Microéconomie, chapter 9 - CEScermsem.univ-paris1.fr/davila/teaching/SBS/Ch09_Pindyck-09.pdf · Microéconomie, chapter 9 . Solvay Business School – Université Libre de Bruxelles

1 Solvay Business School – Université Libre de Bruxelles

1

Competitive markets

Microéconomie, chapter 9

Solvay Business School – Université Libre de Bruxelles 2

List of subjects

 Evaluation of public policies  Efficiency of competitive markets  Minimum prices  Support prices and production quotas  Import quotas and tariffs  Effects of taxes and subsidies


Evaluation of public policies

Example:  If a maximum price is imposed

 Some will benefit since they will be able to buy at a lower cost

 Others will be harmed since they will not get the best possible price for their goods

 But how can we evaluate the net effect?


Evaluation of public policies

 To evaluate the effect of a public policy one can measure the variation of the consumers and producers surpluses


Consumers and producers surplus

 The aggregate demand curve gives the willingness to pay of consumers

 The consumers surplus is the area under the demand curve and above the market price

 The consumers surplus measures the total benefit they obtain



 The aggregate supply curve gives the price producers are willing to accept to produce each level of output

 The producers surplus is the area below the market price and above the supply curve

 The producers surplus measures the total net benefit they obtain



Between 0 and Q0 the producers obtain a

net benefit from selling the good

Consumers surplus

quantity

Price

S

D

Q0

Between 0 and Q0 consumers obtain a

net benefit from buying the good

Producers surplus



1.  Consumers surplus: value they get in excess of their payments   Assume the price is €5   Some consumers are willing to pay more

than €5 for the good   Those willing to pay up to €9 and get it for

€5 obtain a surplus of €4



2.  Producers surplus revenue they get in excess of the cost of production   Some firms would continue to produce even at a

lower price   For instance, some would accept a price of €3

instead of €5   These firms obtain a surplus of €2 per unit


The efficiency of competitive markets

 The market is efficient when it maximizes the aggregate surplus of producers and consumers

 The control of prices can have a cost in terms of efficiency


Some market failures

1.  Externalities   Costs and benefits not taken into account

by the market (e.g., pollution) 2.  Imperfect information

  Missing information may prevent producers and consumers to make optimal decisions

  In these situations a public intervention can improve the efficiency


The efficiency of competitive markets

 In principle, no intervention is the best policy if efficiency is the goal

 But there is often market failures  Prices do not convey the correct information

to consumers and producers  In such cases unregulated competitive

markets lead to inefficient allocations


Price controls and changes in surplus

 Consider a maximum price too low  Demand increases and supply decreases

 Leads to rationing the good

 Firms will get a lower price  Some firms will go out of business  All firms will see their surpluses decrease



 Some consumers willing to pay the price will not find the good  They will lose some surplus

 Those consumers who manage to get the good will buy it at a lower price  They will gain some surplus


Firms lose the sum of A and C

B

A C

Some consumers gain A


Quantity

Price

S

D

P0

Q0

Pmax

Q1 Q2

Some consumers lose B

The total net loss is B and C



 The net loss of surplus (of both consumers and firms) is the inefficiency caused by the price control

 If the demand is very inelastic, the consumers’ losses can be very important


B

A Pmax

C

Q1

With an inelastic demand B can be larger than A so that

consumers suffer a net loss

S

D

Price controls with an inelastic demand

Quantity

Price

P0

Q2


B

A

C

The consumers gain is A minus B, and the firms loss

is A plus C

S D

2.00

2.40

Price

Quantity 0 5 10 15 20 25 30 18

(Pmax)1.00

Evaluating price controls



 Impact of the price control

 A = 18 x €1 = €18

 B = 1/2 x 2 x €0,40 = €0,4

 C = 1/2 x 2 x €1 = €1



 Variation of the consumers surplus  A - B = 18 – 0,4 = €17,6 gain

 Variation of the firms surplus  A + C = 18 + 1 = €19,0 loss

 Net loss  B + C = 0,4 + 1 = €1,4 loss


B A

C


Quantity

Price

S

D

P0

Q0

Pmin

Q1 Q2

When a minimum price Pmin is imposed, the loss of surplus is

the sum of B and C



 The loss of surplus in B and C is a good estimate of the cost in terms of efficiency of the price control policy

 The policy can then be evaluted estimating the areas B and C


Minimum price

 Often governments try to guarantee some incomes setting minimum prices  Minimum wage  Agricultural policies…


Minimum price

 When a minimum price is set above the equilibrium price:  Demand decreases  Firms expand supply due to the higher price  An additional loss comes from the cost of the

production in excess of demand


B A

The change of the producers surplus

is A – C – D

C

D

Minimum price

Quantity

Price

S

D

P0

Q0 Q1 Q2

Pmin

If firms expand output up to Q2,

the difference Q2 – Q1 will remain unsold

D mesures the cost of the unsold additional

output


Minimum price

 Consumers surplus change:  Some surplus is lost from buying some output at a

higher price (rectangle A)  Some surplus is lost from the decrease in the amount

purchased (triangle B)  Producers surplus change (if output is not

increased):  Some surplus is obtained from selling some output at

a higher price (rectangle A)  Some surplus is lost from the decrease in the amount

sold (triangle C)


Minimum price

 But firms increase output up to Q2 to adjust to a higher price  Since they only sell Q1 no revenue covers the cost of

additional production (Q2-Q1)  Since the supply curve gives the CMg, the cost of the

additional output is the area under the supply curve between Q1 and Q2 (area D)

 The producers surplus change is then A – C – D


Minimum wage

 Wage is fixed above the equilibrium level  Employed workers receive a higher wage   The number of employed workers decreases   Involuntary unemployment appears (some

workers willing to work at the minimum wage will not find a job)

 Some workers will see their surplus increase, other will lose some surplus


B

The loss of surplus is the sum of B and C

C

A

L1 L2

unemployment

wmin

A minimum wage Wmin creates involutary

unemployment

S

D

w0

L0

Minimum wage

L

w

A is the gain of those who keep their jobs at the minimum

wage


Production quotas

 The government can also support prices limiting supply


B A

C

Production quotas

Quantity

Price

D

P0

Q0

S

S’

PS

Q1

•  output limited to Q1 •  the supply curve becomes S’

•  ΔSC = – A – B

•  ΔSP = + A – C

• ΔST = – B – C

The social loss is B + C


Price support

  Agricultural policies are based on price supports  Prices are supported above equilibrium levels by government

purchases of excess supplies   Prices can also be artificially supported by retricting

production through quotas or incentive schemes   What are the consequences from consumers, producers

and the government budget?


E

D B

A

To support Ps the government

buys Qg = Q2 – Q1

D + Qg

Qg

Price support

Quantity

Price S

D

P0

Q0

Ps

Q2 Q1

•  ΔSC = – A – B

•  ΔSP = + A + B + D

•  coût = – E – B – D – C

•  ΔST = – E – B – C

The social net loss is

E + B + C C


Price support

 consumers  Demand decreases and supply increases  Government buys the excess supply  Consumers pay a higher price  The loss of surplus is for the consumers A+B


Price support

 producers  Their surplus increases since they sell more

at a higher price  The increase in surplus is A+B+D

 government  The purchase of excess supply is a cost for

the consumers (it is paid by taxes)  This cost is the area (Q2-Q1)PS


Price support

  The government could sell the excess supply in the world market  But then it competes against its own producers in the

world market…

  Total impact on surplus: ΔSC + ΔSP – gov. cost = D – (Q2-Q1)PS

 Social loss E + B + C


Limiting supply

 Incentive schemes  The government can pay producers to

decrease supply  Payments for non cultivated land


D

B A

C

Limiting supply

Quantity

Price

D

P0

Q0

S

S’

Q1

PS

•  ΔSC = – A – B

•  ΔSP = + A + B + D

•  cost = – B – D – C

•  ΔST = – B – C

Net loss for society:

B + C


Limiting supply

  Incentive schemes  The higher price charged to the amount sold

increases the producers surplus in A  The decrease in output decreases the producers

surplus in C  The government pays producers (sufficiently) for not

producing beyond Q1 : B+C+D  total change in the producers surplus SP = A – C + (B+C+D) = A + B + D


Limiting supply

 What is the most costly policy?  The (direct) cost for consumers is the same in both

cases  Producers obtain the same surplus in both cases  Supporting prices is costlier than imposing quotas and

incentive schemes to reduce output


Price support – example

 Consider the following equilibrium  supply: QS = 1800 + 240P  demand: QD = 3550 - 266P  Equilibrium at €3,46 and 2630 units sold

 The government wants to increase the price up to €3,70 buying excess supply



 How much would the government have to buy to support a price of €3,70?  QDTotal = QD + Qg = 3550 - 266P + Qg

 QS = QDT  1800 + 240P = 3550 - 266P + Qg  Qg = 506P - 1750  Qg = 506 x 3,70 – 1750 = 122,2 units


D + Qg

2688

A B C

Qg

PS = €3,70

• -A-B consumers loss • A+B+C producers gain S

D

P0 = €3,46

2630 1800


Quantity

Price

2566



 Change in consumers surplus  A = (3,70 – 3,46) x 2566 = € 615,84  B = 0,5 x (3,70 – 3,46)(2630 – 2566) = € 7,68

 ΔCS = – A – B = € –623,52



 Cost of the intervention:  Cost for the government

€3,70 x 122,2 = €452,14  Total cost

€623,52 + €452,14 = €1075,66  Producers gain

  A + B + C = $638,2 million  Loss of surplus =

 €1075,66 - €638,2 = €437,46


Import quotas and tariffs

 Many countries impose import quotas and tariffs to support domestic prices above world prices  Import quotas: a limit to the amount that can be

imported  tariffs: taxes on imported goods

  This allows domestic producers to obtain higher profits

 But consumers pay a high cost


QS QD

PW

A B C

A zero quota increases the domestic price up to

P0

Limits to imports

Quantity

Price

Q0

D

P0

S

Without intervention, the domestic price and the world price PW coincide

Imports

•  the loss for consumers is A+B+C

•  the gain for producers is A

•  the loss of surplus is B +C.


Tariffs

  Tariffs increase domestic prices

  Supply QS increases and demand QD decreases

  The gain for domestic producers is A

  The loss for consumers is A + B + C + D

  The government income is D = tariff x imports

  The loss of surplus is B + C

D C B

QS QD Q’S Q’D

A P*

Pw

Q

P

D

S


Import quotas

  With an equivalent quota, the rectangle D goes to the world producers

  The loss for consumers is A+B+C+D

  The gain for domestic producers is A

  The net national loss is B + C + D

D C B

QS QD Q’S Q’D

A P*

Pw

Q

P

D

S


Impact of a tax

 If the government imposes a tax of €1 for each unit sold it can  Charge firms €1 for each unit they sell  Charge consumers €1 for each unit they buy

 What is the best option for consumers?


The impact of a tax

 Every tax is actually paid partly by the consumer and partly by the firm

 How the tax is divided between the two depends of the relative elasticities of supply and demand


•  loss for consumers A + B •  tax revenue A + D •  loss for producers D + C •  loss of surplus B + C

Impact of a tax

D

S

B

D

A

C

Quantity

Price

P0

Q0 Q1

PS price received

Pb price paid

Tax


Impact of a tax   After the introduction of a tax:

1.  The quantity purchased QD and the price paid Pb are on the demand curve   Consumers are only interested in the price (including

taxes) they pay

2.  The quantity sold QS and the price received PS are on the supply curve   Producers are only interested in the price (excluding

taxes) they receive

5.  QD = QS 6.  The difference Pb - Ps is the tax


Impact of a tax

 When demand is relatively more inelastic, most of the tax is paid by the consumers

 When supply is relatively more inelastic, most of the tax is paid by the producers

Impact of a tax

Quantity Quantity

Price Price

S

D S

D

Q0

P0 P0

Q0 Q1

Pb

PS

t

Q1

Pb

PS

t

the consumers pay most the producers pay most


Impact of a subsidy

 A subsidy works like a negative tax  Makes the price paid by the consumer lower

than the price received by the firm  It increases the amount exchanged in the

market


D

S

Impact of a subsidy

Quantity

Price

P0

Q0 Q1

PS

Pb

The benefits from a subsidy are also shared

by consumers and producers, according to the relative elasticities of supply and demand

Subsidy


Impact of a subsidy

 Most of a subsidy goes to consumers if ED /ES is small

 Most of a subsidy goes to the firms if ED /ES is big


Impact of a tax - example

 Consider a tax of 50 cents on  demand

 QD = 150 - 50P  supply

 QS = 60 + 40P  equilibrium QS = QD = 100 at a price €1



 After introducing the tax: QD = QS

150 - 50PB = 60 + 40PS

150 - 50(PS+ 0,50) = 60 + 40PS

PS = 0,72 PB = PS + 0,50 = €1,22

QD = QS = 89



 After introducing the tax:  Q decreases 11%  The price paid increases 22 cents  The price received decreases 20 cents  The tax revenue is €44,5


C D

A

Imopact of a tax - example

Quantity

Price

50 150 100

P0 = 1,00

Pb = 1,22

PS = ,72

89

11

Split of the tax : 22 on consumers, 28 cents on firms

S D

60

€0,5Tax

Loss for consumers = A + B

Loss for firms = C + D

Tax revenue = A + D = 0,50 x 89 = €44,5

B

Documents

Microéconomie, chapter 9 - CEScermsem.univ-paris1.fr/davila/teaching/SBS/Ch09_Pindyck-09.pdf · Microéconomie, chapter 9 . Solvay Business School – Université Libre de Bruxelles