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Lecture 5

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12 views7 pages

Lecture 5

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r9905268
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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APPLIED COMPETITIVE ANALYSIS

Economic Efficiency and Welfare Analysis

The area between the demand and the supply curve represents the sum of consumer and
producer surplus

– Measures the total additional value obtained by market participants by


being able to make market transactions

This area is maximized at the competitive market equilibrium

Economic Efficiency and Welfare Analysis


Welfare Loss Computations
• Use of consumer and producer surplus notions makes possible the explicit
calculation of welfare losses caused by restrictions on voluntary transactions
– in the case of linear demand and supply curves, the calculation is simple
because the areas of loss are often triangular

• Suppose that the demand is given by


Q = 10 - P
D

and supply is given by


Q =P-2
S
• Market equilibrium occurs where P* = 6 and Q* = 4
• Restriction of output to Q = 3 would create a gap between what demanders are
0
willing to pay (P ) and what suppliers require (P )
D S
P = 10 - 3 = 7
D
P =2+3=5
S

Price Controls and Shortages


• Sometimes governments may seek to control prices at below equilibrium levels
– this will lead to a shortage
• We can look at the changes in producer and consumer surplus from this policy to
analyze its impact on welfare
Tax Incidence

• To discuss the effects of a per-unit tax (t), we need to make a


distinction between the price paid by buyers (P ) and the price
D
received by sellers (P )
S
P -P =t
D S
Consider the following market model
Qd =a – bp

Qs =−c +dp

If government is imposed a tax on the commodity at the rate of Tk ‘t’ per unit of output
calculate tax incidence .

Given, Qd=a – bp
Qs=−c+ dp

According to market equilibrium condition,

Qd=Qs

 a – bp=−c+ dp

 −bp – dp=−a – c

 − p(b +d )=−(a+c )

a+c
 p=
b+ d

Putting the value of p into demand or supply function we can determine the equilibrium quantity

a+c
Qd=a – b .
b+ d

ab+bc
= a−
b+ d

ab+ ab−ab−bc
¿
b+ d
ab−bc
Q=
b+d

Therefore,

a +c
Equilibrium Price p =
b+d

ad −bc
Equilibrium quantityQ=
b+ d

After imposition of tax the supply function becomes


t
Qs =−c +d ( p−t)

=−c +dp−dt

And, the demand curve will be intact

Qd=a−bp

(i) Post-tax equilibrium condition is,

Qd=Qts
 a−bp=−c +dp−dt
 −bp – dp=−a – c – dt
 − p(b +d )=−(a+c +dt )
a+ c+ dt
=> P=
b+ d

Thus post tax equilibrium price

a+c +dt
pt =
b+d

………….. Calculate post tax equilibrium quantity by yourselves ……………

We get

a +c
Tax free equilibrium price p =
b+d
a+c +dt
Post tax equilibrium price pt =
b+d
Consider the following market model:

Qd = 30 – 2p

Qs = - 6 + 5p

1. Determine equilibrium price & quantity


2. If the govt. wants to impose a tax at the rate of take 1 per unit then what will be the affect on equilibrium
Price and Quantity?
3. How the tax burden will be distributed among the consumer and seller?
4. If the govt. wants to give subsidy at a rate of take 1 per unit then what will be the affect on equilibrium P &
Q?
5. How will the consumer and seller be benefited from the subsidy?

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