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Study Unit 9

Study Unit 9. The Analysis of Competitive Markets. Outcomes. Use consumer and producer surplus to evaluate government policies Determine the efficiency of a competitive market. Describe the effects of the implementation of minimum prices

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Study Unit 9

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  1. Study Unit 9 The Analysis of Competitive Markets

  2. Outcomes • Use consumer and producer surplus to evaluate government policies • Determine the efficiency of a competitive market. • Describe the effects of the implementation of minimum prices • Describe the effects of price support and production quotas • Describe the effects of import quotas and tariffs • Describe the effects of a tax or subsidy

  3. Evaluating the gains and losses from government policies – consumer and producer surplus

  4. Application of consumer and producer surplus • We evaluate welfare effects of government intervention. • I.e. gains and losses to consumers and producers • Look at price controls: • Ceiling price: Government makes it illegal to charge more than a set max price. • Increasing demand and decreasing production = creates a shortage/excess demand

  5. Graph explained • Change in consumer surplus • Some worse off others due to policy • Worse off: Rationed out of market due to ↓ production and sales Q0-Q1. Loose their surplus (green). • Better off: Can buy goods @ Pmaxrather than P0. Enjoy an increase in consumer surplus (blue).

  6. Graph explained • Change in producer surplus: • Some producers will stay in the market others will leave, price control • Remain in market: Produce Q1 will receive lower price. Lose producer surplus (blue). Total production also lost (purple)

  7. Graph explained • Deadweight loss: • Net loss of total surplus (consumer and producer surplus) • Total loss = Green + Purple

  8. Application of consumer and producer surplus

  9. Effect of price controls when demand is inelastic

  10. The efficiency of a competitive market • Evaluate market outcome = Do we achieve economic efficiency? • Max aggregate of consumer and producer surplus • Market failure: • A situation in which an unregulated competitive market • is inefficient because prices fail to provide proper signals • to consumers and producers

  11. The efficiency of a competitive market • Why market failure occurs: • Externalities: • Action taken by producer/consumer • which affects other producers/consumers • but is not accounted for in market price • Lack of information: • Lack info on quality or nature of product • Can’t make max utility decisions

  12. Welfare loss

  13. Minimum price • Government seeks to raise priced above market-clearing levels. • One way is to raise price as a direct regulation – illegal to charge a lower price.

  14. Minimum price

  15. Price supports • Definition: • Price set by government • above free-market level • and maintained by governmental purchases • of excess supply

  16. Price supports

  17. Price supports • Consumers: • At Ps, quantity demanded fall to Q1 • Quantity supplied rises to Q2 • Avoid inventories piling up, government must buy Qg = Q2-Q1 • Loss in consumer surplus = A • Others no longer buy, loss = B • Customers lose ∆CS = -A-B

  18. Price Supports • Producers: • Producers gain hence price SUPPORT • Selling larger quantities Q2 at higher price Ps • Producer surplus: ∆PS = A+B+D • Government: • Cost to government to pay (Q2-Q1)Ps • Cost will lower if dump goods elsewhere – sell abroad • This will hurt domestic production • Change in welfare: ∆CS + ∆PS - (Q2-Q1)Ps = D - (Q2-Q1)Ps

  19. Production quotas • Government can cause price of a good to rise by reducing supply. • Setting a quota on how much firm can produce.

  20. Production quotas

  21. Incentive programs • Output reduced by incentives rather that quotas. • Getting firms to agree to reduce.

  22. Import Tariff or Quota • Import quota: Limit on the quantity of a good that can be imported. • Tariff: Tax on an imported good. • Without quota/tariff: Country will import at a world price below domestic price

  23. Import quotas and tariffs

  24. General case

  25. Impact of a tax • Burden of a tax or benefit of a subsidy falls partly on the consumer and partly the producer. • Government collects in 2 ways: • Producer pay tax over to SARS. • The buyer will pay the tax.

  26. Specific tax • Definition: • Tax of a certain amount per money • Per unit sold • In contrast to ad volarem tax or proportional tax.

  27. Incidence of a tax

  28. Specific tax • Market clearing requires 4 conditions to be satisfied after tax is in place: • Qsold and Pbuyer must be lie on the demand curve • Qsold and Pseller must lie on the supply curve • Qdemanded = Qsupplied • Price buyer pay and Price seller receive = Tax (t)

  29. Tax depend on elasticities • Tax shared evenly in previous graph • Not always the case. • Demand relatively inelastic and supply relatively elastic = Burden of tax mostly on buyers. • General: A tax falls mostly on the buyer if Ed/Es is small and mostly on the seller if Ed/Es is large

  30. Tax depend on elasticities

  31. Effects of a subsidy • Definition: • Payment reducing buyer’s price • Below the seller’s price • A negative tax • The benefit of a subsidy accrues mostly on the buyer if Ed/Es is small and mostly on the seller if Ed/Es is large.

  32. Subsidy

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