ECO 3104

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ECO 3104

• Lecture 17

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Price-Taking Markets and Social Welfare

• Welfare Analysis
• Consumer surplus is the total benefit or value
  that consumers receive beyond what they pay for
  the good.
• Producer surplus is the total benefit or revenue
  that producers receive beyond what it cost to
  produce a good.
• Social welfare is the sum of producer and
  consumer surplus

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Consumer and Producer Surplus
Price
0
Quantity
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Evaluating the Gains and Losses fromGovernment
Policies

• To determine the effects of a government policy
  we can measure the change in social welfare (sum
  of producer and consumer surplus)

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Welfare Loss When PriceIs Held Below
Market-Clearing Level
Price
Quantity
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The Market for Human Kidneys

• The 1984 National Organ Transplantation Act
  prohibits the sale of organs for transplantation.
• Analyzing the Impact of the Act
• Supply QS 8,000 0.2P
• If P 20,000, Q 12,000
• Demand QD 16,000 - 0.2P

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The Market for Kidneys, and Effectsof the 1984
Organ Transplantation Act
Price
40,000
30,000
10,000
Quantity
0
8,000
4,000
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The Market for Human Kidneys

• The act limits the quantity supplied (donations)
  to 8,000.
• Loss to supplier surplus
• A C
• (8,000)(20,000) (1/2)(4,000)(20,000)
  200/m.

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The Market for Human Kidneys

• Gain to recipients
• A - B
• (8,000)(20,000) - (1/2)(4,000)(20,000)
  120/m.
• Deadweight loss
• B C or
• 200 million - 120 million 80 million

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The Market for Human Kidneys

• Other Inefficiency Cost
• Allocation is not necessarily to those who value
  the kidneys the most.
• Price may increase to 40,000, the equilibrium
  price, with hospitals getting the price.

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The Market for Human Kidneys

• Arguments in favor of prohibiting the sale of
  organs
• imperfect information about donors health and
  screening
• unfair to allocate according to the ability to
  pay
• should non-monetary values be considered?
• is first-come, first-served basis more fair?

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Minimum Prices

• Periodically government policy seeks to raise
  prices above market-clearing levels
• regulated prices
• minimum wages

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Price Minimum
Price
Quantity
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The Minimum Wage
w
L
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The Impact of a Tax or Subsidy

• The burden of a tax (or the benefit of a subsidy)
  falls partly on the consumer and partly on the
  producer.
• We will consider a per-unit or excise tax which
  is a tax of a certain amount of money per unit
  sold.

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Incidence of an Excise Tax
Price
Quantity
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Incidence of an Excise Tax

• Four conditions that must be satisfied after the
  tax is in place
• quantity sold and Pb must be on the demand line
  QD QD(Pb)
• quantity sold and PS must be on the supply line
  QS QS(PS)
• QD QS
• Pb - PS tax

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Impact of a Tax Dependson Elasticities of Supply
and Demand
Burden on Buyer
Burden on Seller
Price
Price
Burden is greater the more inelastic the demand
Burden is greater the more inelastic the supply
Quantity
Quantity
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The Effects of a Tax or Subsidy

• A subsidy can be analyzed in much the same way as
  a tax.
• It can be treated as a negative tax.
• The sellers price exceeds the buyers price.

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Subsidy
Price
Quantity
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The Efficiency of Price-Taking (Competitive)
Market

• In general, price-taking markets maximize social
  welfare
• all units that have a value greater than the
  opportunity cost of the resources used to produce
  them are produced and sold
• no way to increase social welfare
• government intervention can only make things worse

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Price-Taking Market Maximizes Social Welfare
Price
Consumer Surplus
At Qe the value of an additional unit to
consumers just equals the value of alternative
goods that could be produced with the same
resources.
PE
Opportunity cost of an additional unit
0
QE
Quantity
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The Efficiency of Price-Taking (Competitive)
Market

• When do competitive markets fail to maximize
  social welfare or lead to an inefficient
  allocation of resources?
• externalities or third-party effects
• even if welfare of consumers and producers is
  maximized, others may be made worse off
• lack of consumer information
• is consumers are poorly informed, may not make
  choices that maximize their well being

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The Efficiency of Price-Taking (Competitive)
Market

• If externalities exist or consumers are poorly
  informed, government intervention may make things
  better
• examples
• zoning regulations
• building codes
• truth in advertising laws
• professional licensure
• product quality regulations

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The Efficiency of Price-Taking (Competitive)
Market

• We will look at the issues of externalities and
  government intervention in more detail later in
  the course

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End of Lecture 17