1. 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.

2. 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.

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.

4. 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.

5. 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.

6. 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 9.17. 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.

7. 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 = 60 + 40P s t = 0.50; P b – P s = 0.50. 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.

8. Exercise: Tax Given S & D of wickets: Qs = -800 + 15P 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.

9. 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..