1. Equilibrium

2. Market Equilibrium  A market is in equilibrium when total quantity demanded by buyers equals total quantity supplied by sellers.  An equilibrium situation is one where agents are choosing the best possible actions and the behaviors of all agents are mutually consistent.

3. Market Equilibrium  It turns out that the equilibrium outcome of a competitive market is Pareto efficient. At any amount of output less than the equilibrium level there is at least one producer willing to supply extra quantity of the good at a price that is less than the price at least one consumer is willing to pay. Therefore, we can improve the situation of at least two people without hurting anybody else.

4. Market Equilibrium  The equilibrium outcome of a competitive market is the only Pareto efficient outcome.

5. Market Equilibrium p D(p) q=D(p) Market demand

6. Market Equilibrium p S(p) Market supply q=S(p)

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

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

9. 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.

10. 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’)

11. 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 must fall towards p*.

12. 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”)

13. 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 must rise towards p*.

14. Market Equilibrium  The effects of setting a maximum price  The effects of setting a minimum price

15. Market Equilibrium  Demand shifts and motives: -income, -preferences, -prices of substitutes or complements have changed, -expectations of future changes in income or prices, -population, -taxes on consumption

16. Market Equilibrium  Supply shifts and motives: -production technology, -changes in the prices of production factors (wages, prices of raw materials, interest rate, …), -number of producers, -expectations of future price changes, -taxes on production

17. Market Equilibrium  The effects of elasticities on price and quantity variations: when one curve is very inelastic, price accommodates; when one curve is very elastic, quantity accommodates (“One of DeBeers’ main roles is to maintain the notion that diamonds are a scarce commodity. This they do by means of advertising and by purchasing excess supplies when that is needed to avoid price decreases: as a matter of principle, prices are never lowered by DeBeers.”)

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

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

20. 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*?

21. Market Equilibrium At the equilibrium price p*, D(p*) = S(p*).

22. Market Equilibrium At the equilibrium price p*, D(p*) = S(p*). That is,

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

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

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

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

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

28. Market Equilibrium p q D -1 (q) = (a-q)/b Market demand q* = c p* = D -1 (q*); that is, p * = (a-c)/b. p* = (a-c)/b Market quantity supplied is fixed, independent of price.

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*

30. Quantity Taxes  A quantity tax levied at a rate of €t is a tax of €t paid on each unit traded.  If the tax is levied on sellers then it is an excise tax.  If the tax is levied on buyers then it is a sales tax.

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?

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.

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.

34. Quantity Taxes and describe the market’s equilibrium. Notice that these conditions apply no matter if the tax is levied on sellers or on buyers.

35. 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 tax rate €t has the same effect no matter the side of the market on which it is levied.

36. Quantity Taxes & Market Equilibrium p D(p), S(p) Market demand Market supply p* q* No tax

37. Quantity Taxes & Market Equilibrium p D(p), S(p) Market demand Market supply p* q* €t An excise tax raises the market supply curve by €t

38. Quantity Taxes & Market Equilibrium p D(p), S(p) Market demand Market supply p* q* An excise tax raises the market supply curve by €t, raises the buyers’ price and lowers the quantity traded. €t pbpb qtqt

39. Quantity Taxes & Market Equilibrium p D(p), S(p) Market demand Market supply p* q* An excise tax 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

40. Quantity Taxes & Market Equilibrium p D(p), S(p) Market demand Market supply p* q* No tax

41. Quantity Taxes & Market Equilibrium p D(p), S(p) Market demand Market supply p* q* A sales tax lowers the market demand curve by €t €t

42. Quantity Taxes & Market Equilibrium p D(p), S(p) Market demand Market supply p* q* An sales tax lowers the market demand curve by €t, lowers the sellers’ price and reduces the quantity traded. €t qtqt psps

43. Quantity Taxes & Market Equilibrium p D(p), S(p) Market demand Market supply p* q* An sales tax 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

44. Quantity Taxes & Market Equilibrium p D(p), S(p) Market demand Market supply p* q* A sales tax levied at rate €t has the same effects on the market’s equilibrium as does an excise tax levied at rate €t. €t pbpb pbpb qtqt pbpb psps

45. Quantity Taxes & Market Equilibrium  Who pays the tax of €t per unit traded?  The division of the €t between buyers and sellers is the economic incidence of the tax.

46. Quantity Taxes & Market Equilibrium p D(p), S(p) Market demand Market supply p* q* pbpb pbpb qtqt pbpb psps

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

48. Quantity Taxes & Market Equilibrium p D(p), S(p) Market demand Market supply p* q* pbpb pbpb qtqt pbpb psps Tax paid by sellers

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

50. Quantity Taxes & Market Equilibrium  E.g. suppose the market demand and supply curves are linear.

51. Quantity Taxes & Market Equilibrium and

52. Quantity Taxes & Market Equilibrium and With the tax, the market equilibrium satisfies andso and

53. Quantity Taxes & Market Equilibrium and With the tax, the market equilibrium satisfies andso and Substituting for p b gives

54. Quantity Taxes & Market Equilibrium and give The quantity traded at equilibrium is

55. Quantity Taxes & Market Equilibrium 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. 

56. Quantity Taxes & Market Equilibrium As t increases, p s falls, p b rises, andq t falls.

57. Quantity Taxes & Market Equilibrium The tax paid per unit by the buyer is

58. Quantity Taxes & Market Equilibrium The tax paid per unit by the buyer is The tax paid per unit by the seller is

59. Quantity Taxes & Market Equilibrium The total tax paid (by buyers and sellers combined) is

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

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

62. 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

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

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

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

66. 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

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

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

69. 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

70. 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 =

71. Tax Incidence and Own-Price Elasticities Tax incidence =

72. Tax Incidence and Own-Price Elasticities Tax incidence = So

73. 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.

74. 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.

75. 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.

76. 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.

77. Tax Incidence and Own-Price Elasticities 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.

78. 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.

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

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

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

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

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

84. 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

85. 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

86. 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

87. 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

88. Deadweight Loss and Own-Price Elasticities p D(p), S(p) Market demand Market supply p* q* €t pbpb qtqt psps CS PS Tax Deadweight loss

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

90. 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.

91. 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.

92. 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.

93. 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.

94. Fiscal Revenue  Fiscal revenue decreases for t sufficiently large, because market transactions are highly reduced: the Laffer curve.

95. Long-Run Implications of Taxation in a Competitive Market  In a short-run equilibrium, the burden of a tax is typically shared by both buyers and sellers, the tax incidence depending upon the own-price elasticities of demand and supply.  Q: Is this true in a long-run market equilibrium?

96. Long-Run Implications of Taxation in a Competitive Market LR supply (no tax) p X,Y Market demand QeQe pepe

97. Long-Run Implications of Taxation in a Competitive Market LR supply (no tax) p X,Y Market demand QeQe p s =p e LR supply (with tax) QtQt p b = p e +t t

98. Long-Run Implications of Taxation in a Competitive Market LR supply (no tax) p X,Y Market demand QeQe p s =p e LR supply (with tax) QtQt p b = p e +t t In the long-run the buyers pay all of a sales or an excise tax.