Evaluating the Welfare Effects of Government Policy: CS

1
Evaluating the Welfare Effects of Government
Policy CS PS
Price
0
Quantity
2
Price Ceilings and the Welfare Loss
Price
Quantity
3
Price Ceiling Demand Is Inelastic
Price
Quantity
4
Price Controls and Natural Gas Shortages
Price (/mcf)
Quantity (Tcf)
0
5
10
15
20
25
30
5
Price Floors and the Welfare Loss
Price
Quantity
6
Price Floor The Minimum Wage
w
L
7
Price Floors Airline Deregulation
Price
Quantity
8
Agricultural Price Floors Price Supports and
Production Quotas
The cost to the government is the speckled
rectangle Ps(Q2-Q1)
Price
S
To maintain a price Ps, the government buys
quantity Qg . The change in CS -A B the
change in PS A B D. Total welfare loss is
D-(Q2-Q1)ps
Ps
B
A
D
P0
Total Welfare Loss
D
Quantity
Q0
Q2
Q1
9
Price Floors Supply Restrictions
Price
Quantity
10
Import Tariff or Quota General Case

• The increase in price can be achieved by a quota
  or a tariff
• A the gain to domestic producers
• The loss to consumers A B C D
• If a tariff is used the government gains D, so
  the net domestic product loss is B C.
• If a quota is used instead, D becomes part of the
  profits of foreign producers, and the net
  domestic loss is B C D.

Price
Quantity
11
US Sugar Quota in 1997
D the gain to foreign firms with quota rights
600m B and C the DWL 800 m.
Price (cents/lb.)
20
16
11
8
4
5
10
15
20
25
0
30
Quantity (billions of pounds)
12
Incidence of a Specific Tax
Price
Quantity
13
Incidence of a Specific Tax

• 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)
• 3) QD QS
• 4) Pb - PS tax

14
Impact of a Tax Depends on Es Ed
Burden on Buyer
Burden on Seller
Price
Price
Quantity
Quantity
15
Impact of a 50 Cent Gasoline Tax
Deadweight loss 2.75 billion/yr
Price ( per gallon)
1.50
The annual revenue from the tax is .50(89) or
44.5 billion. The buyer pays 22 cents of the
tax, and the producer pays 28 cents.
.50
Quantity (billion gallons per year)
0
50
150
16
Effect of a Subsidy
Price
Quantity
17
The Efficiency of a Competitive Market Any
Market Failure?

• 1) Externalities Costs or benefits that are not
  reflected in the market price (e.g. pollution)
• 2) Lack of Information Imperfect information
  prevents consumers from making utility-maximizing
  decisions.
• Government intervention in these markets can
  increase efficiency.
• Government intervention without market failure
  creates inefficiency or DWL.