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Chapter 9 • Use tools of competitive markets to analyze effects of government intervention. • Tools (See Figure 9.1): • Consumer Surplus = CS: – Difference between willingness to pay and market price. – Area above price line but below demand curve. • Producer Surplus = PS: – Difference between willingness to supply and market price. – Area below price line but above supply curve. Welfare Effects • Overall effects of government policies: – Welfare Effects: Gains/losses in produce and consumer surplus caused by government intervention. • Effect of Price Ceiling (Pmax): see CS/PS both before and after ceiling; – – – – See Figure 9.2. CS won and lost PS won and lost Deadweight Loss: See loss that “goes” to noone. – Importance of elasticity: Figure 9.3. Economic Efficiency • Economic Efficiency: – Maximization of aggregate PS and CS. – Can use economic efficiency as gauge to evaluate a market. • Government intervention reduces economic efficiency. – So why intervene? • To make necessary goods more affordable. • To reduce consumption of “bad” goods. • To reduce impact of market failure. Market Failure • Market Failure: when market fails to generate an efficient outcome. • Two common causes: – 1) Externalities : when costs not fully borne by producer; benefits not fully borne by consumer. • Examples: pollution; education. – 2) Lack of information. • Example: child care; bank loans – One solution to lack of information with bank loans is truth in lending laws. Price Floors (Minimum Prices) • Price floor: – Examples: • Wmin • Agricultural price supports – Alters market outcome if Pmin > P*. • See Figure 9.7: – See change in CS and PS. – Deadweight loss. Impact of a Tax • Key Point: What is impact of tax on final price? NOT true that final price = initial price plus the tax. • Example: per unit tax (excise tax); – See Qsold, Pb, Ps, and t. – Note: Pb – Ps = tax. – See Figure 9.17. • Burden of tax: – shared by sellers and buyers; – how shared determined by relative elasticities of S and D. – Pass-through fraction = Es/(Es-Ed) • Tells fraction of tax “passed thru” to buyers in form of higher prices. – In general: a tax falls mostly on buyer if Ed/Es is small and mostly on the seller if Ed/Es is large. Show Tax w/Algebra (Example 9.6) • Terms: – Pb : price paid by buyers – Ps : price received by sellers – Po : no-tax price • Example: Qd = 150 – 50Pb Qs = 60 + 40Ps t = 0.50; Pb – Ps = 0.50. • Approach: Replace Pb with Ps+0.50; set Qd=Qs and then solve for Ps; Then solve for Pb and Q. – See difference if there had been no tax. – Buyers’ tax burden = Pb – P0. – Sellers’ burden = P0 – Ps. Exercise: Tax • Given S & D of wickets: Qs = -800 + 15P Qd = 3200 – 25P • 1. What is market equilibrium price and quantity? • 2. Now impose per unit tax of $20 on consumers. What is new Pb, Ps, quantity, and tax revenue. Answer with algebra and graph. • 3. Show es in CS, and PS, and the deadweight loss. • 4. In general, how do es in Pb, Ps relate to S & D elasticities? Explain. Subsidy (See Figure 9.19) • Treat subsidy like negative tax. • With subsidy: sellers’ price exceeds the buyers’ price and difference between the two is the subsidy. • Approach: – Start at equilibrium P and Q; impose subsidy. – Find Q that makes Ps – Pb = S. – Result is higher quantity sold (opposite of effect of tax). • General rule: the benefit of a subsidy accrues mostly to buyers if Ed/Es is small and mostly to sellers if Ed/Es is large..