Competitive Markets: Applications

1
Lecture 15 Competitive Markets
Applications Lecturer Martin Paredes
2
Outline

• Efficiency of Perfect Competition
• Government Intervention
• Examples of Various Government Policies
• Excise Taxes
• Price Ceilings
• Production Quotas

3
Efficiency of Perfect Competition

• A perfectly competitive market allocates
  resources efficiently
• Alternatively, at a perfectly competitive
  equilibrium, (Q,P), total surplus is maximized.
• It assumes there is no outside intervention

4
Example Maximisation of Surplus in Competitive
Equilibrium
P
Supply
A
C
B
P
D
Demand
Q
Q
5
Example Maximisation of Surplus in Competitive
Equilibrium
P
Supply
A
Consumer Surplus ABC
C
B
P
D
Demand
Q
Q
6
Example Maximisation of Surplus in Competitive
Equilibrium
P
Supply
A
Consumer Surplus ABC
C
B
P
Producer Surplus BCD
D
Demand
Q
Q
7
Example Maximisation of Surplus in Competitive
Equilibrium
P
Supply
A
Consumer Surplus ABC
C
B
P
Producer Surplus BCD
Total Surplus
D
Demand
Q
Q
8
Efficiency of Perfect Competition

• Definition Economic Efficiency means that the
  total surplus is maximized.
• Definition A deadweight loss is a reduction in
  net economic benefits resulting from an
  inefficient allocation of resources.
• Deadweight losses occur when there is government
  intervention

9
Example Deadweight Loss
P
Supply
A
C
B
P
D
Demand
Q
Q
10
Example Deadweight Loss
P
Supply
A
C
B
P
D
Demand
Q
Q
Q1
11
Example Deadweight Loss
P
Supply
A
Pd
C
B
P
D
Demand
Q
Q
Q1
12
Example Deadweight Loss
P
Supply
A
Pd
C
B
P
Ps
D
Demand
Q
Q
Q1
13
Example Deadweight Loss
P
Supply
A
Pd
Deadweight Loss
C
B
P
Ps
D
Demand
Q
Q
Q1
14
Government Intervention

• There are several instruments that the government
  can use to modify the equilibrium in a perfectly
  competitive market
• Deadweight losses occur when there is government
  intervention

15
Government Intervention

• Examples of Government Intervention
• Excise taxes
• Subsidies to producers
• Price floors
• Price ceilings
• Production quotas
• Import tariffs and quotas
• Government Purchase programs
• Acreage Limitation program

16
Excise Tax

• Definition An excise tax (or a specific tax) is
  an amount paid per unit of the good at the point
  of sale.
• It is paid by either the consumer or the
  producer.
• If consumers pay price PD and producers receive
  PS, then the tax is given by T PD PS.

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Example Excise Tax
P
S
P
Demand
Q
Q
18
Example Excise Tax
S S T
P
S
T
P
Demand
Q
Q
19
Example Excise Tax
S S T
P
S
T
P
Demand
Q
Q1
Q
20
Example Excise Tax
S S T
P
S
T
Pd
P
Demand
Q
Q1
Q
21
Example Excise Tax
S S T
P
S
T
Pd
P
Ps
Demand
Q
Q1
Q
22
Example Excise Tax
S S T
P
S
Consumer Surplus
T
Pd
P
Ps
Demand
Q
Q1
Q
23
Example Excise Tax
S S T
P
S
Consumer Surplus
T
Producer Surplus
Pd
P
Ps
Demand
Q
Q1
Q
24
Example Excise Tax
S S T
P
S
Consumer Surplus
T
Producer Surplus
Pd
Tax Revenue
P
Ps
Demand
Q
Q1
Q
25
Example Excise Tax
S S T
P
S
Consumer Surplus
T
Producer Surplus
Pd
Tax Revenue
P
Deadweight Loss
Ps
Demand
Q
Q1
Q
26
Excise Tax

• Definition
• The amount by which the price paid by consumers,
  PD, rises over the non-tax equilibrium price, P,
  is the incidence of the tax on consumers.
• The amount by which the price received by
  sellers, PS, falls below P is called the
  incidence of the tax on producers.

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Price Floors

• Definition A price ceiling is a minimum price
  that consumers can legally pay for a good.
• If the price floor is above the pre-control
  competitive equilibrium price, then it said to be
  binding.

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Example Price Floors
P
S
P
D
Q
Q
29
Example Price Floors
P
S
PMIN
P
D
Q
Q
30
Example Price Floors
P
S
PMIN
P
D
Q
Q
Qd
31
Example Price Floors
P
S
PMIN
P
D
Q
Q
Qd
Qs
32
Example Price Floors
P
S
PMIN
P
Qs Qd Excess Supply
D
Q
Q
Qd
Qs
33
Example Price Floors
P
S
Consumer Surplus
PMIN
P
D
Q
Q
Qd
Qs
34
Example Price Floors
P
S
Consumer Surplus
PMIN
Producer Surplus
P
D
Q
Q
Qd
Qs
35
Example Price Floors
P
S
Consumer Surplus
PMIN
Producer Surplus
P
Deadweight Loss
D
Q
Q
Qd
Qs
36
Production Quotas

• Definition A production quota is a limit either
  on the number of producers in the market or on
  the amount that each producer can sell.
• The goal of a quota is to place a limit on the
  total quantity that producers can supply to the
  market.

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Example Production Quota
P
Original Supply
Demand
Q
Q
38
Example Production Quota
P
Original Supply
Demand
Q
Q
QMAX
39
Example Production Quota
Supply with quota
P
Original Supply
Demand
Q
Q
QMAX
40
Example Production Quota
Supply with quota
P
Original Supply
Consumer Surplus
Producer Surplus
Deadweight Loss
Demand
Q
Q
QMAX
41
Government Intervention Who Wins and Who Loses?
Effect on Effect on Effect
on Effect on
(domestic) (domestic) (domestic) (domestic)
Is a (domestic) Intervention Quantity
Consumer Producer Government Deadweight
Type Traded Surplus
Surplus Budget Loss created?
Excise Tax Falls Falls Falls Positive Yes
Subsidies to Producers Rises Rises Rises Negative Yes
Maximum Price Ceilings for Producers Falls Excess Demand Rise or Fall Falls Zero Yes
Minimum Price Floors for Producers Falls Excess Supply Falls Rise or Fall Zero Yes
Production Quotas Falls Excess Supply Falls Rise or Fall Zero Yes
Import Tariffs Falls Falls Rises Positive Yes
Import Quotas Falls Falls Rises Zero Yes
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Summary

1. An "invisible hand" guides the competitive market
   to the efficient level of production and
   consumption.
2. The government policies examined here all
   resulted in a deadweight loss compared to the
   perfectly competitive equilibrium.

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Summary

1. Efficiency is obtained under the assumption that
   price fully reflects all costs and benefits to
   the market and that there is perfect information.
   
2. Government intervention may be efficient under
   imperfectly competitive markets.

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Additional Slides
45
Subsidies to Producers

• Definition A subsidy is an amount paid by the
  government per unit of the good to the sellers.
• If consumers pay price PD, then the government
  pays an amount T per unit on top of that price,
  so producers receive PS PD T.

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Example Subsidies
P
S
P
D
Q
Q
47
Example Subsidies
P
S
S S T
T
P
D
Q
Q
48
Example Subsidies
P
S
S S T
T
P
D
Q
Q
Q2
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Example Subsidies
P
S
S S T
T
P
Pd
D
Q
Q
Q2
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Example Subsidies
P
S
S S T
T
Ps
P
Pd
D
Q
Q
Q2
51
Example Subsidies
P
S
S S T
T
Consumer Surplus
Ps
P
Pd
D
Q
Q
Q2
52
Example Subsidies
P
S
S S T
T
Ps
Producer Surplus
P
Pd
D
Q
Q
Q2
53
Example Subsidies
P
S
S S T
T
Ps
Government Expenditure
P
Pd
D
Q
Q
Q2
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Example Subsidies
P
S
S S T
T
Ps
P
Deadweight Loss
Pd
D
Q
Q
Q2
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Price Ceilings

• Definition A price ceiling is a legal maximum on
  the price per unit that a producer can receive.
• If the price ceiling is below the pre-control
  competitive equilibrium price, then the ceiling
  is called binding.

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Example Price Ceilings
P
S
P
D
Q
Q
57
Example Price Ceilings
P
S
P
PMAX
D
Q
Q
58
Example Price Ceilings
P
S
P
PMAX
D
Q
Q
Qd
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Example Price Ceilings
P
S
P
PMAX
D
Q
Q
Qd
Qs
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Example Price Ceilings
P
S
Qd Qs Excess Demand
P
PMAX
D
Q
Q
Qd
Qs
61
Example Price Ceilings
P
S
Producer Surplus
P
PMAX
D
Q
Q
Qd
Qs
62
Example Price Ceilings
P
S
Consumer Surplus
Producer Surplus
P
PMAX
D
Q
Q
Qd
Qs
63
Example Price Ceilings
P
S
Consumer Surplus
Producer Surplus
P
PMAX
Deadweight Loss
D
Q
Q
Qd
Qs