Microeconomics Lecture Analysis Of Competitive Market

Chapter 9 The Analysis of Competitive Markets

Consumer and Producer Surplus 1. Consumer surplus is the total benefit or value that consumers receive beyond what they pay for the good.  Assume market price for a good is $5  Some consumers would be willing to pay more than $5 for the good  If you were willing to pay $9 for the good and pay $5, you gain $4 in consumer surplus ©2005 Pearson Education, Inc.

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Consumer and Producer Surplus  The demand curve shows the willingness to pay for all consumers in the market  Consumer surplus can be measured by the area between the demand curve and the market price

 Consumer surplus measures the total net benefit to consumers

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Consumer and Producer Surplus 2. Producer surplus is the total benefit or revenue that producers receive beyond what it cost to produce a good.  Some producers produce for less than market price and would still produce at a lower price  A producer might be willing to accept $3 for the good but get $5 market price

 Producer gains a surplus of $2 ©2005 Pearson Education, Inc.

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Consumer and Producer Surplus  The supply curve shows the amount that a producer is willing to take for a certain amount of a good  Producer surplus can be measured by the area between the supply curve and the market price  Producer surplus measures the total net benefit to producers ©2005 Pearson Education, Inc.

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Consumer and Producer Surplus Price

9

Consumer Surplus

S Between 0 and Q0 consumer A receives a net gain from buying the product-consumer surplus

5 Producer Surplus

3

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QS

Q0 Chapter 9

Between 0 and Q0 producers receive a net gain from selling each product-producer surplus.

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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.  Welfare Effects Gains and losses to producers and consumers. ©2005 Pearson Education, Inc.

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Price Control and Surplus Changes Price Consumers that cannot buy, lose B

Consumers that can buy the good gain A

S The loss to producers is the sum of rectangle A and triangle C.

B P0

A

C

Triangles B and C are losses to society – dead weight loss

Pmax D

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Price controls and Welfare Effects  The total loss is equal to area B + C.  The deadweight loss 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 This has greater effects in political decisions

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Price Controls With Inelastic Demand D Price

S

B

P0 Pmax

A

Q1 ©2005 Pearson Education, Inc.

With inelastic demand, triangle B can be larger than rectangle A and consumers suffer net losses from price controls.

C

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Price Control and Surplus Changes Price

S Pmin A

When price is regulated to be no lower than Pmin, the deadweight loss given by triangles B and C results.

B

P0

C

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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 ©2005 Pearson Education, Inc.

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The Market for Human Kidneys  Many countries have laws prohibiting the sale of organs for transplantation. E.g. India, Malaysia, and the United States  What has been the impact such laws?  We can measure this using the supply and demand for kidneys. Consider the following example. Supply: QS = 8,000 + 0.2P Demand: QD = 16,000 - 0.2P ©2005 Pearson Education, Inc.

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The Market for Human Kidneys  Since sale of organs is not allowed, the amount available depends on the amount donated Supply of donated kidneys is limited to 8000

 The welfare effect of this supply constraint can be analyzed using consumer and producer surplus in the kidney market ©2005 Pearson Education, Inc.

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The Market for Human Kidneys  Suppliers: Those who supply them are not paid the market price estimated at $20,000  Loss

of surplus equal to area A = $160 million

Some who would donate for the equilibrium price do not in the current market  Loss

of surplus equal to area C = $40 million

Total consumer loss of A + C = $200 million ©2005 Pearson Education, Inc.

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The Market for Human Kidneys  Recipients: Since they do not have to pay for the kidney, they gain rectangle A ($140 million) since price is $0 Those who cannot obtain a kidney lose surplus equal to triangle B ($40 million) Net increase in surplus of recipients of $160 - $40 = $120 million

 Dead Weight Loss of C + B = $80 million ©2005 Pearson Education, Inc.

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The Market for Human Kidneys  Other Inefficiency Cost Allocation is not necessarily to those who value the kidney’s the most. Price may increase to $40,000, the equilibrium price, with hospitals getting the price.

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The Market for Kidneys S’

Price

The loss to suppliers Is areas A & C.

$40,000

S

D

$30,000

If kidneys are zero cost, consumer gain would be A minus B.

B $20,000

A and D measure the total value of kidneys when supply is constrained.

C A

$10,000

D

0

4,000

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The Market for Human Kidneys  Arguments in favor of prohibiting the sale of organs: 1. Imperfect information about donor’s health and screening 2. Unfair to allocate according to the ability to pay 

Holding price below equilibrium will create shortages



Organs versus artificial substitutes

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Minimum Prices Price

S

If producers produce Q2, the amount Q2 - Q3 will go unsold.

Pmin A

D measures total cost of increased production not sold

B C

P0

The change in producer surplus will be A - C - D. Producers may be worse off.

D

D

Q3 ©2005 Pearson Education, Inc.

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The Minimum Wage Firms are not allowed to pay less than wmin. This results in unemployment.

w

S wmin A

A is gain to workers who find jobs at higher wage

B C

w0

The deadweight loss is given by triangles B and C. Unemployment

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Supply Restrictions S’

Price

S

PS •Supply restricted to Q1 •Supply shifts to S’ @ Q1

A B

P0

•CS reduced by A + B •Change in PS = A - C •Deadweight loss = BC

C

D Q1 ©2005 Pearson Education, Inc.

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Import Quotas and Tariffs  Many countries use import quotas and tariffs to keep the domestic price of a product above world levels Import quotas: Limit on the quantity of a good that can be imported Tariff: Tax on an imported good

 This allows domestic producers to enjoy higher profits

 Costs to consumers is high ©2005 Pearson Education, Inc.

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Import Quotas and Tariffs  With lower world price, domestic consumers have incentive to purchase from abroad. Domestic price falls to world price and imports equal difference between quantity supplied and quantity demanded

 Domestic industry might convince government to protect industry by eliminating imports Quota of zero or high tariff ©2005 Pearson Education, Inc.

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Import Tariff To Eliminate Imports Price

In a free market, the domestic price equals the world price PW.

S Quota of zero pushes domestic price to P0 and imports go to zero.

P0 A

B

Loss to consumers is A+B+C. Gain to producers is A. Dead weight loss: B +C.

C

PW Imports

D

QS ©2005 Pearson Education, Inc.

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Import Tariff (general case)  The increase in price can P be achieved by a tariff.  QS increases and QD decreases  Area A is the gain to P* domestic producers.  The loss to consumers is Pw A + B + C + D.  DWL = B + C  Government Revenue is D = tariff * imports

S

A B

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D QS

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Q’S

Q’D

Q

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Import Quota (general case)  If a quota is used, rectangle D becomes part of the profits to foreign producers  Consumers lose A+B+C+D  Producers gain A  Net domestic loss is B + C + D.

S

P

P* A B

Pw

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D QS

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Q’S

Q’D

Q

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The Impact of a Tax or Subsidy  The government wants to impose a $1.00 tax on movies. It can do it two ways Make the producers pay $1.00 for each movie ticket they sell Make consumers pay $1.00 when they buy each movie

 In which option are consumers paying more? ©2005 Pearson Education, Inc.

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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.

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Incidence of a Specific Tax Price

S Pb price buyers pay Tax = $1.00

•Buyers lose A + B

A

B

P0 PS price producers get

•Sellers lose D + C

•Government gains A + D in tax revenue.

C

D

•The deadweight loss is B + C.

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Impact of Elasticities on Tax Burdens Burden on Buyer

Burden on Seller

D

Price

Price

S

Pb

S

t

Pb

P0

P0

PS

t D PS

Q1 Q 0

Quantity

Q1 Q0

Quantity

The Effects of a Tax or Subsidy  A subsidy can be analyzed in much the same way as a tax. Payment reducing the buyer’s price below the seller’s price

 It can be treated as a negative tax.

 The seller’s price exceeds the buyer’s price.  Quantity increases ©2005 Pearson Education, Inc.

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Effects of a Subsidy Price

S Like a tax, the benefit of a subsidy is split between buyers and sellers, depending upon the elasticities of supply and demand.

PS Subsidy

P0

Pb

D Q0 ©2005 Pearson Education, Inc.

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