Académique Documents
Professionnel Documents
Culture Documents
Source: Pindyck and Rubinfeld (2018), Microeconomics, 9th Ed., Pearson Prentice Hall. 1
Price Consumer surplus, which measures
the total benefits to all consumers, is
the area between the demand curve
and the market price
0 Q0 Quantity
• When government institutes a price ceiling (Pmax), the price of a good cannot go
above that price
With a binding price ceiling, producers and consumers are affected
How much they are affected can be determined by measuring changes in
consumer and producer surplus
Producers sell less at a lower price and some producers are no longer in
the market
Producers lose and producer surplus decreases
– The economy as a whole is worse off since surplus that used to belong to
producers or consumers is simply gone
Source: Pindyck and Rubinfeld (2018), Microeconomics, 9th Ed., Pearson Prentice Hall. 2
Price
Consumers that can buy the good, gain A
Consumers that cannot buy, lose B
Change in CS (CS) = + A – B
Q1 Q0 Q2 Quantity
Price
P0
Pmax
Q1 Q2 Quantity
Source: Pindyck and Rubinfeld (2018), Microeconomics, 9th Ed., Pearson Prentice Hall. 3
– QS = 15.90 + 0.72PG + 0.05PO and QD = 0.02 –1.8PG + 0.69PO
Q = quantity is measured in trillion cubic feet (Tcf)
PG = price of natural gas in dollars per thousand cubic feet ($/mcf)
PO = price of oil in dollars per barrel ($/bl)
6.40
(Pmax) 3.00
0
23 Quantity (Tcf)
Source: Pindyck and Rubinfeld (2018), Microeconomics, 9th Ed., Pearson Prentice Hall. 4
• Policies such as price controls that cause deadweight losses in society are said
to impose an efficiency cost on the economy
• If efficiency is the goal, then you can argue leaving markets alone is the answer
• However, sometimes a market failure occurs
– Prices fail to provide proper signals to consumers and producers
– Leads to inefficient unregulated competitive market
– Lack of Information
Lack information about the quality or nature of a product prevents
consumers from making utility-maximizing purchasing decisions
Price
When price is regulated to be no lower
than Pmin, only Q1 will be demanded.
If Q1 is produced:
Pmin ΔCS = – A – B
ΔPS = + A – C
P0 Deadweight loss = B + C
Q1 Q0 Q2 Quantity
Source: Pindyck and Rubinfeld (2018), Microeconomics, 9th Ed., Pearson Prentice Hall. 5
Minimum Prices
• Government policy seeks to raise prices above market-clearing levels
– Minimum wage law
– Agricultural policies
• When price is set above the market-clearing price
– QD falls
– Suppliers may, however, choose to increase QS in face of higher prices
– This causes additional producer losses equal to the total cost of production
above QD
Price Price is regulated to be no lower than Pmin.
Producers would like to supply Q2, but
consumers will buy only Q3
Pmin
P QD
ΔCS = – A – B
P0 ΔPS = + A – C
• Minimum 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
w
Deadweight loss = – B – C
Unemployment = L2 – L1
L1 L0 L2 Labor
Source: Pindyck and Rubinfeld (2018), Microeconomics, 9th Ed., Pearson Prentice Hall. 6
Price Supports
• Price set by government above free-market level and maintained by
governmental purchases of excess supply
• Government can also increase prices through restricting production, directly or
through incentives to producers
• What are the impacts on consumers, producers and the federal budget?
ΔCS = – A – B (Loss)
PS ΔPS = + A + B + D (Gain)
Q1 Q0 Q2 Quantity
Production Quotas
• The government can restrict supply either by imposing production quotas or by
giving producers a financial incentive to reduce output
– Taxi medallions
– Required liquor licenses for restaurants
Source: Pindyck and Rubinfeld (2018), Microeconomics, 9th Ed., Pearson Prentice Hall. 7
Price
To maintain price at PS, government can
PS restrict supply to S’ at Q1
Q1 Q0 Quantity
• Incentive Programs
– Agricultural policy uses production incentives instead of direct quotas
– Government gives farmers financial incentives to restrict supply
Acreage limitation programs
Quantity decreases and price increases for the crop
– Change in PS
From increased price = + A – C
Government pays farmers not to produce = B + C + D
Total PS = + A – C + Govt. payments = A + B + D
– Change in CS
CS = – A – B
– Change in welfare
Welfare = CS + PS – cost to government
= – A – B + A + B + D – (B + C + D) = – B – C
• Which program is more costly?
– Both programs have same loss to consumers
– Producers are indifferent between programs because end up with same
amount in both
– Typically acreage limitation program costs society less than price supports
maintained by government purchases
– However, society better off if government would just give farmers cash
Source: Pindyck and Rubinfeld (2018), Microeconomics, 9th Ed., Pearson Prentice Hall. 8
Supporting the Price of Wheat: An Example
• In 1981, the supply and demand curves for wheat were:
– QS = 1800 + 240P and QD = 3550 – 266P
– P* = $3.4585/bushel and Q* = 2,630.04 million bushels
– Government raised the price to $3.70 through government purchases
– How much would the government had to buy (QG) to keep price at $3.70
QDTotal = QD + QG =
QS = QDTotal
Set 1800 + 240P = QG =
At a price of $3.70, QG = = 122.2 million bushels
Price ($)
PS=3.70
P0=3.46
2630 Quantity
Source: Pindyck and Rubinfeld (2018), Microeconomics, 9th Ed., Pearson Prentice Hall. 9
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, but costs to consumers
is high
• In a free market, the domestic price equals the world price PW. Domestic
consumers have incentive to purchase from abroad
– Domestic price falls to PW and imports equal (QD – QS)
• Domestic industry might convince government to protect industry by
eliminating imports
– Quota of zero or high tariff (P0 – PW)
P0 Imports = QD – QS
Quota of zero (or import tariff) pushes
PW domestic price to P0 and imports go to zero
CS = – A – B – C (loss)
PS = A (gain)
Deadweight loss = B + C
QS Q0 QD Quantity
Source: Pindyck and Rubinfeld (2018), Microeconomics, 9th Ed., Pearson Prentice Hall. 10
The Sugar Quota: An Example
• The U.S. Sugar Market in 2010
– U.S. production = 15.9 billion pounds
– U.S. consumption = 22.8 billion pounds
– U.S. price = 36 cents/pound
– World price = 24 cents/pound
– Price elasticity of U.S. supply = 1.5
– Price elasticity of U.S. demand = –0.3
• The data can be used to fit the U.S. supply and demand curves
– QS =
– QD =
Price
(cents/lb.)
The cost of the quotas to consumers:
CS = – A – B – C – D
PUS = 36 The gain to producers:
after quota
PS = A
PW = 24
before quota Deadweight loss = B + C
Source: Pindyck and Rubinfeld (2018), Microeconomics, 9th Ed., Pearson Prentice Hall. 11
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?
– 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 (i.e., the shapes of the curves)
Price
Pb = price paid by buyers
Ps = price received by sellers
t = tax
Buyers loss = A + B
P0 Sellers loss = C + D
Government gain = A + D (tax revenue)
Deadweight loss = B + C
Q1 Q0 Quantity
2. Quantity sold and sellers price, Ps, must be on the supply curve
QS = QS(Ps)
Source: Pindyck and Rubinfeld (2018), Microeconomics, 9th Ed., Pearson Prentice Hall. 12
– Share of Tax Burdens
If demand is relatively inelastic, burden of tax will fall mostly on buyers
Cigarettes
P0 P0
Q1 Q0 Quantity Q1 Q0 Quantity
Source: Pindyck and Rubinfeld (2018), Microeconomics, 9th Ed., Pearson Prentice Hall. 13
– The benefit of the subsidy accrues mostly to buyers if ED/ES is small
– The benefit of the subsidy accrues mostly to sellers if ED /ES is large
Price Price
P0
P0
Q0 Q1 Quantity Q0 Q1 Quantity
– As with a tax, the four conditions must be satisfied when the subsidy is in
place
– Using supply and demand curves, and the size of the subsidy, we can solve
for resulting prices and quantities
Source: Pindyck and Rubinfeld (2018), Microeconomics, 9th Ed., Pearson Prentice Hall. 14