CHAPTER 09 - PHALL-82241 PINDYCK CHAPTER 09 page 4 of 25...

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Unformatted text preview: PHALL-82241 PINDYCK CHAPTER 09 page 4 of 25 FIGURE 9.1 Consumer and Producer Surplus Price $10 Consumer Surplus S 7 5 Producer Surplus D Q0 Consumer A Consumer B Quantity Consumer C Consumer A would pay $10 for a good whose market price is $5 and therefore enjoys a benefit of $5. Consumer B enjoys a benefit of $2, and Consumer C, who values the good at exactly the market price, enjoys no benefit. Consumer surplus, which measures the total benefit to all consumers, is the yellow-shaded area between the demand curve and the market price. Producer surplus measures the total profits of producers, plus rents to factor inputs. It is the green-shaded area between the supply curve and the market price. Together, consumer and producer surplus measure the welfare benefit of a competitive market. Fig 09-01.EPS PHALL-82241 PINDYCK CHAPTER 09 page 5 of 25 FIGURE 9.2 Change in Consumer and Producer Surplus from Price Controls Price S Deadweight Loss B P0 C A Pmax Shortage D Q1 Q0 Q2 Quantity The price of a good has been regulated to be no higher than Pmax, which is below the market-clearing price P0. The gain to consumers is the difference between rectangle A and triangle B. The loss to producers is the sum of rectangle A and triangle C. Triangles B and C together measure the deadweight loss from price controls. Fig 09-02.EPS PHALL-82241 PINDYCK CHAPTER 09 page 6 of 25 FIGURE 9.3 Effect of Price Controls When Demand Is Inelastic D Price S B P0 Pmax A C Q1 Q2 If demand is sufficiently inelastic, triangle B can be larger than rectangle A. In this case, consumers suffer a net loss from price controls. Fig 09-03.EPS Quantity PHALL-82241 PINDYCK CHAPTER 09 page 7 of 25 FIGURE 9.4 Effects of Natural Gas Price Controls 20 Demand P= $19.20 Supply 18 16 PG ($/mcf ) 14 12 10 $7.73 8 B 6 PO = $6.40 4 2 0 C A 0 QD = 29.1 QS = 20.6 Pmax = $3.00 10 20 Quantity (Tcf) Q* = 23 30 The market-clearing price of natural gas is $6.40 per mcf, and the (hypothetical) maximum allowable price is $3.00. Ashortage of 29.1 ? 20.6 = 8.5 Tcf results. The gain to consumers is rectangle A minus triangle B, and the loss to producers is rectangle A plus triangle C. The deadweight loss is the sum of triangles B plus C. Fig 09-04.EPS 40 PHALL-82241 PINDYCK CHAPTER 09 page 8 of 25 FIGURE 9.5 Welfare Loss When Price is Held Above Market-Clearing Level Price S P2 A B P0 C D Q3 Q0 Q2 Quantity When price is regulated to be no lower than P2, only Q3 will be demanded. If Q3 is produced, the deadweight loss is given by triangles B and C. At price P2, producers would like to produce more than Q3. If they do, the deadweight loss will be even larger. Fig 09-05.EPS PHALL-82241 PINDYCK CHAPTER 09 page 9 of 25 FIGURE 9.6 The Market for Kidneys and the Effect of the National Organ Transplantation Act S′ $40,000 S D Price $30,000 B $20,000 C $10,000 A D $0 0 8,000 16,000 Quantity 24,000 The market-clearing price is $20,000; at this price, about 24,000 kidneys per year would be supplied. The law effectively makes the price zero. About 16,000 kidneys per year are still donated; this constrained supply is shown as S’. The loss to suppliers is given by rectangle A and triangle C. If consumers received kidneys at no cost, their gain would be given by rectangle A less triangle B. In practice, kidneys are often rationed on the basis of willingness to pay, and many recipients pay most or all of the $40,000 price that clears the market when supply is constrained. Rectangles A and D measure the total value of kidneys when supply is constrained. Fig 09-06.EPS 32,000 PHALL-82241 PINDYCK CHAPTER 09 page 10 of 25 FIGURE 9.7 Price Minimum S Price Pmin P0 A B C D D Q3 Q0 Q2 Price is regulated to be no lower than Pmin. Producers would like to supply Q2, but consumers will buy only Q3. If producers indeed produce Q2, the amount Q2 ? Q3 will go unsold and the change in producer surplus will be A ? C ? D. In this case, producers as a group may be worse off. Fig 09-07.EPS Quantity PHALL-82241 PINDYCK CHAPTER 09 page 11 of 25 FIGURE 9.8 The Minimum Wage w S wmin A B w0 C D L1 L0 L2 L Unemployment Although the market-clearing wage is w0, firms are not allowed to pay less than wmin. This results in unemployment of an amount L2 ? L1 and a deadweight loss given by triangles B and C. Fig 09-08.EPS PHALL-82241 PINDYCK CHAPTER 09 page 12 of 25 FIGURE 9.9 Effect of Airline Regulation by the Civil Aeronautics Board S Price Pmin A B P0 C D D Q1 Q3 Q0 Q2 Quantity At price Pmin, airlines would like to supply Q2, well above the quantity Q1 that consumers will buy. Here they supply Q3. Trapezoid D is the cost of unsold output. Airline profits may have been lower as a result of regulation because triangle C and trapezoid D can together exceed rectangle A. In addition, consumers lose A + B. Fig 09-09.EPS PHALL-82241 PINDYCK CHAPTER 09 page 13 of 25 FIGURE 9.10 Price Supports Price S Qg PS A B P0 D D + Qg D Q1 Q0 Q2 Quantity To maintain a price Ps above the market-clearing price P0, the government buys a quantity Qg. The gain to producers is A + B + D. The loss to consumers is A + B. The cost to the government is the speckled rectangle, the area of which is Ps(Q2 ? Q1). Fig 09-10.EPS PHALL-82241 PINDYCK CHAPTER 09 page 14 of 25 FIGURE 9.11 Supply Restrictions S′ Price S Ps D A B P0 C D Q1 Q0 Quantity To maintain a price Ps above the market-clearing price P0, the government can restrict supply to Q1, either by imposing production quotas (as with taxicab medallions) or by giving producers a financial incentive to reduce output (as with acreage limitations in agriculture). For an incentive to work, it must be at least as large as B + C + D, which would be the additional profit earned by planting, given the higher price Ps. The cost to the government is therefore at least B + C + D. Fig 09-11.EPS PHALL-82241 PINDYCK CHAPTER 09 page 15 of 25 FIGURE 9.12 The Wheat Market in 1981 S Price (dollars per bushel) Qg Ps = $3.70 A P0 = $3.46 B C D + Qg D 1800 2566 2630 2688 Quantity By buying 122 million bushels of wheat, the government increased the market-clearing price from $3.46 per bushel to $3.70. Fig 09-12.EPS PHALL-82241 PINDYCK CHAPTER 09 page 16 of 25 FIGURE 9.13 The Wheat Market in 1985 S′ Price (dollars per bushel) S Qg Ps = $3.20 P0 = $1.80 D + Qg D 1800 1959 2232 2425 Quantity In 1985, the demand for wheat was much lower than in 1981, because the market-clearing price was only $1.80. To increase the price to $3.20, the government bought 466 million bushels and also imposed a production quota of 2425 million bushels. Fig 09-13.EPS PHALL-82241 PINDYCK CHAPTER 09 page 17 of 25 FIGURE 9.14 Import Tariff or Quota That Eliminates Imports Price S P0 A B Pw C D Qs Q0 Qd Quantity Imports In a free market, the domestic price equals the world price Pw. A total Qd is consumed, of which Qs is supplied domestically and the rest imported. When imports are eliminated, the price is increased to P0. The gain to producers is trapezoid A. The loss to consumers is A + B + C, so the deadweight loss is B + C. Fig 09-14.EPS PHALL-82241 PINDYCK CHAPTER 09 page 18 of 25 FIGURE 9.15 Import Tariff or Quota (General Case) Price S P* Quota T A D B Pw C D Qs Q' s Q' d Qd Quantity When imports are reduced, the domestic price is increased from Pw to P*. This can be achieved by a quota, or by a tariff T = P* ? Pw. Trapezoid A is again the gain to domestic producers. The loss to consumers is A + B + C + D. If a tariff is used, the government gains D, the revenue from the tariff, so the net domestic loss is B + C. If a quota is used instead, rectangle D becomes part of the profits of foreign producers, and the net domestic loss is B + C + D. Fig 09-15.EPS PHALL-82241 PINDYCK CHAPTER 09 page 19 of 25 FIGURE 9.16 Sugar Quota in 2005 40 35 Price (cents per pound) 30 PUS � 27 25 20 A B D C 15 Pw � 12 10 5 0 0 5 Qs � 2.6 10 15 Q� � 15.2 s 20 25 Q� � 20.5 d 30 Qd � 23.9 Quantity (billions of pounds) At the world price of 12 cents per pound, about 23.9 billion pounds of sugar would have been consumed in the United States in 2005, of which all but 2.6 billion pounds would have been imported. Restricting imports to 5.3 billion pounds caused the U.S. price to go up by 15 cents. The cost to consumers, A + B + C + D, was about $3.3 billion. The gain to domestic producers was trapezoid A, about $1.3 billion. Rectangle D, $795 million, was a gain to those foreign producers who obtained quota allotments. Triangles B and C represent the deadweight loss of about $1.2 Fig 09-16.EPS PHALL-82241 PINDYCK CHAPTER 09 page 20 of 25 FIGURE 9.17 Incidence of a Tax Price S Pb A P0 D t B C Ps D Q1 Q0 Quantity Pb is the price (including the tax) paid by buyers. Ps is the price that sellers receive, less the tax. Here the burden of the tax is split evenly between buyers and sellers. Buyers lose A + B, sellers lose D + C, and the government earns A + D in revenue. The deadweight loss is B + C. Fig 09-17.EPS PHALL-82241 PINDYCK CHAPTER 09 page 21 of 25 FIGURE 9.18 Impact of a Tax Depends on Elasticities of Supply and Demand Price Price D S Pb t S P0 Ps Pb P0 D t Ps Q1 Q0 (a) Quantity Q1 Q0 Quantity (b) (a) If demand is very inelastic relative to supply, the burden of the tax falls mostly on buyers. (b) If demand is very elastic relative to supply, it falls mostly on sellers. Fig 09-18.EPS PHALL-82241 PINDYCK CHAPTER 09 page 22 of 25 FIGURE 9.19 Subsidy Price S Ps P0 s Pb D Q0 Q1 Quantity A subsidy can be thought of as a negative tax. Like a tax, the benefit of a subsidy is split between buyers and sellers, depending on the relative elasticities of supply and demand. Fig 09-19.EPS PHALL-82241 PINDYCK CHAPTER 09 page 23 of 25 FIGURE 9.20 Impact of $1 Gasoline Tax Price (dollars per gallon) 3.00 Lost Consumer Surplus Pb = 2.44 A P0 = 2.00 t = 1.00 D Lost Producer Surplus Ps = 1.44 1.00 11 0.00 0 50 89 100 150 Quantity (billion gallons per year) The price of gasoline at the pump increases from $2.00 per gallon to $2.44, and the quantity sold falls from 100 to 89 bg/yr. Annual revenue from the tax is (1.00)(89) = $89 billion. The two triangles show the deadweight loss of $5.5 billion per year. Fig 09-20.EPS ...
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This note was uploaded on 09/28/2011 for the course ECON 105 taught by Professor Prof.eco during the Spring '11 term at Indian School of Business.

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