CHAPTER 9 OUTLINE,9.1 Evaluating the Gains and Losses from Government PoliciesConsumer and Producer Surplus 9.2 The Efficiency of a Competitive Market 9.3 Minimum Prices 9.4 Price Supports and Production Quotas 9.5 Import Quotas and Tariffs 9.6 The Impact of a Tax or Subsidy,EVALUATING THE GAINS AND LOSSES FROM GOVERNMENT POLICIES CONSUMER AND PRODUCER SURPLUS,Review of Consumer and Producer Surplus,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.,Consumer and Producer Surplus,Figure 9.1,EVALUATING THE GAINS AND LOSSES FROM GOVERNMENT POLICIES CONSUMER AND PRODUCER SURPLUS,Review of Consumer and Producer Surplus,Producer surplus measures the total profits of producers, plus rents to factor inputs. It is the benefit that lower-cost producers enjoy by selling at the market price, shown by 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.,Consumer and Producer Surplus (continued),Figure 9.1,EVALUATING THE GAINS AND LOSSES FROM GOVERNMENT POLICIES CONSUMER AND PRODUCER SURPLUS,Application of Consumer and Producer Surplus, welfare effects Gains and losses to consumers and producers.,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.,Change in Consumer and Producer Surplus from Price Controls,Figure 9.2, deadweight loss Net loss of total (consumer plus producer) surplus.,EVALUATING THE GAINS AND LOSSES FROM GOVERNMENT POLICIES CONSUMER AND PRODUCER SURPLUS,Application of Consumer and Producer Surplus,If demand is sufficiently inelastic, triangle B can be larger than rectangle A. In this case, consumers suffer a net loss from price controls.,Effect of Price Controls When Demand Is Inelastic,Figure 9.3,EVALUATING THE GAINS AND LOSSES FROM GOVERNMENT POLICIESCONSUMER AND PRODUCER SURPLUS,Supply: QS = 15.90 + 0.72PG + 0.05PO Demand: QD = 10.35 0.18PG + 0.69PO,The market-clearing price of natural gas is $6.40 per mcf, and the (hypothetical) maximum allowable price is $3.00. A shortage of 23.6 20.6 = 3.0 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.,Effects of Natural Gas Price Controls,Figure 9.4,THE EFFICIENCY OF A COMPETITIVE MARKET,Market Failure,There are two important instances in which market failure can occur: Externalities Lack of Information, economic efficiency Maximization of aggregate consumer and producer surplus., market failure Situation in which an unregulated competitive market is inefficient because prices fail to provide proper signals to consumers and producers., externality Action taken by either a producer or a consumer which affects other producers or consumers but is not accounted for by the market price.,THE EFFICIENCY OF A COMPETITIVE MARKET,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.,Welfare Loss When Price is Held Above Market-Clearing Level,Figure 9.5,THE EFFICIENCY OF A COMPETITIVE MARKET,Supply: QS = 16,000 + 0.4P Demand: QD = 32,0000.4P,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.,The Market for Kidneys and the Effect of the National Organ Transplantation Act,Figure 9.6,THE EFFICIENCY OF A COMPETITIVE MARKET,Supply: QS = 16,000 + 0.4P Demand: QD = 32,0000.4P,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.,The Market for Kidneys and the Effect of the National Organ Transplantation Act (continued),Figure 9.6,MINIMUM PRICES,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