Ec100A Ch9 - 9 GOVERNMENT INTERVENTION IN COMPETITIVE...

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GOVERNMENT INTERVENTION IN COMPETITIVE MARKETS 9 Econ 100A Mortimer
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THE EFFICIENCY OF A COMPETITIVE MARKET Social Welfare: Consumer and Producer Surplus Consumer and producer surplus measure the welfare benefit of a competitive market. In equilibrium, a competitive market allocates resources efficiently. The output produced in a competitive market is the one that maximizes net economic benefits (as measured by the sum of CS and PS). economic efficiency Maximization of aggregate consumer and producer surplus. S D P Q CS Q*=6 P*=8 20 10 PS
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THE EFFICIENCY OF A COMPETITIVE MARKET Social Welfare: Consumer and Producer Surplus S D P Q CS Q*=6 P*=8 20 10 PS welfare effects Gains and losses to consumers and producers. 3 deadweight loss Potential net economic benefit (surplus) that no one captures. Deadweight loss Suppose the government restricts the market output to be 3. The welfare effect of such a policy is negative. Why should we intervene in a competitive market? 1. market failure 2. objectives other than maximizing surplus.
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THE EFFICIENCY OF A COMPETITIVE MARKET There are two important instances in which market failure can occur: 1. Externalities 2. Lack of Information market failure Situation in which an unregulated competitive market is inefficient because prices fail to provide proper signals to consumers and producers. externality Action taken by either a producer or a consumer which affects other producers or consumers but is not accounted for by the market price. $ Q Q 1 Q 2 D= MPB = marginal private benefit MC=S $5 MSB= marginal social benefit Flu vaccine: positive externality We will study market failure and government intervention in Ch. 18
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THE IMPACT OF A TAX OR SUBSIDY P d is the price (including the tax) paid by consumers. P s is the price that sellers receive, less the tax, t. e.g., P d = P s + t The effect of the tax can be analyzed by drawing a new supply curve S+t (it is as if every seller’s MC has increased by t). The new equilibrium is at the intersection of D and the “as if” S curve, S+t . Incidence of a Tax specific tax (excise tax) Tax of a certain amount of money per unit sold. With no Tax With Tax Impact of Tax Consumer Surplus A+B+C+E A -B-C-E Producer Surplus F+G+H H -F-G Gov’t Receipts Zero B+C+G B+C+G Net Benefits A+B+C+E+F+G+H A+B+C+G+H -E-F Deadweight loss zero E+F E+F S+t S D P Q A B C E G F H P d =12 P s =6 The market underproduces Q*=6 Q’=4 P*=8 20 10 $6
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THE IMPACT OF A TAX OR SUBSIDY Exercise: Impact of an Excise Tax Q: In the previous example, assume that the demand and supply curves are given by: Q d =10-0.5P d Q s = -2+P s , when P s ≥2 and 0 when P s <2 where P d represents the price consumers pay, P s the price producers receive, and Q are measured in millions of units. With no tax, the equilibrium price and quantity are P*=$8 and Q*=6 million (verify). Suppose the government imposes an excise tax of $6 per unit. What will the new equilibrium quantity be? Compute P d, P s,
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This note was uploaded on 04/24/2009 for the course ECON 100A taught by Professor Woroch during the Spring '08 term at Berkeley.

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Ec100A Ch9 - 9 GOVERNMENT INTERVENTION IN COMPETITIVE...

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