1' Supply

1
1. Supply demand applications

• Measuring impact of government policies
• Price controls
• Trade
• Taxes and subsidies

2
2. Impact of Government Policies

• New concepts
• 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.

3
3. Consumer surplus example

• Nancy Nortels demand schedule for flights to
  TorontoP Q 15 1 10
  2 6 3 3 4 1 5

4
4. Consumer surplus example

• Nancy Nortels demand schedule for flights to
  TorontoP Q Value 15 1
  1510 2 6 3 3 4 1
  5

5
5. Consumer surplus example

• Nancy Nortels demand schedule for flights to
  TorontoP Q Value 15 1
  1510 2 25 6 3 3
  4 1 5

6
6. Consumer surplus example

• Nancy Nortels demand schedule for flights to
  TorontoP Q Value 15 1
  1510 2 25 6 3
  31 3 4 34 1 5
  35

7
7. Consumer surplus example

• If P10, then Q2
• P Q Value PQ Consumer
  surplus 15 1 1510
  2 25 20 5 6
  3 31 3 4 34 1
  5 35

8
8. Consumer surplus example

• Looking now at all prices
• P Q Value PQ Consumer
  surplus 15 1 15
  15 010 2 25
  20 5 6 3 31
  18 13 3 4 34
  12 22 1 5 35
  5 30

9
9. Consumer surplus

• Definition difference between maximum consumer
  is willing to pay and what consumer actually pays
• Graphically area under demand curve but above
  market price
• Applications pricing, government policy
  analysis, nonmarket evaluation

10
10. Producer surplus

• Definition difference between amount received by
  producer and minimum amount necessary to get
  production at a given level
• Graphically area between market price and above
  supply curve

11
11.Consumer producer surplus
Price
10
S
7
5
D
0
Quantity
12
12.Consumer producer surplus
Price
10
Consumer Surplus
S
7
Between 0 and Q0 consumers A and B receive a net
gain from buying the product-- consumer surplus
5
D
0
Q0
Quantity
Consumer B
Consumer C
Consumer A
13
13.Consumer producer surplus
Price
10
Consumer Surplus
S
7
Between 0 and Q0 producers receive a net gain
from selling each product-- producer surplus.
5
Producer Surplus
D
0
Q0
Quantity
Consumer B
Consumer C
Consumer A
14
14. Evaluating Gains and Losses from Government
Policies--Consumer and Producer Surplus

• To determine the impact of a governmental policy
  we can measure the gain or loss in consumer and
  producer surplus.

15
15. Price ceilings (gas, rent, power)
Price
S
Suppose the government imposes a price
ceiling which is below the market-clearing price
P0.
P0
D
Q0
Quantity
16
16. Consumer impact
x
Price
S
w
B
The gain to consumers is the difference
between the rectangle A and the triangle B.
z
y
P0
C
A
Pmax
u
v
D
Q0
Q1
Q2
Quantity
17
17. Producer and total impact
Price
S
B
The loss to producers is the sum of rectangle A
and triangle C. Triangle B and C together
measure the deadweight loss.
P0
e
f
C
A
Pmax
g
h
D
d
Q0
Q1
Q2
Quantity
18
18. Price floors

• Periodically government policy seeks to raise
  prices above market-clearing levels.
• We will investigate this by looking at two
  cases1. Quantity determined by demand
  (airfares before 1980, minimum wage)2. Quantity
  determined by supply (price supports)

19
19. Airfares before deregulation
Price
S
pmin
Firms are not allowed to charge less than pmin.
This results in excess capacity.
p0
Excess Capacity
D
Q0
Q1
Q2
Quantity
20
20. Airfares before deregulation
Price
S
Pmin
B
A
The deadweight loss is given by triangles B and
C.
w0
C
Excess capacity
D
Q0
Q1
Q2
Quantity
21
21. Price Supports
Price
Quantity
22
22. Price Supports
Price
The cost to the government is the speckled
rectangle Ps(Q2-Q1)
S
Ps
B
A
D
P0
Total welfare loss D-(Q2-Q1)ps
Total Welfare Loss
D
Quantity
Q0
Q2
Q1
23
23. World trade

• Which goods are tradedExports world price gt
  domestic price without tradeImports world
  price lt domestic price without trade

24
24. Exports
Price
S
Exports
P
P0
D
QD
QS
Q0
Quantity
25
25. Imports
Price
S
P0
P
Imports
D
QS
QD
Q0
Quantity
26
26. Limiting imports

• By reducing imports, the domestic price is
  increased from Pw to P.

S
Price
P
Pw
D
QS
QD
Quantity
27
27. Effect of restricting imports

• This can be achieved by a quota or a tariff.
• Area A is again the gain to domestic producers.
• The loss to consumers is A B C D.
• If a tariff is used the government gains D, so
  the net domestic product loss is B C.

S
Price
P
D
C
B
A
Pw
D
QS
QD
QS
QD
Quantity
28
28. Effect of restricting imports

• If a quota is used instead, rectangle D becomes
  part of the profits of foreign producers, and the
  net domestic loss is B C D.
• Question
• Would the U.S. be better off or worse off with a
  quota instead of a tariff? (e.g. Japanese import
  restrictions in the 1980s)

S
Price
P
D
C
B
A
Pw
D
QS
QD
QS
QD
Quantity
29
29. Recent case studies

• What have higher steel tariffs done? Who
  gains/loses?
• What have been the consequences of sugar tariffs
  and quotas in the US and EU?

30
30. 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 specific tax which is a tax of
  a certain amount of money per unit sold.

31
31. Equilibrium with taxes

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

32
32. Equilibrium with taxes

• Four conditions that must be satisfied after the
  tax is in place
• 3) QD QS
• 4) Pb - PS tax
• Subsidies similar except Pb s Ps, where s
  subsidy

33
33. Incidence of a Tax
Price
S
Pb
Pb is the price (including the tax) paid by
buyers. PS is the price sellers receive, net of
the tax. The burden of the tax is split evenly
here.
P0
PS
D
Q0
Q1
Quantity
34
34. Incidence of a Tax
Price
S
Pb
Buyers lose A B, and sellers lose D C, and
the government earns A D in revenue. The
deadweight loss is B C.
B
A
P0
D
C
t
PS
D
Q0
Q1
Quantity
35
35. Subsidy
Price
S
Like a tax, the benefit of a subsidy is
split between buyers and sellers, depending upon
the elasticities of supply and demand.
PS
s
P0
Pb
D
Q0
Q1
Quantity
36
36. Impact of a Tax Depends on Elasticities
D
Price
Price
S
S
P0
P0
D
Quantity
Quantity
Q0
Q0
37
37. Impact of a Tax Depends on Elasticities
D
Price
Price
S
Pb
S
t
Pb
P0
P0
PS
t
D
PS
Quantity
Quantity
Q0
Q0
Q1
Q1
38
38. Pass-through function

• The more inelastic the demand, the greater the
  percentage of the tax burden that falls on the
  buyer.
• Pass-through fraction
• ES/(ES - Ed)
• For example, when demand is perfectly inelastic
  (Ed 0), the pass-through fraction is 1, and all
  the tax is born by the buyer.

39
39. A primer on taxes

• All involve deadweight loss distortions smallest
  when output relatively unaffected, e.g.,
  inelastic demand
• Specific casessales taxes on retail
  merchandisesin taxes (tobacco, alcohol)income
  taxes (rates, deductions)development fees for
  new homes in Cary
• What about the internet?