Survey
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
CHAPTER Consumers, Producers, and the Efficiency of Markets Economics PRINCIPLES OF N. Gregory Mankiw © 2009 South-Western, a part of Cengage Learning, all rights reserved In this chapter, look for the answers to these questions: What is consumer/producer surplus? How are they related to the demand/supply curves? How do they relate to identifying the best market outcomes? What is deadweight loss? How do these concepts relate to mechanisms, like taxes, that are artificially imposed upon the marketplace? 1 Welfare Economics Recall, the allocation of resources refers to: how much of each good is produced which producers produce it which consumers consume it Welfare economics studies how the allocation of resources affects economic well-being. First, we look at the well-being of consumers. CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS 2 Willingness to Pay (WTP) A buyer’s willingness to pay for a good is the maximum amount the buyer will pay for that good. WTP measures how much the buyer values the good. name WTP Anthony $250 Chad 175 Flea 300 John 125 Example: 4 buyers’ WTP for an iPod CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS 3 WTP and the Demand Curve P $350 $300 P Qd $250 $200 $301 & up 0 251 – 300 1 $150 176 – 250 2 $100 $50 126 – 175 3 0 – 125 4 $0 Q 0 1 2 3 4 CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS 4 Consumer Surplus (CS) Consumer surplus is the amount a buyer is willing to pay minus the amount the buyer actually pays: CS = WTP – P name WTP Anthony $250 Suppose P = $260. Flea’s CS = $300 – 260 = $40. Chad 175 Flea 300 The others get no CS because they do not buy an iPod at this price. John 125 Total CS = $40. CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS 5 CS and the Demand Curve P Flea’s WTP $350 $300 Anthony’s WTP $250 $200 Instead, suppose P = $220 Flea’s CS = $300 – 220 = $80 Anthony’s CS = $250 – 220 = $30 $150 Total CS = $110 $100 $50 $0 Q 0 1 2 3 4 CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS 6 CS and the Demand Curve P The lesson: Total CS equals the area under the demand curve above the price, from 0 to Q. $350 $300 $250 $200 $150 $100 $50 $0 Q 0 1 2 3 4 CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS 7 CS with Lots of Buyers & a Smooth D Curve CS is the area b/w P and the D curve, from 0 to Q. Recall: area of a triangle equals ½ x base x height Height = $60 – 30 = $30. So, CS = ½ x 15 x $30 = $225. P The demand for shoes $ 60 50 h 40 30 20 10 D Q 0 0 5 10 15 20 25 30 CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS 8 Cost and the Supply Curve Cost is the value of everything a seller must give up to produce a good (i.e., opportunity cost). Includes cost of all resources used to produce good, including value of the seller’s time. Example: Costs of 3 sellers in the lawn-cutting business. name cost Jack $10 Janet 20 Chrissy 35 A seller will produce and sell the good/service only if the price exceeds his or her cost. Hence, cost is a measure of willingness to sell. CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS 9 Producer Surplus PS = P – cost P $40 Producer surplus (PS): the amount a seller is paid for a good minus the seller’s cost $30 $20 $10 $0 Q 0 1 2 3 CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS 10 Producer Surplus and the S Curve PS = P – cost P $40 Chrissy’s cost $30 Janet’s cost $20 Jack’s cost $10 $0 Q 0 1 2 3 Suppose P = $25. Jack’s PS = $15 Janet’s PS = $5 Chrissy’s PS = $0 Total PS = $20 Total PS equals the area above the supply curve under the price, from 0 to Q. CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS 11 How a Lower Price Reduces PS If P falls to $30, PS = ½ x 15 x $15 = $112.50 60 Two reasons for the fall in PS. 40 2. Fall in PS due to remaining sellers getting lower P P 50 1. Fall in PS due to sellers leaving market S 30 20 10 Q 0 0 5 10 15 20 25 30 CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS 12 CS, PS, and Total Surplus CS = (value to buyers) – (amount paid by buyers) = buyers’ gains from participating in the market PS = (amount received by sellers) – (cost to sellers) = sellers’ gains from participating in the market Total surplus = CS + PS = total gains from trade in a market = (value to buyers) – (cost to sellers) CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS 13 The Market’s Allocation of Resources In a market economy, the allocation of resources is decentralized, determined by the interactions of many self-interested buyers and sellers. Is the market’s allocation of resources desirable? Or would a different allocation of resources make society better off? To answer this, we use total surplus as a measure of society’s well-being, and we consider whether the market’s allocation is efficient. (Policymakers also care about equality, though are focus here is on efficiency.) CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS 14 Efficiency Total = (value to buyers) – (cost to sellers) surplus An allocation of resources is efficient if it maximizes total surplus. Efficiency means: The goods are consumed by the buyers who value them most highly. The goods are produced by the producers with the lowest costs. Raising or lowering the quantity of a good would not increase total surplus. CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS 15 Evaluating the Market Equilibrium Market eq’m: P = $30 Q = 15,000 Total surplus = CS + PS Is the market eq’m efficient? P 60 S 50 40 CS 30 PS 20 10 D Q 0 0 5 10 15 20 25 30 CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS 16 Does Eq’m Q Maximize Total Surplus? The market eq’m quantity maximizes total surplus: At any other quantity, can increase total surplus by moving toward the market eq’m quantity. P 60 S 50 40 30 20 10 D Q 0 0 5 10 15 20 25 30 CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS 17 The free market vs. central planning Suppose resources were allocated not by the market, but by a central planner who cares about society’s well-being. To allocate resources efficiently and maximize total surplus, the planner would need to know every seller’s cost and every buyer’s WTP for every good in the entire economy. This is impossible, and why centrally-planned economies are never very efficient. CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS 18 Taxes The govt levies taxes on many goods & services to raise revenue to pay for national defense, public schools, etc. The govt can make buyers or sellers pay the tax. The tax can be a % of the good’s price, or a specific amount for each unit sold. For simplicity, we analyze per-unit taxes only. SUPPLY, DEMAND, AND GOVERNMENT POLICIES 19 EXAMPLE 3: The Market for Pizza Eq’m w/o tax P S1 $10.00 D1 500 SUPPLY, DEMAND, AND GOVERNMENT POLICIES Q 20 A Tax on Buyers The price buyers pay Hence, a tax on buyers is nowthe $1.50 higher than shifts D curve down the market price by the amount ofP. the tax. Effects of a $1.50 per unit tax on buyers P P would have to fall by $1.50 to make $10.00 buyers willing to buy same Q as before. $8.50 E.g., if P falls from $10.00 to $8.50, buyers still willing to purchase 500 pizzas. SUPPLY, DEMAND, AND GOVERNMENT POLICIES S1 Tax D1 D2 500 Q 21 A Tax on Buyers New eq’m: Effects of a $1.50 per unit tax on buyers Q = 450 Sellers receive PS = $9.50 Buyers pay PB = $11.00 P PB = $11.00 S1 Tax $10.00 PS = $9.50 Difference between them = $1.50 = tax SUPPLY, DEMAND, AND GOVERNMENT POLICIES D1 D2 450 500 Q 22 The Incidence of a Tax: how the burden of a tax is shared among market participants In our example, buyers pay $1.00 more, P PB = $11.00 S1 Tax $10.00 PS = $9.50 sellers get $0.50 less. D1 D2 450 500 SUPPLY, DEMAND, AND GOVERNMENT POLICIES Q 23 A Tax on Sellers The tax effectively raises sellers’ costs by P $1.50 per pizza. $11.50 Sellers will supply 500 pizzas only if P rises to $11.50, to compensate for this cost increase. Effects of a $1.50 per unit tax on sellers S2 Tax S1 $10.00 Hence, a tax on sellers shifts the S curve up by the amount of the tax. SUPPLY, DEMAND, AND GOVERNMENT POLICIES D1 500 Q 24 A Tax on Sellers New eq’m: Effects of a $1.50 per unit tax on sellers Q = 450 Buyers pay PB = $11.00 Sellers receive PS = $9.50 P PB = $11.00 S2 S1 Tax $10.00 PS = $9.50 Difference between them = $1.50 = tax SUPPLY, DEMAND, AND GOVERNMENT POLICIES D1 450 500 Q 25 The Outcome Is the Same in Both Cases! The effects on P and Q, and the tax incidence are the same whether the tax is imposed on buyers or sellers! What matters is this: A tax drives a wedge between the price buyers pay and the price sellers receive. P PB = $11.00 S1 Tax $10.00 PS = $9.50 SUPPLY, DEMAND, AND GOVERNMENT POLICIES D1 450 500 Q 26 Elasticity and Tax Incidence CASE 1: Supply is more elastic than demand It’s easier for sellers than buyers to leave the market. P Buyers’ share of tax burden PB S Tax Price if no tax Sellers’ share of tax burden So buyers bear most of the burden of the tax. PS D Q SUPPLY, DEMAND, AND GOVERNMENT POLICIES 27 Elasticity and Tax Incidence CASE 2: Demand is more elastic than supply P Buyers’ share of tax burden S PB Price if no tax Sellers’ share of tax burden It’s easier for buyers than sellers to leave the market. Tax PS Sellers bear most of the burden of the tax. D Q SUPPLY, DEMAND, AND GOVERNMENT POLICIES 28 CASE STUDY: Who Pays the Luxury Tax? 1990: Congress adopted a luxury tax on yachts, private airplanes, furs, expensive cars, etc. Goal of the tax: raise revenue from those who could most easily afford to pay – wealthy consumers. But who really pays this tax? SUPPLY, DEMAND, AND GOVERNMENT POLICIES 29 CASE STUDY: Who Pays the Luxury Tax? The market for yachts P Buyers’ share of tax burden Demand is price-elastic. S In the short run, supply is inelastic. PB Tax Sellers’ share of tax burden PS D Q SUPPLY, DEMAND, AND GOVERNMENT POLICIES Hence, companies that build yachts pay most of the tax. 30 The Effects of a Tax P Eq’m with no tax: Price = PE Quantity = QE Eq’m with tax = $T per unit: Buyers pay PB Sellers receive PS Size of tax = $T S PB PE PS D Quantity = QT QT APPLICATION: THE COSTS OF TAXATION QE Q 31 The Effects of a Tax P Revenue from tax: $T x QT Size of tax = $T S PB PE PS D QT APPLICATION: THE COSTS OF TAXATION QE Q 32 The Effects of a Tax Next, we apply welfare economics to measure the gains and losses from a tax. We determine consumer surplus (CS), producer surplus (PS), tax revenue, and total surplus with and without the tax. Tax revenue can fund beneficial services (e.g., education, roads, police) so we include it in total surplus. APPLICATION: THE COSTS OF TAXATION 33 The Effects of a Tax P Without a tax, CS = A + B + C PS = D + E + F Tax revenue = 0 Total surplus = CS + PS =A+B+C +D+E+F A S B PE D C E D F QT APPLICATION: THE COSTS OF TAXATION QE Q 34 The Effects of a Tax With the tax, CS = A PS = F Tax revenue =B+D Total surplus =A+B +D+F P A PB S B D C E PS D F The tax reduces total surplus by C+E APPLICATION: THE COSTS OF TAXATION QT QE Q 35 The Effects of a Tax P C + E is called the deadweight loss (DWL) of the tax, the fall in total surplus that results from a market distortion, such as a tax. A PB S B D C E PS D F QT APPLICATION: THE COSTS OF TAXATION QE Q 36 About the Deadweight Loss P Because of the tax, the units between QT and QE are not sold. The value of these units to buyers is greater than the cost of producing them, PB S PS D so the tax prevents some mutually beneficial trades. APPLICATION: THE COSTS OF TAXATION QT QE Q 37 What Determines the Size of the DWL? Which goods or services should govt tax to raise the revenue it needs? One answer: those with the smallest DWL. When is the DWL small vs. large? Turns out it depends on the price elasticities of supply and demand. Recall: The price elasticity of demand (or supply) measures how much QD (or QS) changes when P changes. APPLICATION: THE COSTS OF TAXATION 38 DWL and the Elasticity of Supply When supply is inelastic, P it’s harder for firms to leave the market when the tax reduces PS. So, the tax only reduces Q a little, and DWL is small. S Size of tax D Q APPLICATION: THE COSTS OF TAXATION 39 DWL and the Elasticity of Supply The more elastic is supply, the easier for firms to leave the market when the tax reduces PS, the greater Q falls below the surplusmaximizing quantity, P S Size of tax the greater the DWL. APPLICATION: THE COSTS OF TAXATION D Q 40 ACTIVE LEARNING 3 Discussion question The government must raise tax revenue to pay for schools, police, etc. To do this, it can either tax groceries or meals at fancy restaurants. Which should it tax? 41 The Effects of Changing the Size of the Tax Policymakers often change taxes, raising some and lowering others. What happens to DWL and tax revenue when taxes change? We explore this next…. APPLICATION: THE COSTS OF TAXATION 42 DWL and the Size of the Tax Initially, the tax is T per unit. Tripling the tax causes the DWL to more than triple. P new DWL S T 3T D initial DWL Q3 APPLICATION: THE COSTS OF TAXATION Q1 Q 43 Revenue and the Size of the Tax P PB PB When the tax is larger, increasing it causes tax revenue to fall. S 3T 2T D PS PS Q3 APPLICATION: THE COSTS OF TAXATION Q2 Q 44 Revenue and the Size of the Tax The Laffer curve Tax shows the revenue relationship between the size of the tax and tax revenue. The Laffer curve Tax size APPLICATION: THE COSTS OF TAXATION 45