but inefficiently high
(b)
↓ Gains from Trade = Deadweight Loss
(c)
↑ Government Purchase and Storage Costs – opportunity costs
(d)
Dumping Surplus Abroad
(e)
Payments to Farmers Not to Plant – or to restrict acreage, burn the surplus
(f)
↑ Environmental Costs
(g)
↑ Illegal Activity
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EC 201
Dr. Bresnock
Lecture 5
Consumer Surplus (CS) -- the difference between the maximum amount that a person is willing to
pay for each unit of a good and its current market price.
Graph 5
Consumer Surplus
$
8
7
6
5
4
0
CS = $3 + $2 + $1 = $6
Market Price
D = MB
1
2
3
4
5
Quantity (discrete measurement)
$
10
CS = ½ ($7 x 8) = ½ ($56) = $28
3
0
Market Price
2
4
6
D = MB
10
8
Quantity (continuous measurement)
Producer Surplus – the difference between the current market price and the minimum price at which a
producer would be willing to sell each unit of a good.
Graph 6
Producer Surplus
PS = $1 + $2 + $3 + $4 = $10
$
7
6
5
4
3
2
1
S = MC
Market Price
Quantity (discrete measurement)
0
1
2
3
4
5
6
4
EC 201
Dr. Bresnock
Graph 6
Lecture 5
Producer Surplus (cont.)
PS = ½ ($2 x 8) = ½ ($16) = $8
$
S = MC
3
Market Price
1
Quantity ( continuous measurement)
0
8
How Do Producer and Consumer Surplus Relate to Market Efficiency?
Graph 7
Allocative Efficiency = MB = MC
$
A
S = MC
At QE : CS = APEC
PS = EPEC
C
PE
E
D = MB
Q
0
NOTE:
QE
At QE total net benefits to society are maximized. Total net benefits to society are CS
plus PS, or AEC. Total net benefits are also referred to as total surplus.
In the next two sections, underallocation of resources (MB > MC), and overallocation or
resources (MC > MB) will be presented and examples for each will be examined. When
under- or overallocation of resources occur, society does not maximize total net benefits.
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EC 201
Dr. Bresnock
A.
Lecture 5
Underproduction = MB > MC
Graph 8
Total Net Benefits to Society are not maximized
Inefficiency of Underproduction
$
A
S = MC
Buyer’s New P =H
B
PE
F
Seller’s New P = G
I
At QE : CS = APEC
PS = EPEC
C
At Q1: CS = APEF
PS = EPEFI
DW Loss = BCI
E
D = MB
Q
0
Q1
QE
Dead Weight Loss (DW) -- the decrease in consumer surplus (CS) and producer surplus (PS)
from producing an inefficient quantity of a good. DW represents a social loss to society.
Causes of Underproduction: Obstacles to Allocative Efficiency
1)
Price Ceiling (Ex. Rent Control)
Graph 9
Inefficiency of Price Ceiling (PC = G)
At PC: Shortage = Q2 – Q1 = DF
Too Little Produced = QE – Q1
Rent $
A
S = MC
Buyer’s New P =H
B
At PE : CS = APEC
PS = EPEC
C
PE
Seller’s New P = G
I
F
E
0
D = MB
Q1
QE
Q2
At PC: CS = AHB
PS = EGI
DW Loss = BCI
Max Total Search Costs = HGBI
Max Unit Search Costs = HG = BI
Q = Rental Units
Note: At Q1 the MB > MC, total net benefits to society are not maximized. If search costs = 0, then
CS = HGBI + AHB.
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EC 201
Dr. Bresnock
2)
Lecture 5
Taxes
Graph 10
Inefficiency of Taxes
Too Little Produced = QE – QE´
$
S´= S + Tax
S = MC
A
B
Buyer’s New P = H
PE
Seller’s New P = G
At QE : CS = APEC
PS = EPEC
C
I
E
At Q1: CS = AHB
PS = EGI
DW Loss = BCI
Total Tax Revenue = HGBI
Tax per Unit = BI = HG
D = MB
Q
0
QE´
QE
Note: At QE´ the MB > MC, total net benefits to society are not maximized. This is a producer-side
tax, like an excise tax. Tax incidence depends on the elasticities of supply and demand.
Graph 11
Inefficiency of Taxes (cont.)
Too Little Produced = QE – QE´
$
A
S = MC
Buyer’s New P =H
PE
At QE : CS = APEC
PS = EPEC
B
C
At Q1: CS = AHB
PS = EGI
DW Loss = BCI
Total Tax Revenue = HGBI
Tax per Unit = BI = HG
Seller’s New P = G
I
E
0
D = MB
D´ = D - Tax
QE´
QE
Q=
Note: At QE´ the MB > MC, total net benefits to society are not maximized. This is a consumer-side
tax, like an excise tax. Tax incidence depends on the elasticities of supply and demand.
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EC 201
Dr. Bresnock
Graph 12
Lecture 5
Tax Incidence (or tax Burden) on Seller
$
S
S + Tax
S
PE
D
PE
PE - Tax
D
0
Q
0
Q E´
QE
Q
Note: In both cases above, the entire tax incidence, or tax burden, falls on the producer. In both cases
the TR will decrease as a result of the tax. As noted in your text, the more relatively inelastic the supply
(relative to demand), and the more elastic the demand (relative to supply), the greater the tax incidence
that is places on the producer. See your text for the less extreme examples and graphs.
Graph 13
Tax Incidence (or Tax Burden) on Buyer
$
$
D
S + Tax
S
PE + Tax
S + Tax
PE
PE + Tax
S
PE
D
0
QE ´
QE
Q
0
QE
Q
Note: In both cases above, the entire tax incidence, or tax burden, falls on the consumer. As noted in
your text, the more relatively inelastic the demand (relative to supply), and the more elastic the supply
(relative to demand), the greater the tax incidence that is places on the consumer. See your text for the
less extreme examples and graphs.
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EC 201
Dr. Bresnock
3)
Lecture 5
Quotas – A quota is a quantity control and is represented as Q1 below.
Graph 14
Inefficiency of Quotas
Too Little Produced = QE – Q1
$
Quota
A
S = MC
Buyer’s New P =H
B
PE
F
Seller’s New P = G
I
At QE : CS = APEC
PS = EPEC
C
E
0
At Q1: CS = AHB
PS = GIE
DW Loss = BCI
Total Max Quota Rent = HGBI
Unit Max Quota Rent = HG = BI
D = MB
Q1
QE
Q
Note: At Q1 the MB > MC, total net benefits to society are not maximized.
4)
Minimum Wage (WM, or PC) -- leads to less hiring than at the competitive market wage. The
supply of labor (SL) comes from the employees, and the demand for labor (DL) comes from the
employers. Note that the CS is the Firm’s Surplus in this application, and the PS is the
Worker’s Surplus. Although more workers will want to work at the minimum wage, less than
the equilibrium amount will be hired at the minimum wage.
Graph 15 Inefficiency of Minimum Wage
Unemployment at PC = Q2 – Q1
Too Few Hired at PC = QE – Q1
Wage $
A
SL = MC
PC = H
WM
B
PE
G
At PE : CS = APEC
PS = EPEC
C
I
At PC: CS = AHB
PS = EGI + HGBI
(If no search costs)
DL = MB
PS = EGI
(If search costs = HGBI)
Q = Labor DW Loss = BCI
E
0
Q1
QE
Q2
Note: At Q1 the MB > MC, total net benefits to society are not maximized.
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EC 201
Dr. Bresnock
Lecture 5
5)
Monopoly -- market controlled by one firm. Same graph as quota graph in (3). Competitive
market produces too little.
B.
Overproduction = MC > MB
Graph 16
Inefficiency of Overproduction
$
A
S = MC
B
At QE : CS = APEC
PS = EPEC
C
PE
F
At Q2:
I
E
CS = APEC
+ PS = EPEC
MINUS DW Loss = BCI
D = MB
0
QE
Q2
Q
Note: At Q2 the MC > MB, total net benefits to society are not maximized.
Causes of Overproduction: Obstacles to Allocative Efficiency
1)
Price Floor (PC) (ex. Agricultural Price Supports)
Graph 17
Inefficiency of Price Floor
Surplus = Q2 – Q1
Too Much Produced = Q2 - QE
$
A
S = MC
F
B
Gov’t Buys at = PC
At PE : CS = APEC
PS = EPEC
C
PE
At PC:
Gov’t Sells at = G
CS = AGI
+ PS = EPCB
MINUS DW Loss = BCI
I
E
D = MB
0
Q1
QE
Q2
Q
Total Subsidy = PCGIB
Per Unit Subsidy = PCG= BI
Note: At Q2 the MC > MB, total net benefits to society are not maximized. All other subsidies see
price floor example above.
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