1. Evaluating the Welfare Effects of Government Policy: CS & PS
Price
Consumer
Surplus D 10 7
Consumer B
Consumer A
Between 0 and Q0
consumers A and B
receive a net gain from
buying the product--
consumer surplus S 5 Q0
Consumer C
Producer
Surplus
Between 0 and Q0
producers receive
a net gain from
selling each product--
producer surplus.
Quantity 9

2. Price Ceilings and the Welfare Loss
Pmax Q1 Q2
Suppose the government
imposes a price ceiling Pmax
which is below the
market-clearing price P0.
Price S D
The loss to producers is
the sum of rectangle
A and triangle C. Triangle
B and C together measure
the deadweight loss. B A C
The gain to consumers is
the difference between
the rectangle A and the
triangle B.
Deadweight Loss P0 Q0
Chapter 9
Quantity 13

3. Price Ceiling: Demand Is InelasticB A
Pmax C Q1
If demand is sufficiently
inelastic, triangle B can
be larger than rectangle
A and the consumer
suffers a net loss from
price controls.
Example
Oil price controls
and gasoline shortages
in 1979
Price S D P0 Q2
Quantity
Chapter 9 17

4. Price Controls and Natural Gas Shortages
($/mcf) S D B A
2.40 C
The gain to consumers is
rectangle A minus triangle
B, and the loss to
producers is rectangle
A plus triangle C.
2.00 18
(Pmax)1.00 5 10 15 20 25 30
Quantity (Tcf)
Chapter 9 25

5. Price Floors and the Welfare LossQ3 A B C Q2
What would the deadweight
loss be if QS = Q2?
When price is
regulated to be no
lower than P2 only Q3
will be demanded. The
deadweight loss is given
by triangles B and C
Price S D P0 Q0
Chapter 9
Quantity 37

6. Price Floor: The Minimum Wage
wmin L1 L2
Unemployment
Firms are not allowed to
pay less than wmin. This
results in unemployment. w S D w0 L0 B
The deadweight loss
is given by
triangles B and C. C L
Chapter 9 55

7. Price Floors: Airline DeregulationQ1
Pmin Q2
Prior to deregulation
price was at Pmin and
QD = Q1 and Qs = Q3. S D P0 Q0
Price Q3 D
Area D is the cost
of unsold output. B A C
After deregulation:
Prices fell to PO. The
change in consumer
surplus is A + B.
Quantity
Chapter 9 59

8. Agricultural Price Floors: Price Supports and Production Quotas
The cost to the
government is the
speckled rectangle
Ps(Q2-Q1)
Price
D + Qg Qg S
To maintain a price Ps, the
government buys quantity Qg .
The change in CS = -A – B; the
change in PS = A + B + D.
Total welfare loss is D-(Q2-Q1)ps Ps A B D P0
Total
Welfare
Loss D Q1 Q0 Q2
Quantity
Chapter 9 66

9. Price Floors: Supply RestrictionsPS S’ Q1
Supply restricted to Q1
Supply shifts to Q1
Ps is maintained with production
quota and/or financial incentive
Cost to government = B + C + D
Price D P0 Q0 S B A
CS reduced by A + B
Change in PS = A - C
Deadweight loss = BC C D
Quantity
Chapter 9 71

10. Import Tariff or Quota: General Case
The increase in price can be achieved by a quota or a tariff
A = the gain to domestic producers
The loss to consumers = A + B + C + D
If a tariff is used the government gains D, so the net domestic product loss is B + C.
If a quota is used instead, D becomes part of the profits of foreign producers, and the net domestic loss is B + C + D. D S
Price D C B QS QD
Q’S
Q’D A P* Pw
Quantity
Chapter 9 94

11. US Sugar Quota in 1997 SUS DUS D A B Price PW = 11 PUS = 21.9 C
D = the gain to
foreign firms with
quota rights = $600m
B and C = the DWL =
$800 m.
SUS
DUS
Price
(cents/lb.)
PW = 11
PUS = 21.9 C D B
QS = 4.0
Q’S = 15.6
Q’d = 21.1
Qd = 24.2 A
The cost of the quotas
to consumers was
A + B + C + D, or $2.4b.
The gain to producers
was area A, or $1b. 20 16 11 8 4 5 10 15 20 25 30
Quantity
(billions of pounds)
100

12. Incidence of a Specific TaxQ1 PS Pb t
Pb is the price (including
the tax) paid by buyers.
PS is the price sellers receive,
net of the tax. The burden
of the tax is split evenly.
Price D S B D A
Buyers lose A + B, and
sellers lose D + C, and
the government earns A + D
in revenue. The deadweight
loss is B + C. C P0 Q0
Quantity
Chapter 9
106

13. Incidence of a Specific Tax
Conditions that must be satisfied after the tax is in place:
1) Quantity sold and Pb must be on the demand line: QD = QD(Pb)
2) Quantity sold and PS must be on the supply line: QS = QS(PS)
3) QD = QS
4) Pb - PS = tax
Chapter 9
107

14. Impact of a Tax Depends on Es & Ed
Burden on Buyer
Burden on Seller S D
Price
Price Q1 Pb PS t Q1 Pb PS t Q0 P0
Quantity
Quantity
110

15. Impact of a 50 Cent Gasoline Tax
Deadweight loss = $2.75 billion/yr S D 60
Price
($ per
gallon)
1.50 D A
Lost Consumer
Surplus
Lost Producer
PS = .72
Pb = 1.22
The annual revenue
from the tax is .50(89)
or $44.5 billion. The buyer
pays 22 cents of the tax, and
the producer pays 28 cents. 89
t = 0.50 11
100
P0 = 1.00
.50
Quantity (billion
gallons per year) 50
150
Chapter 9
122

16. upon the elasticities of
Effect of a Subsidy
Price D S Q1 PS Pb s
Like a tax, the benefit
of a subsidy is split
between buyers and
sellers, depending
upon the elasticities of
supply and demand. P0 Q0
Quantity
Chapter 9
114

17. The Efficiency of a Competitive Market: Any Market Failure?
1) Externalities: Costs or benefits that are not reflected in the market price (e.g. pollution)
2) Lack of Information: Imperfect information prevents consumers from making utility- maximizing decisions.
Government intervention in these markets can increase efficiency.
Government intervention without market failure creates inefficiency or DWL.
Chapter 9 30