1. The Analysis of Competitive Markets
Chapter 9
The Analysis of Competitive Markets

2. Q: Rent Control
Chuncheon City decided to control rent around KNU campus for students.
Are KNU students going to be better off?
Chapter 9

3. Consumer and Producer Surplus
Consumer surplus is the total benefit or value that consumers receive beyond what they pay for the good.
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4. Consumer and Producer Surplus
Producer surplus is the total benefit or revenue that producers receive beyond what it cost to produce a good.
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5. Consumer and Producer Surplus
Price D 5 9
Consumer
Surplus S
Between 0 and Q0 consumer A receives a net gain from buying the product-- consumer surplus 3
Producer
Surplus
Between 0 and Q0
producers receive
a net gain from
selling each product--
producer surplus. QD QS Q0
Quantity
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6. Consumer and Producer Surplus
To determine the welfare effect of a governmental policy we can measure the gain or loss in consumer and producer surplus.
Welfare Effects
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7. Price Control and Surplus ChangesB P0 Q0 A C
Pmax Q1 Q2
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8. Price controls and Welfare Effects
The total loss is equal to area B + C.
The deadweight loss is the inefficiency of the price controls – the total loss in surplus (consumer plus producer)
If demand is sufficiently inelastic, losses to consumers may be fairly large
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9. Price Controls With Inelastic DemandQ1 B P0 Q2
With inelastic demand, triangle B can be larger than rectangle A and consumers suffer net losses from price controls. C A
Pmax
Quantity
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10. The Efficiency of a Competitive Market
In the evaluation of markets, we often talk about whether it reaches economic efficiency
Policies such as price controls that cause dead weight losses in society are said to impose an efficiency cost on the economy
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11. The Efficiency of a Competitive Market
If efficiency is the goal, then you can argue leaving markets alone is the answer
However, sometimes market failures occur
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12. Types of Market Failures
Externalities
Costs or benefits that do not show up as part of the market price (e.g. pollution)
Costs or benefits are external to the market
Lack of Information
Imperfect information prevents consumers from making utility-maximizing decisions.
Government intervention may be desirable in these cases
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13. The Efficiency of a Competitive Market
Other than market failures, unregulated competitive markets lead to economic efficiency
What if the market is constrained to a price higher than the economically efficient equilibrium price?
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14. Price Control and Surplus Changes
Pmin Q1 A B Q2 P0 Q0 C
Quantity
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15. The Efficiency of a Competitive Market
Deadweight loss triangles, B and C, give a good estimate of efficiency cost of policies that force price above or below market clearing price.
Measuring effects of government price controls on the economy can be estimated by measuring these two triangles
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16. Minimum Wages Wage is set higher than market clearing wage
Decreased quantity of workers demanded
Those workers hired receive higher wages
Unemployment results since not everyone who wants to work at the new wage can
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17. The Minimum Wage S D w0 L0 wmin L1 L2 w A B C L Unemployment Chapter 955

18. Price Supports
Much of agricultural policy is based on a system of price supports.
Government can also increase prices through restricting production, directly or through incentives to producers
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19. Price Supports
What are the impacts on consumers, producers and the federal budget?
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20. CS + PS – Govt. cost = D – (Q2-Q1)PS
Price Supports
Government may be able to “dump” some of the goods in the foreign markets
Total welfare effect of policy
CS + PS – Govt. cost = D – (Q2-Q1)PS
Society is worse off over all
Less costly to simply give farmers the money
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21. Price Supports E S D P0 Q0 D + Qg Qg Ps Q2 Q1 D B Price
To maintain a price Ps
the government buys
quantity Qg . Ps Q2 Q1 A D B E
Net Loss to society is E + B
Quantity
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22. Production Quotas
The government can also cause the price of a good to rise by reducing supply.
Limitations of taxi medallions in New York City
Limitation of required liquor licenses for restaurants
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23. Supply Restrictions S’ D P0 Q0 S PS Q1 Price A B C Quantity Chapter 971

24. Import Quotas and Tariffs
Many countries use import quotas and tariffs to keep the domestic price of a product above world levels
Import quotas: Limit on the quantity of a good that can be imported
Tariff: Tax on an imported good
This allows domestic producers to enjoy higher profits
Costs to consumers is high
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25. Import Tariff To Eliminate Imports
Price D P0 S Q0 A B C PW QS QD
Imports
Quantity
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26. The Impact of a Tax or Subsidy
The government wants to impose a $1.00 tax on movies. It can do it two ways
Make the producers pay $1.00 for each movie ticket they sell
Make consumers pay $1.00 when they buy each movie
In which option are consumers paying more?
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27. The Impact of a Tax or Subsidy
The burden of a tax (or the benefit of a subsidy) falls partly on the consumer and partly on the producer.
How the burden is split between the parties depends on the relative elasticities of demand and supply.
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28. The Effects of a Specific Tax
For simplicity we will consider a specific tax on a good
For our example, consider a specific tax of $t per widget sold
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29. Incidence of a Specific Tax
Price D S
Pb price buyers pay
Tax = $1.00 Q1 A B P0 Q0 D C
PS price producers get
Quantity
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30. Incidence of a Specific Tax
In the previous example, the tax was shared almost equally by consumers and producers
If demand is relatively inelastic, however, burden of tax will fall mostly on buyers
If supply is relatively inelastic, the burden of tax will fall mostly on sellers
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31. Impact of Elasticities on Tax Burdens
Burden on Buyer
Burden on Seller S D
Price
Price Q1 Pb PS t Q1 Pb PS t Q0 P0
Quantity
Quantity
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