Chapter 9 The Analysis of Competitive Markets. Chapter 92 Q: Rent Control Chuncheon City decided to...

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Chapter 9

The Analysis of Competitive Markets

Chapter 9 2

Q: Rent Control

Chuncheon City decided to control rent around KNU campus for students.

Are KNU students going to be better off?

Chapter 9 3

Consumer and Producer Surplus

1. is the total benefit or value that consumers receive beyond what they pay for the good.

Chapter 9 4

Consumer and Producer Surplus

2. is the total benefit or revenue that producers receive beyond what it cost to produce a good.

Chapter 9 5

Consumer and Producer Surplus

Between 0 and Q0 producers receive

a net gain from selling each product--

producer surplus.

Quantity

Price

S

D

Q0

5

9

Between 0 and Q0

consumer A receives a net gain from buying

the product-- consumer surplus

ProducerSurplus

3

QD QS

Chapter 9 6

Consumer and Producer Surplus

To determine the welfare effect of a governmental policy we can measure the gain or loss in consumer and producer surplus.

Chapter 9 7

B

A C

Price Control and Surplus Changes

Quantity

Price

S

D

P0

Q0

Pmax

Q1 Q2

Chapter 9 8

Price controls and Welfare Effects

The total loss is equal to area .The is the inefficiency

of the price controls – the total loss in surplus (consumer plus producer)

If demand is sufficiently inelastic, losses to consumers may be fairly large

Chapter 9 9

B

APmax

C

Q1

With inelastic demand, triangle B can be larger

than rectangle A and consumers suffer net

losses from price controls.

S

D

Price Controls With Inelastic Demand

Quantity

Price

P0

Q2

Chapter 9 10

The Efficiency ofa Competitive Market

In the evaluation of markets, we often talk about whether it reaches economic efficiency

Policies such as price controls that cause dead weight losses in society are said to impose an efficiency cost on the economy

Chapter 9 11

The Efficiency ofa Competitive Market

If efficiency is the goal, then you can argue leaving markets alone is the answer

However, sometimes occur

Chapter 9 12

Types of Market Failures

1. Costs or benefits that do not show up as

part of the market price (e.g. pollution) Costs or benefits are external to the market

2. Imperfect information prevents consumers

from making utility-maximizing decisions. Government intervention may be

desirable in these cases

Chapter 9 13

The Efficiency of a Competitive Market

Other than market failures, unregulated competitive markets lead to economic efficiency

What if the market is constrained to a price higher than the economically efficient equilibrium price?

Chapter 9 14

BA

C

Price Control and Surplus Changes

Quantity

Price

S

D

P0

Q0

Pmin

Q1 Q2

Chapter 9 15

The Efficiency of a Competitive Market

Deadweight loss triangles, B and C, give a good estimate of efficiency cost of policies that force price above or below market clearing price.

Measuring effects of government price controls on the economy can be estimated by measuring these two triangles

Chapter 9 16

Minimum Wages

Wage is set higher than market clearing wage

Decreased quantity of workers demanded

Those workers hired receive higher wages

Unemployment results since not everyone who wants to work at the new wage can

Chapter 9 17

BC

A

L1 L2

Unemployment

wmin

S

D

w0

L0

The Minimum Wage

L

w

Chapter 9 18

Price Supports

Much of agricultural policy is based on a system of .

Government can also increase prices through restricting production, directly or through incentives to producers

Chapter 9 19

Price Supports

What are the impacts on consumers, producers and the federal budget?

Chapter 9 20

Price Supports

Government may be able to “dump” some of the goods in the foreign markets

Total welfare effect of policy

CS + PS – Govt. cost = D – (Q2-Q1)PS

Society is worse off over allLess costly to simply give farmers the

money

Chapter 9 21

B

DA

To maintain a price Ps

the government buys quantity Qg .

D + Qg

Qg

Price Supports

Quantity

PriceS

D

P0

Q0

Ps

Q2Q1

E

Net Loss to society is E + B

Chapter 9 22

Production Quotas

The government can also cause the price of a good to rise by reducing supply.Limitations of taxi medallions in New York

CityLimitation of required liquor licenses for

restaurants

Chapter 9 23

BA

C

Supply Restrictions

Quantity

Price

D

P0

Q0

S

S’

PS

Q1

Chapter 9 24

Import Quotas and Tariffs

Many countries use import quotas and tariffs to keep the domestic price of a product above world levelsImport quotas: Limit on the quantity of a

good that can be importedTariff: Tax on an imported good

This allows domestic producers to enjoy higher profits

Costs to consumers is high

Chapter 9 25

QS QD

PW

AB C

Import Tariff To Eliminate Imports

Quantity

Price

Q0

D

P0

S

Imports

Chapter 9 26

The Impact of a Tax or Subsidy

The government wants to impose a $1.00 tax on movies. It can do it two waysMake the producers pay $1.00 for each

movie ticket they sellMake consumers pay $1.00 when they buy

each movie

In which option are consumers paying more?

Chapter 9 27

The Impact of a Tax or Subsidy

The burden of a tax (or the benefit of a subsidy) falls partly on the consumer and partly on the producer.

How the burden is split between the parties depends on the relative elasticities of demand and supply.

Chapter 9 28

The Effects of a Specific Tax

For simplicity we will consider a specific tax on a good

For our example, consider a specific tax of $t per widget sold

Chapter 9 29

Incidence of a Specific Tax

D

S

B

D

A

C

Quantity

Price

P0

Q0Q1

PS price producers get

Pb price buyers pay

Tax = $1.00

Chapter 9 30

Incidence of a Specific Tax

In the previous example, the tax was shared almost equally by consumers and producers

If demand is relatively inelastic, however, burden of tax will fall mostly on buyers

If supply is relatively inelastic, the burden of tax will fall mostly on sellers

Impact of Elasticities on Tax Burdens

Quantity Quantity

Price Price

S

D S

D

Q0

P0 P0

Q0Q1

Pb

PS

t

Q1

Pb

PS

t

Burden on Buyer Burden on Seller