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 (P max ): 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 P min > 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 Q sold, P b, P s, and t. –Note: P b – P s = tax. –See Figure Burden of tax: –shared by sellers and buyers; –how shared determined by relative elasticities of S and D. –Pass-through fraction = E s /(E s -E d ) Tells fraction of tax “passed thru” to buyers in form of higher prices. –In general: a tax falls mostly on buyer if E d /E s is small and mostly on the seller if E d /E s is large.

Show Tax w/Algebra (Example 9.6) Terms: –P b : price paid by buyers –P s : price received by sellers –P o : no-tax price Example: Qd = 150 – 50P b Qs = P s t = 0.50; P b – P s = Approach: Replace P b with P s +0.50; set Qd=Qs and then solve for P s ; Then solve for P b and Q. –See difference if there had been no tax. –Buyers’ tax burden = P b – P 0. –Sellers’ burden = P 0 – P s.

Exercise: Tax Given S & D of wickets: Qs = P Qd = 3200 – 25P 1. What is market equilibrium price and quantity? 2. Now impose per unit tax of $20 on consumers. What is new P b, P s, 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 P b, P s 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 P s – P b = S. –Result is higher quantity sold (opposite of effect of tax). General rule: the benefit of a subsidy accrues mostly to buyers if E d /E s is small and mostly to sellers if E d /E s is large..