1. MICROECONOMICS: Theory & Applications
Chapter 10: Using the Competitive Model
By Edgar K. Browning & Mark A. Zupan
John Wiley & Sons, Inc.
11th Edition, Copyright 2012
PowerPoint prepared by Della L. Sue, Marist College

2. The Evaluation of Gains and Losses
Consumer surplus – a measure of the net gain to a consumer or group of consumers from purchasing a good arising from cost being below the maximum that consumers are willing to pay
Producer surplus – gains to producers from the sale of output to consumers, arising from price exceeding the minimum necessary to compensate the seller.
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3. Producer Surplus Who gets the producer surplus?
Suppliers of inputs to the industry if the supply curve is upward-sloping
Owners of inputs with horizontal supply curves to the industry receive no producer surplus.
There is no aggregate producer surplus for a constant-cost competitive industry in long-run equilibrium.
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4. Figure 10.1 - Producer Surplus
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5. Consumer Surplus, Producer Surplus, and Efficient Output
Total surplus – 2 approaches:
the sum of producer and consumer surplus
the sum of total surplus associated with each unit of output, added over all units of output
Efficiency in output – the condition in which output is expanded to the point where marginal benefit equals marginal cost
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6. Figure 10.2 - Competition Maximizes Total Surplus
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7. The Deadweight Loss of a Price Ceiling
Deadweight loss – also called welfare cost, a measure of the aggregate loss in well-being of participants in a market resulting from an inefficient output level
Comparison of changes in consumer surplus and producer surplus indicate who gains and who loses
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8. Figure 10.3 - A Price Ceiling Reduces Total Surplus
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9. Excise Taxation Excise tax – a tax levied on a specific good
Per unit tax: does not depend on the market price
Ad valorem tax: an excise tax that is levied as a certain percentage of the market price
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10. Figure 10.4 - Effects of a Per-Unit Excise Tax
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11. The Consequences of an Excise Tax
Short-Run Effects
Firms reduce output.
Market price rises.
Long-Run Effects
Even when the tax is levied on and collected from firms, consumers bear a cost as a result of the higher price.
After the long-run adjustment to the tax, firms make zero economic profits.
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12. Figure 10.5 - How Elasticities Affect the Tax Burden
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13. Who Bears the Burden of the Tax?
When an excise tax is imposed on a good, elasticity determines how much output falls and how much the price to consumers rises.
For a given demand curve and tax per unit, the more inelastic the supply curve:
the smaller is the tax burden on consumers
the larger is the tax burden on producers
the smaller is the output reduction
For a given supply curve and tax per unit, the more inelastic the demand curve:
the greater is the tax burden on consumers
the smaller is the tax burden on producers
the smaller is the reduction in output
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14. When the Consumer Bears the Entire Burden of the Tax
Situations of extreme elasticity:
If the demand is perfectly inelastic, the demand curve is vertical.
If the supply curve is perfectly elastic, the supply curve is horizontal, which is the constant-cost case.
In both cases,
the price to consumers rises by the amount of the tax.
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15. The Deadweight Loss of Excise Taxation
Any deviation from the competitive level of output is inefficient and results in a decrease in consumer surplus and producer surplus (total loss)
Tax revenue: gain to the government
Excess burden –deadweight loss produced by a tax
total loss = tax revenue + excess burden
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16. Figure 10.6 - The Deadweight Loss of Excise Taxation
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17. Figure 10. 7 - The Deadweight Loss of Rent Control
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18. Airline Regulation and Deregulation
: period of regulation in the airline industry by the Civil Aeronautics Board (CAB)
Factors that were regulated:
Fares
Routes between 2 cities
Entry of new firms into the industry
Support for deregulation:
Fares were set above the market equilibrium fare.
Accounting profits for the airline industry were below the national average for all industries over the 20 years prior to deregulation in 1978.
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19. What Happened to the Profits? [in the airline industry]
Profitable routes covered the loss from unprofitable routes that airlines were required to operate.
Airline employee unions bargained for higher wages when fares were above competitive levels.
Nonprice competition increased costs.
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20. Figure 10.8 - Airline Profitability Under CAB Regulation
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21. The Airline Industry After Deregulation
Since the domestic airline industry was deregulated, several changes have occurred:
The cost of air travel to consumers has fallen.
A major restructuring of the industry has taken place.
New entrants into the industry have been able to operate at lower costs than the established carriers.
Air service to small communities has increased but fares have also gone up.
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22. The Contestability of Airline Markets
Contestable markets – markets in which competition is so perfect that the market price is independent of the number of firms currently serving a market, because the mere possibility of entry suffices to discipline the actions of incumbent suppliers.
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23. Results of Airline Deregulation
Concerns after deregulation:
Greater congestion at airports
Issues of airline safety
Possible solutions:
Re-regulation
Expand airport capacity
Implement peak-load pricing
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24. City Taxicab Markets
Medallion – a city-issued taxi license; fixed supply
Value of medallion: determined by expected profitability of operating a taxi
Results include higher fares and lower output than under unregulated conditions
Alternative regulation: maximum fares (price ceiling)
Illegal markets in transportation services develop
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25. Figure 10.9 – Licensing Taxicabs
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26. Figure 10.10 - Consumer and Producer Surplus, and the Net Gains from Trade [International Trade]
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27. Figure 10.11 - The Gains from Free Trade [International Trade]
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28. The Link Between Imports and Exports
Both nations are better off from trading.
When nations trade, one country’s imports are the other country’s exports.
When the U.S. imports goods from the rest of the world, the dollars used to pay international suppliers for those goods come back to the U.S. economy in the form of international demand for U.S. exports.
Currency is a medium of exchange between imports and exports - Free trade neither creates or destroys currency.
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29. Government Intervention in Markets: Quantity Controls
Quotas – government-imposed maximum quantities of goods
Application: sugar import quota in the United States
Effect of quotas:
Deadweight loss occurs
Markets of related products are affected
Price differentials between countries arise in the regulated market
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30. Figure 10.12 - The Sugar Import Quota
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