Download Microeconomics Unit 1

Microeconomics
Unit 1
Chapters 4-7
Consumer Surplus
o Willingness to pay
• Maximum price a consumer is willing to buy
o Individual consumer surplus- is the net gain to an individual buyer for the
purchase of a good. It is the difference of the buyers willingness to pay and
price paid.
o Consumer Surplus - Is the sum of the individual consumer surpluses of all buyer
in a market
P
Consumer
Surplus
P
Consumer
Surplus
½ base * Height
Price
Q
Q
Increase/Decrease in
Consumer Surplus
P
Original consumer surplus
Added Consumer surplus for original
buyers
Price 1
Consumer surplus gained
by new buyers
Price 2
Demand
Q
Producer Surplus
•
•
Cost - the lowest price at which a seller is willing to sell a good
Individual producer surplus – the net gain to an individual seller from selling a
good. It is equal to the difference between the price received and the seller
cost.
o Total Producer surplus – in a market is the sum of the individual producer
surplus of all sellers in a market.
PRODUCER SURPLUS
P
PRICE
PRICE
PRODUCER
SURPLUS
½ BASE *
HEIGHT
Q
Gains from trade
P
S
CS
TOTAL
SURPLUS
PS
Q
This illustrates gains from trade, both buyers and sellers are better off
Because of the market.
Efficiency of markets
• Markets produce gains from trade.
• Markets are many times efficient
o That once a market has produced gains
from trade, there is no way to make some
people better off without making other
people worse off.
o Consumer and produce surplus show this.
o Ex. If there was committee was devised to increase total surplus away
from market equilibrium by deciding who gets and who gives up a good.
• Reallocate consumption among consumers
• Reallocate sales among sellers
• Change the quantity traded.
Efficiency of markets
• Reallocate consumption among consumers
o Or taking a good away from one consumer and giving it to another who
may have a lower willingness to pay
o Reduces consumer surplus.
P
S
Loss of consumer surplus
Equilibrium price
D
Q
Efficiency of markets
• Reallocate sales among sellers: the committee might try to increase total
surplus by taking sales away from sellers who would of sold their goods
in the market equilibrium and instead compelling those who would not
have sold their goods.
S
P
Loss in producer surplus
D
Q
Efficiency of markets
Change the quantity traded: the committee will try to either compel people to buy
more goods or less goods than the market equilibrium quantity.
P
Prevented from sale
S
Forced sale
Possible loss of total surplus
Possible
Loss of
Total Surplus
D
Q
Why Governments Control markets
• Political pressure to intervene in markets
o Regulate price or Price controls
• Price ceiling – upper limits
• Price Floor – lower limits
o There are always side effects of Price Controls in efficient markets
o Price Ceiling typically imposed during crisis
• War, poor harvest, natural disaster,
o WWII, rubber, steel, oil, Rent control in NYC.
P
S
EP
Q
• Dead weight loss: Loss of surplus due to
action or policy that reduces quantity
transacted below the efficient level
• Loss to society because there is a loss in
surplus that accrues to no ones gain.
• EX. Rent control: not all renters make
out only the ones with rent control
apts.
D • Producer surplus is lost due to lower
price
Price controls
• Inefficient allocation to consumers
o People who need a place to live may not be able to find one
o Those who have one may have less urgent needs.
• Wasted resources
o People expend money, effort, and time to cope with the shortages
caused by price ceilings.
• Ex. Gas shortage in the 1970’s : hours lost in waiting on gas lines
• Inefficiently Low Quality:
o Sellers offer low quality goods at a low price even though buyers would
rather have higher quality and are willing to pay a higher price for it.
• Ex. Rent control: Landlords have no incentive to provide better
conditions because they cannot raise rents but can find tenants
easily.
• Black market
o Illegal activity
• Illegal subletting by tenants.
So Why Price Ceilings
• They do benefit some people.
• Also, when price ceiling have been in effect for a
long time, buyers may not have a realistic idea of
what would happen without them.
• Lastly government officials often do not understand
supply and demand analysis.
Price Floors
• Price Floor- Lowest price you can pay.
o Agriculture
o Minimum Wage
• Used to help some but generate predictable + Undesirable side effects
o Not always
o Must be above equilibrium price (not Binding)
S
P
D
Q
If Binding what happens
• Depends Gov’t policy
Price floor
• Gov’t buys surplus
• Must find a way to unload
produce
Price Floors
• How do Price Floors cause inefficiency
o Creates Dead weight loss – It lowers the amount being sold below
equilibrium quantity creation dead weight loss.
S
P
Price Floor
D
Dead weight loss
Q
Price Floors
• Inefficient allocation of sales among sellers
o Ex minimum wage
• Give a job to reluctant worker
• Motivated worker willing to work for less but gets shut out due to
minimum wage
• Wasted Resources
o Governments who buy surplus goods either destroy or goods go bad.
o Can lead to wasted time and effort in finding a job
• Inefficiency of higher quality
o Higher costs to make higher quality of goods
Price Floors
• Why do we have price floors
o Government officials believe that market is poorly described by supply
and demand
o Imposed because of influential sellers
o Gov’t officials don’t understand supply and demand
Controlling Quantity
• Quotas – regulate the quantity of a good that can
be bought and sold
o
o
o
o
Government imposed
Give only the upper limit
Over time hard to revoke
Create dead weight loss.
S
P
Wedge
D
Q
Dead weight
loss.
Elasticity
• Price Elasticity of Demand or Ed
o Law of demand states as price decreases quantity demanded increases
o Elasticity tells us by how much or how sensitive a good or service is to price
change
o Ed = % ^ in quantity demanded / % ^ in Price
• (Q2-Q1)/Q1 divided BY (P2-P1)/P1
• Note law of demand insures that Ed is negative for ease we use the
absolute value.
• If Ed > 1 the good is elastic. Or sensitive to price change
o % ^ in quantity demanded is 2 and %^ in Price is 1 Ed= 2
• Elastic good
• If Ed < 1 the good is inelastic
o %^ in quantity demanded is 1 and %^ in Price is 2 Ed= ½ or .5
• Inelastic good
• If Ed = 1 the good is unitary elastic
o %^ in quantity demanded is 1 and %^ in Price is 1 Ed=1
• Unitary elastic
Elasticity
• Midpoint method USED TO ALLIEVAITE PROBLEMS IN
PERSPECTIVE.
o Change in Quantity demanded/Average of quantity or
• Q2-Q1/(Q1+Q2) /2
o DIVIDED BY
o Change in price/ Average price or
• P2-P1/(P1+P2)/2
o EX Gas price in Europe vs. the U.S.
• European gas price are 3 times more expensive depending on who’s
perspective you are you using will change you numbers in original
• 10-30/30=20/30x100=66.7%
• 30-10/10=20/10x100=200%
Elasticity
• Why does Elasticity matter?
o Helps predict how price change will affect total revenue for a producer.
o Total Revenue = Price x Quantity sold
o Raising prices can either generate more revenue or less depending on
the price elasticity of demand.
• Two effects are present when price rise, unless the good is perfectly
elastic or perfectly inelastic
o Price effect after a price increases, each unit sold sell at a higher
price, which tends to raise revenues
o Quantity effect after a price increase, fewer units are sold, which
tends to lower revenue.
o Unit elastic no effect on revenue
o Inelastic higher prices increase total revenue. Price effect is stronger
o Elastic higher price decreases total revenue. Quantity effect is stronger.
Elasticity
• Price elasticity of demand changes along the
demand curve.
o When measuring elasticity you are measuring it at a particular point on
the demand curve.
P
TR
Q
Elasticity
• FACTORS THAT DETERMINE ELASTICITY OF DEMAND
o
o
o
o
Close substitutes
Necessity or Luxury
Share of income
Time
Elasticity
• Other types of elasticity
o Cross price – measures the effect of price change in one good on the
quantity demanded of the other good
• %^ of Quantity of good A / %^ Price of good B
o Positive it a substitute
o Negative it is a compliment
o Income Elasticity
• How much demand for a good is affected by changes in consumer
incomes.
• Determines whether a good is an inferior good or a normal good.
o % ^ quantity demanded / % ^ income
• Positive it is a normal good
o Income elastic if greater than one ( vacations)
o Income inelastic if less than one (food)
• Negative it is a inferior good
o Helps identify growth industries during times of strong growth
Elasticity of Supply
• Price elasticity of supply
o
Measure of how responsive of the quantity of a good supplied to price change.
• % ^ quantity supplied /% ^ in price
o Es >1 elastic
o Es <1 inelastic
o Es = 1 unit elastic
• Perfectly elastic
perfectly inelastic
P
P
Q
Q
Elasticity of Supply
• Factors that determine the price elasticity of supply
o Availability of inputs
o Time
Elasticity and Tax
• Government Excise Tax
o Is a per unit tax on production that results in a vertical shift in the supply
curve by the amount of the tax.
• Why
o Increase government revenue
o Decrease consumption
o Tax incidence
• The proportion of the tax paid by consumers in the form of a higher
price for the taxed good.
Price elasticity Gov’t Rev
of demand
Decrease in
consumption
Incidence of
tax paid by
consumers
Incidence of
tax paid by
suppliers
Ed=
Least
Most
0%
100%
Ed>1
Falling
Sizeable
<50%
>50%
Ed<1
Rising
Minimal
>50%
<50%
Ed=0
most
zero
100%
0%
Elasticity and Tax
D
P
P
D
Q
Q
Elasticity and Tax
S
P
P
S
Q
Q
Elasticity and Tax
• Supply and excise tax
Price elasticity
of supply
Gov’t
Revenue
Decrease in
Incidence of Tax
consumption paid by
consumers
Incidence of
tax paid by
producers
Es=
Least
Most
100%
0%
Es>1
Falling
Sizeable
More than %50
Less than 50%
Es<1
Rising
Minimal
Less than %50
More the %50
Es=0
Most
zero
0%
%100
Elasticity and Tax
S+T
P
S
p+T
p1
D
qt
q1
Q
Taxes
• Who pays the Excise Tax
o Remember an excise tax is a tax on any unit of a good or service sold.
• How does it effect Price and Quantity if tax is put on a producer?
120
S1
100
80
60
40
S
D
5K
10K
• Every price point
changes for each
quantity by the
amount of the tax
• Pre tax 5,000 at $60
• Post tax 5000 at $100
• Buyers were
expecting to pay 80$
pretax
• Now have to pay 100$
• Tax incidence (who
really pays the tax) is
split by consumers
and producers
Taxes
• How does it effect Price and Quantity if tax is put
on the consumer?
120
100
S
80
60
D
40
D1
5K
10k
• The original equilibrium
was 80$ for 10,000
• Consumers must pay a 40$
tax
• Reduces demand by 40$ at
every quantity.
Taxes
• Splitting the tax incidence does not always happen.
o More often than not either producer or the consumer will pay more of the
tax incidence.
• It depends on Elasticity
• Elasticity of supply > Elasticity of demand paid by the consumer
• Elasticity of demand > Elasticity of supply paid by the producer
Taxes
• Revenue from the excise tax is calculated as the
area of rectangle created on the graph.
o Height X Width.
$40 X 5,000 = $200,000
Taxes
• Tax rates can be expressed in $ amounts or % of
sale
o Sometimes either increasing or reducing the tax rate does not increase or
decrease revenue.
S1
120
REVENUES = P x Q= 20 x 7.5k =
150,000
S
100
80
D
60
40
7.5K
10K
Tax
• Cost of taxation
o Prevents mutually beneficial transactions from occurring.
• Some transactions don’t occur that would of because of the higher
price
• The more elastic the curves the greater the dead weight loss for a
good.
Creates dead weight
loss and a loss to the
consumer and producer
surplus.