Download Consequences of Intervening in Competitive Markets Prices Above

Consequences of Intervening in
Competitive Markets
2
Prices Above Equilibrium Result in a
Surplus
S
…
P
Lectures 4 and 5 outline
Surplus
¾ A couple items from the end of last lecture
¾ Supply
S
l and
dd
demand
d
¾ Price controls
¾Price ceiling
¾Price floor
Equilibrium
¾Consumer and producer surplus
D
¾ Excise taxes
Price Below Its Equilibrium Level Creates a
Shortage
3
Quantity supplied
Q
Quantity demanded
¾ Efficiency, Tax revenues, and Who bears the tax?
4
Analyze the (short run) Market for Diet Dr. Pepper if
the Surgeon General Says It Promotes Weight Loss
Price An increase in demand…
S
… leads to a movement
along the supply curve to a
hi h equilibrium
higher
ilib i
price
i andd
quantity
P’
P
D
Q
Q’
D’
Quantity
1
5
Analyze the Orange Market if Florida
has a Wisconsin Winter
S’
A decrease in supply…
Price
Simultaneous Shifts of the Demand and Supply
Curves: Two Examples
…
S
P
P’
P
D
Q’
Q
Bad weather in Florida, and
fruit causes hair loss
… leads
l d to a
movement along
the demand curve
to a higher
equilibrium price
and lower
quantity
Quantity
7
Q falls, P ? (up here)
8
A price ceiling holds prices down – it is a limit,
above which prices cannot go.
†
…
This is a price set by government to prevent a price from
rising to the equilibrium price.
price
Why would government do this?
Perhaps the government worries that necessities, like
housing, are unaffordable.
† Perhaps the government worries that producers are
making “excess” profit (like gas lines in the 1970s).
†
„
There can be clear “winners” in a market with price ceilings (those
who get the commodity at below-market prices).
S
P
Manufacturing
efficiencies and viruses
S
D
Price Ceilings (such as rent control in New York City)
…
S’
…
D’
Q of oranges
S’
S
D’
D
Q of computers
Q ? (up here), P 6falls
A Price Ceiling Example
Rent
Demand Supply
$1,400
1,000
2,000
$1 200
$1,200
1 100
1,100
1 500
1,500
$1,000
1,200
1,200
$800
1,500
1,000
$600
1,800
750
$400
2,100
600
Rent
D
S
1200
800
400
Housing shortage of 500 units
500 1000 1500 2000
Q
2
Price Floors
(such as minimum wage legislation)
Consequences of Price Ceilings
9
10
…
Inefficient allocation to consumers.
†
…
Because of shortages, people may need to spend
abnormally large amounts of time finding the regulated
product.
…
†
…
11
Wages
8.75
$8.75
$
Labor
Labor
Demand Supply
300
500
$8.00
400
400
$7.75
500
300
$7.50
550
200
$7.00
600
100
$6.75
650
50
Policymakers sometimes also appear to have a poor
understanding of the behavior of competitive markets.
Price floors and ceilings may not be binding...
Consequences of Price Floors
S
Unemployment of 200 units
12
…
8.50
Inefficiency
Greater unemployment – people are willing to work and
employers will hire them for less.
† For commodity price floors, there will be surpluses
†
8.00
…
Wasted resources.
†
7.50
†
…
…
200
400
600
Unemployment requires greater job search.
Surplus resources may not be used well.
Illegal activity
†
7.00
6.50
There are influential groups of sellers (i.e., farmers).
Policy-makers dislike market outcomes (low-skilled
people get paid too little).
„
Black markets
D
For example, a minimum wage, if binding, will restrict
wages to falling to their equilibrium level.
Why would government do this?
†
Price ceilings lower incentives to maintain and improve
property.
A Price Floor Example
A price floor holds up a price that would otherwise
fall to the equilibrium wage.
†
Low quality.
†
…
…
Wasted resources.
†
…
Demand reflects willingness to pay. Price ceilings shut many
who would willingly pay, and others who would willingly
supply, out of the market.
“Underground” (or black) market activities.
Inefficiently high “quality” (like textbook airline
example).
Q
3
Lecture 5: Consumer and Producer
Surplus
Consumer Surplus and the Demand
Curve
14
…
…
The demand curve reflects willingness to pay.
†
Lecture 5 outline
¾ A question from last lecture
…
¾C
¾Consumer
and
d producer
d
surplus
l
Individual consumer surplus is the net gain to an
individual buyer from the purchase of a good.
good
†
¾ Excise taxes
¾ Efficiency, Tax revenues, and Who bears the tax?
…
Consumer Surplus
15
16
The willingness to pay is also the marginal benefit from
consumption.
It is equal to the difference between a buyer’s willingness to
pay and the price paid.
Total consumer surplus is the sum of individual
consumer surpluses of all the buyers of the good.
Price Reductions Will Increase
Consumer Surplus
P
P
… etc.
Consumer surplus – the
area under the demand
curve and above the
market price
Consumer surplus at price of $5,000
$5,000
Increase in consumer surplus to
original
i i l buyers
b
Consumer surplus
gained by new buyers
$1,500
D
Quantity of computers
1 million
The total consumer surplus generated by purchases of a good at a
given price is equal to the area below the demand curve but
above that price.
$1,500
200,000
1 million
Quantity of comp
4
Producer Surplus
Producer Surplus and the Supply Curve
17
18
…
…
The supply curve shows the potential seller’s cost
(actually, marginal cost) at which he or she is willing
to sell a good.
Individual producer surplus is the net gain to a seller
from selling a good
good. It is equal to the difference
between the price received and the seller’s cost.
†
P
Producer surplus
S
$5
Total producer surplus in a market is the sum of the individual
producer surpluses of all the sellers of the good.
Quantity of wheat
1 million
The total producer surplus from sales of a good at a given price is
the area above the supply curve but below that price.
19
A Price Increase will Increase Producer
Surplus
P
$7
Total Surplus: Consumer and Producer
Surplus
20
…
Increase in
producer surplus
to original sellers
S
The total surplus generated in a market is the total net
gain to consumers and producers from trading in the
market.
†
$5
Producer surplus
gained by new
sellers
Producer surplus
…
Total surplus is the sum of the producer and consumer surplus.
The maximum
Th
i
ttotal
t l surplus
l iis achieved
hi d att th
the market
k t
equilibrium in a competitive market.
†
In equilibrium there is no way to make some people better
off without making others worse off.
„
1 million
This is the sense in which (competitive) markets are efficient.
1.5 million
Quantity of whea
5
Total Surplus: The Sum of Consumer and
Producer Surplus
Equilibrium and Efficiency
21
Price
175
100
60
S
Consumer
surplus:
0.5*100*75
0.5
100 75 =
3,750
…
…
…
Producer surplus:
0.5*40*100 =
2,000
100
D
…
Quantity
Total surplus is therefore 5,750
An Application of Consumer and
Producer Surplus: Taxes
23
…
A tax causes a deadweight loss to society, because
less to the good is produced and consumed than in
the absence of the tax.
…
Sales are allocated to those who
most value the sales.
Each consumer values the purchase P
D
S
more than every producer who
provides it.
Producing less than the
Those who do not make a
equilibrium Q implies the
purchase value the good less than value that people place on
every potential seller who does not the last unit exceeds the Q
make a sale.
cost of producing it.22
Deadweight Loss of an Excise Tax (Area of
a Triangle, ½*B*H)
24
P
Some mutually beneficial trades between producers and
consumers do not take place.
125
Good economic policymaking should, all else being
equal, seek to minimize deadweight loss.
Taxes imposed on goods with inelastic demand
and/or supply, will lead to small reductions in
quantities and, therefore, in a small deadweight loss.
100
†
…
Producing more than
equilibrium Q implies the cost
of producing the last unit
Those who value the goods most exceeds the value people place
on it.
highly receive them.
75
S’
S
Reduction in consumer surplus:
25*90+0.5*60*25=3000
Increase in government tax
revenue: 50*90=4500
DWL: 0.5*50*60=1500
Reduction in producer surplus:
25*90+0.5*60*25=3000
D
90
150
Deadweight loss is the sum of the green triangle and Q
the purple
triangle – the loss in producer and consumer surplus that exceeds
the increase in tax revenue
6
25
Effects of an Excise Tax Levied on Cab
Drivers
S’
Price
P
Price
S
Price paid by consumers
Shaded rectangle is
the tax revenue
collected by
government
tax
26
Effects of an Excise Tax Levied on
Those Who Ride Cabs
Price received by producers
S
Price paid by consumers
P
Shaded rectangle is
the tax revenue
collected by
government
Tax
Price received by producers
D
Q’
Q
Quantity
What is the incidence of this tax?
27
Q’
Q
D’
D
Quantity
The results are identical to the previous example
Key Concepts in the Analysis of
Taxation and Price Controls
…
Incidence
†
…
Who bears the tax. It is not necessarily the person who
writes the check!
Efficiency (or deadweight loss or excess burden)
The iinefficiency
Th
ffi i
th
thatt results
lt b
because th
the ttax di
discourages
mutually beneficial transactions.
† Taxes drive a wedge between the price that consumers pay
and that producers receive.
†
…
Tax revenue
†
The average tax rate times the quantity that is consumed at
the new equilibrium.
7