producer and consumer surplus colander 8 th ed ch. 8 (179 – 180) colander 9 th ed ch. 7 baumol ch....
TRANSCRIPT
PRODUCER AND CONSUMER SURPLUS
Colander 8th ed Ch. 8 (179 – 180)Colander 9th ed Ch. 7Baumol Ch. 5 (94-96)
1
Market Demand: Value consumers place on each unit purchased
2
The distance to the Demand curve tells us how much
consumers are willing to pay for a given quantity of the good.
100th
$10
$1
The distance to the Demand curve tells us how much the last
unit is worth to the consumer
500th
D
1st
$11
Willing to pay $10 for
the 100th unit
Willing to pay $1 for the 500th unit
When she buys 100 units: she is willing to pay $10 only for the last unit
3
Willingness to Pay
D
1
10W
illin
gnes
s to
pay
2 3
8
6
$10 for one unit
$8 for the second unit
$6 for the third unit
10
8
6
$24
© 2000 Claudia Garcia-Szekely 4
Consumer Surplus The difference between the
price the consumer actually pays and the price s/he is
willing to pay.
5
Willingness to Pay
D
60
20
60 60
15
5If the price is $0.05
60*0
.2=$
12
60*0
.15=
$9
60*0
.05=
$3Consumer Actually
pays $0.05 x 180 = $9
Long distance phone service
Minutes
$9
Consumer is willing to
pay $24 for 180 minutes
Consumer Surplus = 24 – 9= 15
$15
Cents per minute
6
Willingness to Pay
D30
9
30 30
7
5
Consumer Surplus
If the price is $0.05
10
8
6
Consumer Actually
pays
7
Consumer Surplus
D
Will
ingn
ess
to p
ay
1 Minute intervals180 minutes
What the consumer
actually pays = 0.05*180
Consumer surplus
If the price is $0.05
© 2000 Claudia Garcia-Szekely 8
Consumer Surplus
The amount consumers are willing to pay MINUS amount they actually pay
The area below the demand curve and above the price the consumer
pays
9
Consumer Surplus
D
Will
ingn
ess
to p
ay
1 Minute intervals180 minutes
What the consumer
actually pays = Price x Quantity
Consumer surplus = Area of triangle
If the price is $0.05
10
Consumer surplus in a Perfectly Competitive market
D
Supply = Cost
Number of units purchased
Consumer Surplus
Price Consumer
PaysWhat the consumer actually pays = Price
x Quantity
Market Supply
11
The distance to the Supply curve tells us how much it costs to produce a given
quantity of the good.
$3
$1
The distance to the Supply curve tells us the cost of producing the last unit
S
1st
Cost $1
2nd
Cost $3
Producer would be willing to produce
this unit if and only if the price covers
the costPrice
Quantity Produced
If the price is $3 per unit, this price
covers the cost of producing the first
and the second units
$10
20th
Cost $10
If the price is $10 per unit, this price
covers the cost of producing 20 units
© 2000 Claudia Garcia-Szekely 12
Producer SurplusThe difference between the per unit
price the producer receives and his/her per unit cost.
13
Producer Surplus
S = Cost
2
4
6
1 2 3
If The market price is $6
Producer Surplus = 18 – 12 = 6
Cost=12 TR = $18
PS = 6The area above the supply curve and below the price the producer
receives
14
Producer Surplus under Perfect Competition
D
Supply = Cost
Quantity Sold
PS
10
Price producer receives
2
15
Consumer surplus in a Perfectly Competitive market:
D
Supply = Cost
Equilibrium Quantity = 4000
CS = Triangle Area
10
Equilibrium Price = $5
2
Triangle Area = Base x Height x ½Triangle Area = 4000 x (10-5) x 1/2
16
Producer Surplus under Perfect Competition
D
Supply/Cost
4000
PS = Triangle
Area
10
5
2
Triangle Area = Base x Height x ½Triangle Area = 4000 x (5-2) x 1/2
17
Perfect Competition
D
Q
Supply/Cost
Qe=4000
C S
P S
10
5
2
100th 1000th
S (cost)
Cost $10$10
$1Cost $1
Willing to pay $10
D (Value given by consumer)Willing to
pay $1
Optimum Output Level
S (cost)
Cost
Cost
Willing to pay
D (Value given by consumer)
Willing to pay
Optimum Output Level is the Equilibrium Quantity
Equilibrium QThese units should be produced
These units should NOT be
produced
Consumers are willing to pay the cost of bringing these units to market
Consumers are not willing the pay the
cost of bringing these units to
market
Equilibrium Quantity
20
D
S
27
16.5
8.5
30
11
343
24.5
PracticeCalculate Consumer and Producer Surplus at
equilibrium
THE EFFECT OF PRICE CONTROLS
Colander 8th ed. Ch. 8 (187-188)Colander 9th ed. Ch. 7Baumol Ch. 4
21
A Price Ceiling: Government prohibits any price above $3
D
Q
S
P=$3
C S
P S
Qd =6000
Shortage
Qs =2000
CS
PS
Consumer surplus when
only 2000 units are purchased
due to shortage
4000
Lost consumer and producer surplus when only 2000
units are purchased and sold at $3
Producer surplus when
only 2000 units are sold
Producer surplus when 4000 units are purchased at
equilibrium
Consumers purchase 2000 at $3 per unit
Consumer surplus when 4000 units are purchased at
equilibrium10
5
2
23
The Effect of a Price Ceiling
D
S
600
3,900
2,200
CS at equilibrium
300
Gain to consumerLoss to Consumer7,300
1000
900
CS: Area below DAbove Price
24
The Effect of a Price Ceiling
D
SLoss to Producer
3,900
2,200
600300
1000
7,300
900
PS: Area below Price
Above S
25
CS
A Price Ceiling has the same effect of charging a Tax to Producers and giving that money as a
subsidy to Consumers
Loss to Producer
D
S
600
3,900
2,200
300
Gain to consumer
D
S
600
3,900
2,200
300
TaxSubsidy
26
Welfare Loss From Price Ceiling
D
Q
$
S
P=$2
4
C S
P S$1
27
Welfare Loss From Price Ceiling
D
Q
S
$6
40
C S
P S$4
$8
$10
20
$2
28
A Price Floor: Government prohibits any price below $8
D
Q
SP=$8
C S
P S
Qs =6000
Surplus
Qd =2000
PS
4000Consumers
purchase 2000 at $8 per unit
10
5
2
Consumer surplus when
only 2000 units are purchased due to price
above equilibrium
Producer surplus when
only 2000 units are sold due to
price above equilibrium
Consumer surplus when 4000 units are purchased at
equilibrium
Producer surplus when 4000 units are purchased at
equilibrium
Lost consumer and producer surplus when only 2000
units are purchased and sold at $8
29
The Effect of a Price Floor on Consumer Surplus
D
S
4
2
2
3Loss to Consumer
6
CS
30
The Effect of a Price Floor on Producer Surplus
D
S
4
2
2
3Loss to Producer
Gain to Producer
6
31
D
S
4
2CS at Equilibrium
2
3 CS
D
S
4
2
2
3
PS
A Price Floor has the same effect as charging a Tax to Consumers and giving that money as a subsidy to
Producers
Loss to Consumer
Gain to Producer
Tax Subsidy
32
D
S
4
2
CS
2
3 CS
PS
D
S
4
2
2
3
PS
Loss of Surplus to Society
Loss to Consumer
Loss to Producer
Welfare Loss from Price Floor
D
Q
$
S
P=$2
4
$5C S
P SP S
34
Welfare Loss from Price Floor
D
Q
S
50
$8C S
$4
$6
$10
30
$2
35
Most governments around the world intervene actively in the operation of their agricultural
markets.
Governments in poor Third World countries
36
• Though numerous, farmers do not organize politically and therefore have much less political power than people in the cities
• To gain favor with their more politically powerful urban residents. Governments impose price controls to keep food prices artificially low.
• By artificially depressing the price of food, Third World governments reduce incentives for farmers to produce and reduce the availability of food from domestic sources
By artificially depressing the price of food, Third World governments create a permanent shortage of food.
37
Fair Trade Coffee• Agricultural prices are low because there is
overproduction.• To solve overproduction, only the most efficient
farmers should remain in business.• The market mechanism ensures that only those with
lower costs (the most efficient) remain in business.• If prices are held artificially high, farmers will not
have an incentive to leave this industry and find alternatives.
• Fair trade prices perpetuate the surplus…not so good for the farmers after all.
38
Why Agricultural Price Supports?
• Rural districts have greater political power.
• Farmers are often viewed as disadvantaged.
• Farm prices are volatile from uncertain weather conditions.
Floors
39
Forms of Price Supports
1. Government buys any quantity of a product at the guaranteed "support price."
For example In the U.S. the Commodity Credit Corporation buys to support the price of milk.
The CCC disposes of the commodities in ways that will not depress the domestic market price.
For example, dairy products are often given away to low-income people, in the school lunch program, and as foreign aid. A price
floorA price floor
40
D
Q
S
$1.5
4020
$2
60
Effect of a Price Floor
$0.5
$1
No transactions allowed below $2Price paid by consumers
increasesQuantity decreases
Use tax payer money to purchase Surplus 60-20 = 40$2.5
41
Other Forms of Price Supports
2. Limiting production. Each farmer is given a quota that stipulates
how much he can sell in a given year. Example: peanuts in the United States and milk in
Canada. Limiting supply can raise market prices as long
as government inspectors monitor the market to ensure that no production above the quota is sold for a lower price.Leftward
shift in supply
Leftward shift in supply
42
Forms of Price Supports
3. Set-aside program: Requiring (or paying) farmers to take land out of production. Rarely effective because farmers set aside their least productive land and intensively produce in the more productive land thus increasing supply
Leftward shift in supply
Leftward shift in supply
43
D
Q
S0
$1.5
4020 60
Effect of a Leftward shift in Supply
$0.5
$1
Price paid by consumers increases
Quantity decreases
S1
$2
44
Forms of Price Supports4. Purchase and Release: CCC buys grain at the
support price, stores it, and releases it back into the market if the market price rises to a prescribed trigger level of, say, 140 percent of the support price.
This policy protects growers against the risk of low prices but also protects consumers against unusually high prices.
45
D0
Q
S0
$1.5
4020
$2
60
Purchase and Release
$0.5
$1
Government purchase the surplus at $2
D1
If the price in the market rises above $2
$2.5 S1
The government releases the surplus until the price is $2
46
Forms of Price Supports5. Loans: CCC gives farmers nine-month loans equal
to their production times the support price. The CCC accepts the grain as collateral for the loan. • If, during the term of the loan, the market price
rises above the support price, farmers repay the loan with interest and sell the grain in the market.
• If the market price remains at or below the loan rate, farmers forfeit the grain to the CCC, keep the money, and have no further obligation.
47
D0
Q
S0
$1.5
4020
$2
60
Loans to Farmers
$0.5
$1D1
If the price in the market falls below $2, the farmer forfeits the grain and does
not repay the loan
$2.5
If the price in the market rises above $2, farmers sell their crop at the higher
price and repay the loan.
Government loan= Production(60) x $2(support
price)
48
Farmers compete against one another for limited amount of farmland, bidding up its price. Thus, it is the owners of farmland, and not farmers, who are the principal beneficiaries.
Price supports create a surplus.
The typical way for the price support agency to get rid of its inventories is to use export subsidies to make them cheaper for foreigners to buy. Is subsidizing foreign consumption a proper use of taxpayer money?
•The EC uses this approach for grains. From the mid seventies to early eighties, internal EC grain prices were 150 to 200 percent of the prices at which other countries were willing to buy their grain. Subsidies to agriculture account for over two-thirds of the total EC budget.
Effect of Price Supports
49
D
S
150
200
100
200
250
100
50
300
Figure 2
1. Equilibrium price is: ______ Equilibrium quantity is __________2. If the price is $100, there would be a (surplus/shortage)_________ of size__________3. Given your answer to #2 above, you expect the price to (increase/decrease/remain the same)
to _________4. Draw a supply and demand diagram showing the effect of an increase in incomes. Be sure to
label properly old and new values (P0, Q0, P1,Q1), show shortage/surplus and write your answer.
Practice
D
S
10
20
25
5
90 210 650
6
Calculate CS, PS, WL and the equivalent “tax/subsidy” resulting from a price ceiling placed at $6.
Practice
D
S
11
21.5
25
4
5 20 50
Calculate CS, PS, WL and the equivalent “tax/subsidy” resulting from a price floor placed at $20.
5.75
Practice
52
D
S
10
15
25
5
420200 650
20
1. Equilibrium price is: ______ Equilibrium quantity is __________
2. A $10 ceiling, would cause a (surplus/shortage)_________ of size__________
3. Calculate Consumer and Producer Surplus at equilibrium
Practice
53
D
S
15
1000
10
20
25
500
5
1500
1. Equilibrium price is: ______ Equilibrium quantity is __________2. A $20 floor, would cause a (surplus/shortage)_________ of
size__________3. Calculate Consumer and Producer Surplus at equilibrium
Practice
©2001,2002Claudia Garcia-Szekely 54
Another Look at Supply and Demand
60
Producers are willing to bring 500 units for sale if and only if the price per
unit is $60
500
Consumers are willing to buy 500 units if and only if
the price per unit is $60
Elasticity and Price Controls
• When supply and demand are both elastic, a price floor will cause a larger surplus than when supply and demand are inelastic
• When supply and demand are both elastic, a price ceiling will cause a a larger shortage than when supply and demand are inelastic.
55
©2001Claudia Garcia-Szekely 56
The Effect of a Tax
Consumers and producers share the burden of a tax
©2001Claudia Garcia-Szekely 57
The Effect of a Tax
Levied on the Producer
©2001,2002Claudia Garcia-Szekely 58
The Effect of a $10 Tax Paid by Producers
60
500
If the price is $60 per unit, producer would produce 500 units
After tax, producers receive only $50
At $50, producers would not bring 500 units for sale.
70
S0
For producers to be willing to produce 500 units, the consumer must pay $70
50
Less than 500
©2001,2002Claudia Garcia-Szekely 59
The Effect of a $10 Tax Paid by Producers
10
10
10S0
The same would be true for all quantities…
60
70
500
10
53
63
260
Splus tax
The tax is equivalent to an increase
in cost.
©2001,2002Claudia Garcia-Szekely 60
After Tax Equilibrium Price
60
500
70
S0
S1
After the shift in supply, the new equilibrium price is higher than $60
New Equilibrium
Price
New Equilibrium
Quantity
But is NOT $70!!
61
After the tax…
60
500
S0
Swith tax
And pay a higher price: Pc
The government
receives t (tax per unit)
The producer
receives Pc- t
Pc- t
Consumers purchase fewer units
New Equilibrium
Price
Pc
New Equilibrium
Quantity
tt
©2001,2002Claudia Garcia-Szekely 62
A Producer TaxThe tax drives a
“wedge” between the price the buyer pays
60
500
Pc- t
Pc
Tax
and the price the seller receives
©2001,2002Claudia Garcia-Szekely 63
P SPS
Welfare Loss From a Tax
D
Q
$
S
P=$2
4
C S
$1 PS
CS
Tax Revenue
Welfare Loss
3
Tax = $2 per unit
4
6
8
9
S0
2
3
5
7
10
403020 5010 60 70 80
Impose a $2 tax on Producers
1. Shift Supply up by the amount of the tax
4
6
8
9
S0
Stax
2
3
5
7
10t=$2
403020 5010 60
PC
2. Find the new equilibrium price: Pc the price the consumer pays after the tax
4
6
8
9
S0
Stax
2
3
5
7
10t=$2
403020 5010 60
PC=
PP=
3. Drop a line to the OLD supply curve: this represents subtracting the tax from the price the consumer pays, to get the price the producer receives
4
6
8
9
S0
Stax
2
3
5
7
10
403020 5010 60
PC=
PP=
3. Ignore the Supply +tax line to determine CS, PS and Tax Revenue.
CS
PS
Tax Revenue
4
6
8
9
S0
2
3
5
7
10
403020 5010 60
PC=
PP=
4. At equilibrium (before the tax) 40 units are produced.
CS
PS
Tax Revenue WL After the tax, only 30 units are produced:
Tax creates a Welfare Loss
4
6
8
9
S0
2
3
5
7
10
403020 5010 60
PC=
PP=
CS=3*30*1/2
3*30*1/2= PS
Tax Rev=2*30
WL= 2*10*1/2
©2001Claudia Garcia-Szekely 70
The Effect of a Tax
Levied on the Consumer
71
10
S0
The same would be true for all quantities…
Pc=60
Pp=50
500
10
45
55
600
D0
10
10
DTax
If the price is $60 consumers buy 500 unitsWith a $10 tax, the actual Price consumers pay to be willing to buy 500 units is $10 lower than before
The Effect of a $10 Tax Paid by Consumers
4
6
8
9
S0
2
3
5
7
10
403020 5010 60 70 80
Impose a $2 tax on Consumers
1. Shift Demand down by the amount of the tax
4
6
8
9
S0
2
3
5
7
10
403020 5010 60 70 80
2. Find the new equilibrium price: Pp Price the producer receives
after the tax
3. Draw a line up to the OLD demand curve: this represents adding the tax from the price the producer receives, to get the price the consumer pays
4
6
8
9
S0
Stax
2
3
5
7
10
403020 5010 60
PC=
PP=
CS
PS
Tax RevenueTax
WL
4
6
8
9
D0
Dtax
2
3
5
7
10
403020 5010 60
S0
$2 tax on Producer
$2 tax on consumer
PC
PP
Stax
4
6
8
9
D0
Dtax
2
3
5
7
10
403020 5010 60
S0
$2 tax on Producer
$2 tax on consumer
PC
PP
$4 tax on consumer
$4 tax on Producer
PC
PP
4
6
8
9
D0
Dtax
2
3
5
7
10
403020 5010 60
S0
$2 tax on Producer
$2 tax on consumer
PC
PP
Stax
©2001,2002Claudia Garcia-Szekely 78
Regardless of Who Pays the Tax
Pe
Qe
Tax
Price Consumer
Pays
Price Producer Receives
As price Increases quantity demanded falls
As price drops quantity supplied falls
The Consumer
The Producer
©2001,2002Claudia Garcia-Szekely 79
Determining the Burden of The Tax
Regardless on who the tax is levied on, consumers and producers end up “sharing” the burden of the tax…
60
500
Pc-t
Pc
Consumers now pay $tc
more per unit.
Producers now receive $tp less per unit sold
tc
tp
80
The more Inelastic Demand is relative to Supply:
Larger the price increase to consumer
The smaller the price drop to producer
P
Q
Pp
Pc
tc
tp
Pc
Pc
tc
tc
©2001,2002Claudia Garcia-Szekely 81
60
500
57
67
490
If Demand is more inelastic than Supply
The price the consumer pays after tax is $7 higherThe price the producer receives after tax is $3 lower
Clearly, the consumer bears a larger burden of the tax than the producer…
Extra cost to
consumer
Cost to producer
7 x 4907 x 490
3 x 4903 x 490
10
82
The more Inelastic Supply is relative to Demand:
Smaller the price increase to consumer
The larger the price drop to producer
P
Q
P0-t
P0
tc
tp
©2001,2002Claudia Garcia-Szekely 83
The more Inelastic Supply is relative to Demand:
A 70 unit decrease in quantity demanded, requires a “smaller” increase in priceA 70 unit decrease in quantity supplied, requires a “larger” decrease in price
500430
60
S0
53
63
©2001,2002Claudia Garcia-Szekely 84
The more Inelastic Supply is relative to Demand:
The price the consumer pays after tax is $3 higher
The price the producer receives after tax is $7 lower
Clearly, the producer bears a larger burden of the tax than the consumer…
500430
60
S0
53
63
85
epd= %Qd/%P
60
500
S0
65
450
At new equilibrium: quantity demanded and quantity supplied must both drop by the same amount: say 10%
Since the elasticity of demand is equal to the elasticity of supply say: 1.2
eps= %Qs/%P
8.3% increase
8.3% decrease55
10% decrease
-10%-10%
-1.2-1.2
When Demand and Supply have the Same Elasticity
The % change in price must also be the same.
©2001,2002Claudia Garcia-Szekely 86
When Demand and Supply have the Same Elasticity
The price the consumer pays after tax is $5 higher
The price the producer receives after tax is $5 lower
The tax burden is equally shared…
60
S0
65
55
©2001Claudia Garcia-Szekely 87
Regardless of Who Pays the Tax
The Burden of the tax falls more heavily on the group with the lowest
elasticity
TAX ON INSURANCE
“If the government imposes a tax on insurance companies, the tax will be entirely passed on to consumers and insurance premiums will increase”
Is this true? When is this true?We need to know first if demand for health
insurance is more or less inelastic than supplyIf Demand is more inelastic is this true?
88
Would it help if the government
offers more alternatives for consumers to
purchase insurance?
©2001,2002Claudia Garcia-Szekely 89
If Demand is More Inelastic Than Supply…
60
500
S0
57
480
DDtax
67
The price the consumer pays after tax is $7 higher
The price the producer receives after tax is $3 lower
Clearly, the consumer bears a larger burden of the tax than the producer…
©2001,2002Claudia Garcia-Szekely 90
The More Elastic Demand Is Relative to Supply
Pe
Qe
Price Consumer
Pays
D0
D1
Price Consumer
Pays
Price Consumer
Pays
D2
The smaller the increase in price necessary to reduce the quantity demanded
The smaller the burden of the tax shared by the consumer
91
Percentage of the tax burden on Producer
Producer’s tax Share
Price Elasticity of Demand
Price elasticity of Supply + Price elasticity of Demand
X 100=
epd = 0.7 ep
s = 0.1
0.7
0.1 + 0.7 = 0.887.5%
©2001,2002Claudia Garcia-Szekely 92
The More Elastic Demand is Relative to Supply
Pe
Qe
D0
D1
D2
Price Producer ReceivesPrice
Producer Receives
Price Producer Receives
The larger the drop in price necessary to reduce the quantity supplied
The larger the burden of the tax shared by the producer
©2001,2002Claudia Garcia-Szekely 93
Pe
Qe
Smaller the drop in quantity after
the tax is imposed
The smaller the welfare loss
Same size tax
Inelastic supply and
demand
Elastic
Larger the drop in quantity after the
tax is imposed
The larger the welfare loss
The larger the elasticity of demand and supply, the larger the welfare loss
©2001,2002Claudia Garcia-Szekely 94
Pe
Qe
The larger the tax revenueThe larger the tax revenue
Inelastic supply and
demand
Elastic
The larger the elasticity of demand and supply, the smaller the amount of tax revenue collected.
Tax RevenueSame size tax
Tax RevenueTax Revenue
The smaller the tax revenueThe smaller the tax revenue
Larger the drop in quantity after the tax is imposed
Larger the drop in quantity after the tax is imposed
Smaller the drop in quantity after the tax is imposed
Smaller the drop in quantity after the tax is imposed
©2001,2002Claudia Garcia-Szekely 95
Percentage of the tax burden on Consumer
Consumer’s tax Share
Price Elasticity of Supply
Price elasticity of Supply + Price elasticity of Demand
X 100=
epd = 0.7 ep
s = 0.1
0.1
0.1 + 0.7 = 0.812.5%
©2001,2002Claudia Garcia-Szekely 96
Perfect Competition
D
Q
$
MC
Pe=$2
Qe=4000
C S
P S