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Besanko 6th. ed. slides ch10

Chapter 10 discusses competitive markets, focusing on concepts such as economic efficiency, deadweight loss, and government interventions like excise taxes, price ceilings, and production quotas. It explains how these policies affect consumer and producer surplus, as well as the overall market equilibrium. The chapter also covers the implications of tariffs, import quotas, and the phenomenon of dumping in international trade.

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13 views

Besanko 6th. ed. slides ch10

Chapter 10 discusses competitive markets, focusing on concepts such as economic efficiency, deadweight loss, and government interventions like excise taxes, price ceilings, and production quotas. It explains how these policies affect consumer and producer surplus, as well as the overall market equilibrium. The chapter also covers the implications of tariffs, import quotas, and the phenomenon of dumping in international trade.

Uploaded by

k61.2212340007
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© © All Rights Reserved
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Chapter 10

Competitive Markets:
Applications
Chapter Ten Overview
• The Invisible Hand, Excise Taxes, and Subsidies
• Price Ceilings and Floors
• Production Quotas
• Price Supports in the Agricultural Sector
• Import Quotas and Tariffs

Copyright (c) 2020 John Wiley & Sons, Inc.


2
Economic Efficiency
• Economic efficiency means that the total surplus is maximized
• Every consumer who is willing to pay more than the
opportunity cost of the resources needed to produce extra
output is able to buy; every consumer who is not willing to pay
the opportunity cost of the extra output does not buy
• All gains from trade (between buyers and suppliers) are

Copyright (c) 2020 John Wiley & Sons, Inc.


exhausted at the efficient point
• The perfectly competitive equilibrium attains economic
efficiency

3
Surplus Maximization in Competitive
Equilibrium
• At the perfectly competitive
equilibrium, (Q*,P*), total
surplus is maximized
• Consumer's surplus
at (Q*,P*): ABC
• Producer's surplus

Copyright (c) 2020 John Wiley & Sons, Inc.


at (q*,p*): DBC
• Total surplus
at (Q*,P*): ADC

4
Deadweight Loss
• A deadweight loss is a reduction
in net economic benefits resulting
from an inefficient allocation of
resources
• Consumer's surplus
at (Q1,Pd): AEF
• Producer's surplus
at (Q1,Pd): EFGD

Copyright (c) 2020 John Wiley & Sons, Inc.


• Total surplus
at (Q1,Pd): AFGD
• Deadweight loss
at (Q1,Pd): AFC

5
Government Intervention: Winners & Losers

Copyright (c) 2020 John Wiley & Sons, Inc.


6
Policy: Excise Tax
• An excise tax (or a specific tax)
is an amount paid by either the
consumer or the producer per
unit of the good at the point of
sale
• The amount paid by the
demanders exceeds the total

Copyright (c) 2020 John Wiley & Sons, Inc.


amount received by the sellers
by amount T

7
Impact of a $6 Excise Tax

Copyright (c) 2020 John Wiley & Sons, Inc.


Key Definitions
• Incidence of a tax is a measure of the effect of a tax on the
prices consumers pay and sellers receive in a market
• The amount by which the price paid by buyers, Pd, rises
over the non-tax equilibrium price, P*, is the incidence of
the tax on consumers
• The amount by which the price received by sellers, Ps,

Copyright (c) 2020 John Wiley & Sons, Inc.


falls below P* is called the incidence of the tax on
producers
9
Incidence of Tax in Two Extreme Cases

10

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Incidence of Tax in Two Cases: Case 1
• The demand curve is relatively
inelastic
• The incidence of the $10 tax is
borne primarily by consumers

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11
Incidence of Tax in Two Cases: Case 2
• The supply curve is relatively
inelastic
• The incidence of the tax is
borne primarily by producers

Copyright (c) 2020 John Wiley & Sons, Inc.


12
Back of the Envelope
• "Back of the envelope" method to calculate the incidence
of a specific tax
• Pd/Ps = /
• Where  is the own-price elasticity of supply  is the own-
price elasticity of demand

Copyright (c) 2020 John Wiley & Sons, Inc.


13
Back of the Envelope Continued
• Why – consider a small tax applied to an economy at point
(Q*,P*)
– =(Q/Q*)/(Pd/P*)… Q/Q*=Pd/P*
– =(Q/Q*)/(Ps/P*)… Q/Q*=Ps/P*
• But for market to clear, Q/Q* must be the same for

Copyright (c) 2020 John Wiley & Sons, Inc.


demand and supply, hence
–Pd/P* = Ps/P*

14
Tax Effect
• Example: Let  = -.5 and  = 2. What is the relative
incidence of a specific tax on consumers and producers?
–Pd/Ps = 2/-.5 = -4
• Interpretation: consumers pay four times as much as the
decrease in price producers receive
• Hence, an excise tax of $1 results in an increase in

Copyright (c) 2020 John Wiley & Sons, Inc.


consumer price of $.8 and a decrease in price received by
producers of $.2
• Note: Subsidies are negative taxes
15
Impact of a $3 Subsidy

16

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Policy: Price Ceilings
• A price ceiling is a legal maximum on the price per unit
that a producer can receive
• If the price ceiling is below the pre-control competitive
equilibrium price, then the ceiling is called binding
• Rent control is a form of price ceiling

Copyright (c) 2020 John Wiley & Sons, Inc.


17
Rent Control: Maximum Consumer
Surplus
• Assume all 50,000 available
housing units are rented by the
consumers with the highest
willingness to pay
– Those between points Y and U on
the demand curve D
• Consumer surplus under rent
control is maximized

Copyright (c) 2020 John Wiley & Sons, Inc.


• Net economic benefits are also
maximized
• Deadweight loss is minimized

18
Rent Control: Minimize Consumer
Surplus
• Assume all 50,000 available
housing units are rented by the
consumers with the lowest
willingness to pay
– Those between points T and X on the
demand curve
• Consumer surplus under rent
control is minimized

Copyright (c) 2020 John Wiley & Sons, Inc.


• Net economic benefits are also
minimized
• Deadweight loss is maximized

19
Impact of Rent Controls

20

Copyright (c) 2020 John Wiley & Sons, Inc.


Policy: Price Floor
• A price floor is a minimum price that consumers can
legally pay for a good
• Price floors sometimes are referred to as price supports
• If the price floor is above the pre-control competitive
equilibrium price, it is said to be binding

Copyright (c) 2020 John Wiley & Sons, Inc.


• A minimum wage is a form of a price floor

21
Impact of Minimum Wage Law

22

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Impact of a $12 Price Floor

23

Copyright (c) 2020 John Wiley & Sons, Inc.


Policy: Production Quotas
• A production quota is a limit on either the number of
producers in the market or on the amount that each
producer can sell
• The quota usually has a goal of placing a limit on the total
quantity that producers can supply to the market

Copyright (c) 2020 John Wiley & Sons, Inc.


24
Impact of a 4 Million Unit Production
Quota

Copyright (c) 2020 John Wiley & Sons, Inc.


25
Policy: Import Tariffs and Quotas
• Tariffs are taxes levied by a government on goods
imported into that government's country
–Tariffs sometimes are called duties
• An import quota is a limit on the total number of units of a
good that can be imported into the country

Copyright (c) 2020 John Wiley & Sons, Inc.


–Set by the government the goods are being imported into

26
Impact of a Trade Prohibition versus Free
Trade versus a Quota of 3 Million Units

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27
Impact of a Tariff of $2 per Unit versus Free
Trade

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28
Comparing a Tariff to a Quota
• Let quota limit imports to Q3-Q2 • Is there a difference?
• The equilibrium price would be • The quota generates no
the same as for the tariff government revenue
• The (world) deadweight loss • So, the total supply and total
price for the domestic market
would be the same as well remains the same under the
two policies

Copyright (c) 2020 John Wiley & Sons, Inc.


• However, domestic deadweight
loss is larger under the quota

29
Dumping
• When a country subsidizes their own industry to help them
gain a larger share of the world market
–It has often been alleged that Japanese producers of steel are selling
in foreign markets at a price below their cost to produce
• How will dumping affect the domestic market?
• Domestic consumers will benefit: their surplus will increase
• Domestic producer surplus will fall

Copyright (c) 2020 John Wiley & Sons, Inc.


• In practice, it is not easy to establish that dumping is occurring
because one needs proof that firms are selling at a price
below cost

30
Impact of Dumping

31

Copyright (c) 2020 John Wiley & Sons, Inc.

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