6 Surplus and Welfare Flashcards
What is the loss of overall surplus also known as?
Dead-weight loss (DWL)
What are the two main types of price controls?
Minimum prices (price ceilings), and maximum prices (price floors).
On what grounds are price control often justified on?
On distributional grounds. i.e. that they are welfare-improving for consumers (or particular groups of them)
How must maximum prices relate to market equilibrium?
pmax < p* (duh)
Supply-demand diagrams (with surpluses) before and after maximum price
Pros and cons of a maximum price
While this means that producers get more surplus (usually), it inherently distorts the market, causing an inefficient allocation. This causes a DWL, and may take surplus away from struggling producers.
This also decreases quantity so may be more inaccessible arguably.
Maximum prices and price elasticity of demand + diagram
If demand is price elastic, consumers tend to benefit more from a price cap.
If demand is price inelastic, their loss in surplus may outweigh the gain in surplus from a price cap:
What are minimum wages examples of?
Minimum prices (price floors)
What is important to remember about the labour market?
The producers (suppliers) of labour are the people ☭
The consumers (demanders) of labour are firms
Supply-demand diagrams (with surpluses) before and after minimum price
Pros and cons of a minimum price
While this means that the workers get more surplus (usually), it inherently distorts the market, causing an inefficient allocation. This causes a DWL, and may take surplus away from struggling producers.
This also decreases quantity so may be more inaccessible arguably (i.e. exclude other workers so they are left unemployed).
Minimum prices and price elasticity of supply
If supply is price elastic, workers tend to benefit more from a price floor.
If supply is price inelastic, their loss in surplus may outweigh the gain in surplus from a price floor:
What is meant by price support policy?
When governments influence markets by becoming a player themselves. By buying up quantities of goods and services.
How do we show a price control diagrammatically?
A shift outwards of demand by G units
How do price supports affect the private sector demand?
Competition → bad for private buyers.
Their consumer surplus decreases, they lose areas B and C.
How do price supports affect the private sector supply?
Higher quantities supplied and at a higher price.
Producer surplus increases, gain of B, C, and F.
What is the cost to the government of a price support?
Govt cost = pgG
How do we show deadweight loss of a price support?
What are quotas?
A legally set limit on how much goods and services can be traded.
How can we show a quota diagrammatically?
How does a quota affect surpluses?
Consumers lose areas B and C.
Producers lose E but gain B.
Deadweight loss is areas C and E.
Who benefits and who loses to a quota?
Consumers lose.
Producers often gain but may lose if area E > area B (depending on elasticity of supply and quota size).
NOTE: Loss in PS relates to the producers that can no longer produce. Whereas those who can can charge a higher price.
Thus, incentive to keep entrants out and against increases in quotas (usually citing the importance of “standards”).
Society loses: deadweight loss.
Examples of quotas in use
Licences e.g. Taxi drivers in a certain city
What does a tax effectively do?
Create a “wedge: between the price the consumer pays (pD) and the price the supplier recieves (pS).
Two types of taxes and their equations
Two types of tax incidence
Formal incidence
Effective incidence
What is formal incidence?
The formal incidence of a tax is upon the entity which is responsible for remitting the tax.
What is effective incidence?
The effective incidence of a tax is upon the entity which bears the economic cost.
Who often bears the formal incidence? How do we write this?
Suppliers.
New supply curve of S(pD - T).
Specific tax diagrammatically
Surpluses and revenue of specific taxes
Consumers lose areas B and C.
Producers lose areas D and E.
Government revenue of B and D.
Deadweight loss of C and E.
How can we calculate effective incidence?
Suppose the government taxes consumption instead? How do we write this?
How does a tax on consumption change our analysis?
Entire analysis is identical. Effective incidence is unchanged.
Ad valorem tax diagrammatically
Analysis is very similar to specific taxes.
Changes to formal incidence do not change effective incidence.
What economic intuition underpins effective incidence?
Those who realise the least surplus from a trade can avoid the tax by walking away.
Those who make the greatest surplus could walk away, but won’t, and therefore bear the effective incidence.
How does price elasticity affect effective tax incidence?
Price inelastic demand → greater loss in CS → greater tax incidence.
Price inelastic supply → greater loss in PS → greater tax incidence.
How can we think of subsidies?
As negative taxes which move in the opposite way to a tax.
Remember the money has to come from somewhere so include it in analysis.
5 major policy points of taxation
- Taxes cause DWL’s in competitive markets
- Formal incidence ≠ effective incidence
- Effective incidence depends on relative price elasticities
- The side of the market which is least able to “walk away: will end up bearing the tax
- To tax consumers, you should target highly inelastic products such as petrol, water, highly addictive drugs etc.
