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Chapter 16 Equilibrium. Market Equilibrium A market is in equilibrium when total quantity demanded by buyers equals total quantity supplied by sellers.

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Presentation on theme: "Chapter 16 Equilibrium. Market Equilibrium A market is in equilibrium when total quantity demanded by buyers equals total quantity supplied by sellers."— Presentation transcript:

1 Chapter 16 Equilibrium

2 Market Equilibrium A market is in equilibrium when total quantity demanded by buyers equals total quantity supplied by sellers. 2

3 Market Equilibrium p D(p), S(p) q=D(p) Market demand Market supply q=S(p) 3

4 Market Equilibrium p D(p), S(p) q=D(p) Market demand Market supply q=S(p) p* q* 4

5 Market Equilibrium p D(p), S(p) q=D(p) Market demand Market supply q=S(p) p* q* D(p*) = S(p*): the market is in equilibrium. 5

6 Market Equilibrium p D(p), S(p) q=D(p) Market demand Market supply q=S(p) p* S(p’) D(p’) < S(p’): an excess of quantity supplied over quantity demanded. p’ D(p’) 6

7 Market Equilibrium p D(p), S(p) q=D(p) Market demand Market supply q=S(p) p* S(p’) D(p’) < S(p’): an excess of quantity supplied over quantity demanded. p’ D(p’) Market price will fall towards p*. 7

8 Market Equilibrium p D(p), S(p) q=D(p) Market demand Market supply q=S(p) p* D(p”) D(p”) > S(p”): an excess of quantity demanded over quantity supplied. p” S(p”) 8

9 Market Equilibrium p D(p), S(p) q=D(p) Market demand Market supply q=S(p) p* D(p”) D(p”) > S(p”): an excess of quantity demanded over quantity supplied. p” S(p”) Market price will rise towards p*. 9

10 Market Equilibrium An example of calculating a market equilibrium when the market demand and supply curves are both linear. 10

11 Market Equilibrium p D(p), S(p) D(p) = a-bp Market demand Market supply S(p) = c+dp p* q* 11

12 Market Equilibrium p D(p), S(p) D(p) = a-bp Market demand Market supply S(p) = c+dp p* q* What are the values of p* and q*? 12

13 Market Equilibrium At the equilibrium price p*, D(p*) = S(p*). That is, which gives and 13

14 Market Equilibrium p D(p), S(p) D(p) = a-bp Market demand Market supply S(p) = c+dp 14

15 Market Equilibrium Can we calculate the market equilibrium using the inverse market demand and supply curves? Yes, it is the same calculation. 15

16 Market Equilibrium the equation of the inverse market demand curve. And the equation of the inverse market supply curve. 16

17 Market Equilibrium q D -1 (q), S -1 (q) D -1 (q) = (a-q)/b Market inverse demand Market inverse supply S -1 (q) = (-c+q)/d p* q* 17

18 Market Equilibrium q D -1 (q), S -1 (q) D -1 (q) = (a-q)/b Market demand S -1 (q) = (-c+q)/d p* q* At equilibrium, D -1 (q*) = S -1 (q*). Market inverse supply 18

19 Market Equilibrium and At the equilibrium quantity q*, D -1 (p*) = S -1 (p*). That is, which gives and 19

20 Market Equilibrium q D -1 (q), S -1 (q) D -1 (q) = (a-q)/b Market demand Market supply S -1 (q) = (-c+q)/d 20

21 Market Equilibrium Two special cases:  quantity supplied is fixed, independent of the market price, and  quantity supplied is extremely sensitive to the market price. 21

22 Market Equilibrium S(p) = c+dp, so d=0 and S(p)  c. p qq* = c Market quantity supplied is fixed, independent of price. 22

23 Market Equilibrium S(p) = c+dp, so d=0 and S(p)  c. p q p* D -1 (q) = (a-q)/b Market demand q* = c Market quantity supplied is fixed, independent of price. 23

24 Market Equilibrium S(p) = c+dp, so d=0 and S(p)  c. p q p* = (a-c)/b D -1 (q) = (a-q)/b Market demand q* = c p* = D -1 (q*); that is, p * = (a-c)/b. Market quantity supplied is fixed, independent of price. 24

25 25 Market Equilibrium S(p) = c+dp, so d=0 and S(p)  c. p q D -1 (q) = (a-q)/b Market demand q* = c p* = D -1 (q*); that is, p * = (a-c)/b. with d = 0 give p* = (a-c)/b Market quantity supplied is fixed, independent of price.

26 Market Equilibrium Two special cases are  when quantity supplied is fixed, independent of the market price, and  when quantity supplied is extremely sensitive to the market price. 26

27 Market Equilibrium Market quantity supplied is extremely sensitive to price. S -1 (q) = p*. p q p* 27

28 Market Equilibrium Market quantity supplied is extremely sensitive to price. S -1 (q) = p*. p q p* D -1 (q) = (a-q)/b Market demand q* 28

29 Market Equilibrium Market quantity supplied is extremely sensitive to price. S -1 (q) = p*. p q p* D -1 (q) = (a-q)/b Market demand q* = a-bp* p* = D -1 (q*) = (a-q*)/b so q* = a-bp* 29

30 Quantity Taxes A quantity tax levied at a rate of $t is a tax of $t paid on each unit traded. Quantity taxes might be levied on sellers or buyers. 30

31 Quantity Taxes What is the effect of a quantity tax on a market’s equilibrium? How are prices affected? How is the quantity traded affected? Who pays the tax? How are gains-to-trade altered? 31

32 Quantity Taxes A tax rate t makes the price paid by buyers, p b, higher by t from the price received by sellers, p s. 32

33 Quantity Taxes Even with a tax the market must clear. i.e. quantity demanded by buyers at price p b must equal quantity supplied by sellers at price p s. 33

34 Quantity Taxes and describe the market’s equilibrium. Notice that these two conditions apply no matter if the tax is levied on sellers or on buyers. Hence, a sales tax rate $t has the same effect as an excise tax rate $t. 34

35 Quantity Taxes & Market Eqm p D(p), S(p) Market demand Market supply p* q* No tax 35

36 Quantity Taxes & Market Eqm p D(p), S(p) Market demand Market supply p* q* $t A quantity tax levied on sellers raises the market supply curve by $t. 36

37 Quantity Taxes & Market Eqm p D(p), S(p) Market demand Market supply p* q* A quantity tax levied on sellers raises the market supply curve by $t, raises the buyers’ price and lowers the quantity traded. $t pbpb qtqt 37

38 Quantity Taxes & Market Eqm p D(p), S(p) Market demand Market supply p* q* A quantity tax levied on sellers raises the market supply curve by $t, raises the buyers’ price and lowers the quantity traded. $t pbpb qtqt And sellers receive only p s = p b - t. psps 38

39 Quantity Taxes & Market Eqm p D(p), S(p) Market demand Market supply p* q* No tax 39

40 Quantity Taxes & Market Eqm p D(p), S(p) Market demand Market supply p* q* A quantity tax levied on buyers lowers the market demand curve by $t. $t 40

41 Quantity Taxes & Market Eqm p D(p), S(p) Market demand Market supply p* q* A quantity tax levied on buyers lowers the market demand curve by $t, lowers the sellers’ price and reduces the quantity traded. $t qtqt psps 41

42 Quantity Taxes & Market Eqm p D(p), S(p) Market demand Market supply p* q* A quantity tax levied on buyers lowers the market demand curve by $t, lowers the sellers’ price and reduces the quantity traded. $t pbpb pbpb qtqt pbpb And buyers pay p b = p s + t. psps 42

43 Quantity Taxes & Market Eqm p D(p), S(p) Market demand Market supply p* q* A quantity tax levied on sellers at rate $t has the same effects on the market’s equilibrium as does a quantity tax levied on buyers at rate $t. $t pbpb pbpb qtqt pbpb psps 43

44 Quantity Taxes & Market Eqm Who pays the tax of $t per unit traded? The division of the $t between buyers and sellers is the incidence of the tax. 44

45 Quantity Taxes & Market Eqm p D(p), S(p) Market demand Market supply p* q* pbpb pbpb qtqt pbpb psps 45

46 Quantity Taxes & Market Eqm p D(p), S(p) Market demand Market supply p* q* pbpb pbpb qtqt pbpb psps Tax paid by buyers 46

47 Quantity Taxes & Market Eqm p D(p), S(p) Market demand Market supply p* q* pbpb pbpb qtqt pbpb psps Tax paid by buyers Tax paid by sellers 47

48 Quantity Taxes & Market Eqm E.g. suppose the market demand and supply curves are linear. 48

49 Quantity Taxes & Market Eqm and With the tax, the market equilibrium satisfies and so and 49 Solving these two equations gives Therefore,

50 Quantity Taxes & Market Eqm As t  0, p s and p b  the equilibrium price if there is no tax (t = 0) and q t the quantity traded at equilibrium when there is no tax.  50

51 Quantity Taxes & Market Eqm As t increases, p s falls, p b rises, andq t falls. 51

52 Quantity Taxes & Market Eqm The tax paid per unit by the buyer is The tax paid per unit by the seller is 52

53 Quantity Taxes & Market Equm The total tax paid (by buyers and sellers combined) is 53

54 Tax Incidence and Own-Price Elasticities The incidence of a quantity tax depends upon the own-price elasticities of demand and supply. 54

55 Tax Incidence and Own-Price Elasticities p D(p), S(p) Market demand Market supply p* q* $t pbpb qtqt psps 55

56 Tax Incidence and Own-Price Elasticities p D(p), S(p) Market demand Market supply p* q* $t pbpb qtqt psps Change to buyers’ price is p b - p*. Change to quantity demanded is  q. qq 56

57 Tax Incidence and Own-Price Elasticities Around p = p* the own-price elasticity of demand is approximately 57

58 Tax Incidence and Own-Price Elasticities p D(p), S(p) Market demand Market supply p* q* $t pbpb qtqt psps 58

59 Tax Incidence and Own-Price Elasticities p D(p), S(p) Market demand Market supply p* q* $t pbpb qtqt psps Change to sellers’ price is p s - p*. Change to quantity demanded is  q. qq 59

60 Tax Incidence and Own-Price Elasticities Around p = p* the own-price elasticity of supply is approximately 60

61 Tax Incidence and Own-Price Elasticities p D(p), S(p) Market demand Market supply p* q* pbpb pbpb qtqt pbpb psps Tax paid by buyers Tax paid by sellers 61

62 Tax Incidence and Own-Price Elasticities p D(p), S(p) Market demand Market supply p* q* pbpb pbpb qtqt pbpb psps Tax paid by buyers Tax paid by sellers Tax incidence = 62

63 Tax Incidence and Own-Price Elasticities Tax incidence = So 63

64 Tax Incidence and Own-Price Elasticities Tax incidence is The fraction of a $t quantity tax paid by buyers rises as supply becomes more own-price elastic or as demand becomes less own-price elastic. 64

65 Tax Incidence and Own-Price Elasticities p D(p), S(p) Market demand Market supply p* q* $t pbpb qtqt psps As market demand becomes less own- price elastic, tax incidence shifts more to the buyers. 65

66 Tax Incidence and Own-Price Elasticities p D(p), S(p) Market demand Market supply p* q* $t pbpb qtqt psps As market demand becomes less own- price elastic, tax incidence shifts more to the buyers. 66

67 Tax Incidence and Own-Price Elasticities p D(p), S(p) Market demand Market supply p s = p* $t pbpb q t = q* As market demand becomes less own- price elastic, tax incidence shifts more to the buyers. 67

68 Tax Incidence and Own-Price Elasticities p D(p), S(p) Market demand Market supply p s = p* $t pbpb q t = q* As market demand becomes less own- price elastic, tax incidence shifts more to the buyers. When  D = 0, buyers pay the entire tax, even though it is levied on the sellers. 68

69 Tax Incidence and Own-Price Elasticities Tax incidence is Similarly, the fraction of a $t quantity tax paid by sellers rises as supply becomes less own-price elastic or as demand becomes more own-price elastic. 69

70 Deadweight Loss and Own-Price Elasticities A quantity tax imposed on a competitive market reduces the quantity traded and so reduces gains-to-trade ( i.e. the sum of Consumers’ and Producers’ Surpluses). The lost total surplus is the tax’s deadweight loss, or excess burden. 70

71 Deadweight Loss and Own-Price Elasticities p D(p), S(p) Market demand Market supply p* q* No tax 71

72 Deadweight Loss and Own-Price Elasticities p D(p), S(p) Market demand Market supply p* q* No tax CS 72

73 Deadweight Loss and Own-Price Elasticities p D(p), S(p) Market demand Market supply p* q* No tax CS PS 73

74 Deadweight Loss and Own-Price Elasticities p D(p), S(p) Market demand Market supply p* q* No tax CS PS 74

75 Deadweight Loss and Own-Price Elasticities p D(p), S(p) Market demand Market supply p* q* $t pbpb qtqt psps CS PS The tax reduces both CS and PS 75

76 Deadweight Loss and Own-Price Elasticities p D(p), S(p) Market demand Market supply p* q* $t pbpb qtqt psps CS PS The tax reduces both CS and PS, transfers surplus to government Tax 76

77 Deadweight Loss and Own-Price Elasticities p D(p), S(p) Market demand Market supply p* q* $t pbpb qtqt psps CS PS The tax reduces both CS and PS, transfers surplus to government Tax 77

78 Deadweight Loss and Own-Price Elasticities p D(p), S(p) Market demand Market supply p* q* $t pbpb qtqt psps CS PS The tax reduces both CS and PS, transfers surplus to government Tax 78

79 Deadweight Loss and Own-Price Elasticities p D(p), S(p) Market demand Market supply p* q* $t pbpb qtqt psps CS PS The tax reduces both CS and PS, transfers surplus to government, and lowers total surplus. Tax 79

80 Deadweight Loss and Own-Price Elasticities p D(p), S(p) Market demand Market supply p* q* $t pbpb qtqt psps Deadweight loss 80

81 Deadweight Loss and Own-Price Elasticities p D(p), S(p) Market demand Market supply p* q* $t pbpb qtqt psps Deadweight loss falls as market demand becomes less own- price elastic. 81

82 Deadweight Loss and Own-Price Elasticities p D(p), S(p) Market demand Market supply p* q* $t pbpb qtqt psps Deadweight loss falls as market demand becomes less own- price elastic. 82

83 Deadweight Loss and Own-Price Elasticities p D(p), S(p) Market demand Market supply p s = p* $t pbpb q t = q* Deadweight loss falls as market demand becomes less own- price elastic. When  D = 0, the tax causes no deadweight loss. 83

84 Deadweight Loss and Own-Price Elasticities Deadweight loss due to a quantity tax rises as either market demand or market supply becomes more own-price elastic. If either  D = 0 or  S = 0 then the deadweight loss is zero. 84


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