This preview shows page 1. Sign up to view the full content.
Unformatted text preview: PADP 6950: Founda1ons of Policy Analysis Surpluses Angela Fer1g, PhD Consumer Welfare Policy analysts are oAen concerned with how policy changes affect the welfare of consumers. For example, if we reduce public transit fares, by how much will transit riders benefit? To answer such ques1ons, one obviously must have a method for measuring consumer welfare. Fortunately, a useful welfare measure can be devised with the help of the market demand curve 1 Consumer Surplus Consumer surplus is the difference between the maximum amount consumers are willing to pay for a good and the amount they must actually pay CS is a commonly used welfare measure Over the next few slides, I will argue to you that the demand curve gives us the maximum willingness to pay Reading the Demand Curve as the Marginal Benefit Curve 1 The usual way that we read the demand curve is from price to quan1ty In other words, at a par1cular price, what is the quan1ty demanded by all the consumers in the market? P 5 D Q At a price of $5, 100 units are demanded 100 2 Reading the Demand Curve as the Marginal Benefit Curve 2 But the demand curve also measures marginal benefit: it gives the value the consumer places on another unit of Q So, we can read it the opposite way: from quan1ty to price When we do this we are asking: at a par1cular quan1ty, what is the marginal benefit that consumers aWach to the last unit purchased? P 5 MB Q 100 The marginal benefit of the 100th unit is $5 Maximum Willingness to Pay Since the demand curve measures the marginal benefit of X, it also measures the maximum amount consumers are willing to pay for an addi1onal unit of X This is because the consumer would be willing to pay any amount up to his/her marginal benefit, but would not be willing to pay any more than that So the marginal benefit measures the maximum amount he or she is willing to pay 3 Consumer Surplus Since the demand curve shows the maximum willingness to pay, consumer surplus is the difference between the height of the demand curve and the actual price of the good The consumer surplus of the 100th unit is $2 if the price paid is $3 5 3 100 D Graphical Illustra1on of Consumer Surplus PMAX CS = 0.5 Q* (PMAX P*) CS P* D Q Q* 4 Producers' Surplus Producers' surplus is the difference between the minimum amount the producer would be willing to sell a good for and the amount she actually sells it for Supply curve measures the amount that will be supplied at each price Inverse supply func1on measures what the price would have to be to get the producer to supply x units of the good Supply curve = minimum willingness to sell Graphical Illustra1on of Producer Surplus PMAX S P* PS PS = 0.5 Q* P* Q Q* 5 Consumer Surplus and Policy Analysis Changes in consumer surplus reflect changes in the economic welfare of consumers: If public policies increase consumer surplus, they make consumers beWer off If there is an increase in consumer surplus, this is considered part of the social benefits of a policy An increase in CS does not mean the policy should be adopted If there is a decrease in consumer surplus, this is considered part of the social costs of the policy A decrease in CS does not mean it should not be adopted Need to weigh total social costs against total social benefits when deciding issue of adop1on. Equivalent is true for producer surplus. Policy Example: Taxes & Surpluses How does CS and PS change when a tax is imposed? Assume it is a quan1ty tax: PD = PS + t not PD = (1+)PS Doesn't maWer if imposed on consumers or producers so assume tax on consumers 6 Graphical Illustra1on of Tax Change in Surpluses Before Tax CS PS Tax Revenue Total Surplus A3er Tax Change Deadweight loss of the tax is the loss in surplus that cannot be regained through tax revenue DWL measures the value of the output that is not sold due to the presence of the tax 7 Who is hurt more by the tax? i.e. who pays more of the tax? Consumers or producers? Depends on the elas1ci1es of demand and supply P PD P* PS Dtax D Qtax Q* S P PD P* PS Q Qtax Q* S D Dtax Q Are taxes Pareto efficient? A situa1on is Pareto efficient if there is no way to make some group of people beWer off without making some other group worse off. 8 ...
View Full Document
- Spring '11