Chapter 3 Flashcards
Consumer Surplus
measures the aggregate net benefit that consumers obtain from a
competitive market
- Defined as the difference between what a consumer is willing to pay for a good and the consumer actually pays when buying it
Producer surplus
measures the aggregate net benefit to produces
- Defined as the sum over all units produced of the difference between the market price of the good and the marginal cost of its production
- The benefit that lower-cost producers enjoy by selling at the market price
Welfare effects: gains and losses to consumers and producers. Different changes in supply and demand and their impact?
increase in producer surplus:
○ Benefit:
○ Don’t benefit:
○ Change in producer surplus :
Deadweight loss: net loss of total (consumer plus producer) surplus
○ total change in surplus = (
○ It is an caused by price controls
○ Loss in exceeds gain in
Change in consumer surplus:
- Increase in consumer surplus:
- Benefit: consumers who can still buy the good
- Can buy the good at a lower price
- Benefit: consumers who can still buy the good
- Don’t benefit: those who can no longer buy the good lose surplus
- Those who have been rationed out of the market because of the reduction in production and sales
- consumer surplus = A − B
For graph extra
Change in producer surplus:
○ Benefit: those who will receive a lower price
○ Don’t benefit: those who leave the market
○ Change in producer surplus : − A − C
Deadweight loss: net loss of total (consumer plus producer) surplus
○ total change in surplus = (A − B) + (− A − C) = − B − C
○ It is an inefficiency caused by price controls
○ Loss in producer surplus exceeds gain in consumer surplus
economic efficiency and Market failure
Economic efficiency: the maximization of aggregate consumer and producer surplus
Market failure: unregulated competitive market is inefficient because prices fail to provide proper signals to consumers and producers. 2 ways in which market failure can occur:
- Externalities : action taken by producer or consumer which affects other producers or consumers but its not accounted for by the market price
- Lack of information : consumers are not informed about quality of product and so cannot make purchase decisions
for Graph
Change in consumer surplus:
Change in producer surplus:
Change in consumer surplus:
ΔCS =− A − B
Change in producer surplus
ΔPS = A − C − D
Price supports and production quotas
Government can also …by…
For graph
● Consumers: ΔCS =
● Producers: ΔPS =
● Government:
Production quotas
Government can cause…
Government can cause price of good to rise by reducing supply by setting quotas on How much each firm can produce
Incentive programs:Acreage limitation programs:
Acreage limitation programs: give farms financial incentives to leave some of their
acreage idle
Production quotes cause:
● Consumer surplus:
● Producer surplus:
● Cost to government and total change of producer surplus:
● Consumer surplus: ΔCS =− A − B
● Producer surplus: ΔPS = A − C + Payments for not producing
● Cost to government and total change of producer surplus:
ΔPS = A − C + B + C + D = A + B + D
● Change in welfare: ΔWELFARE = − A − B + A + B + D − B − C − D = − B − C
Import quotas and tariffs
Government uses import quota & tariffs
● Import quota:
● Tariff:
Impact on:
● ΔCS = − A − B − C − D
● ΔPS = A
Import quotas and tariffs
Government uses import quota & tariffs to keep domestic price of a produce above work levels and enable domestic industry to enjoy higher profits than under free trade
● Import quota: limit on the quantity of a food that can be imported
● Tariff: tax on an imported good
Impact on:
● ΔCS = − A − B − C − D
● ΔPS = A
impact of a tax or subsidy
The effects of specific tax:
● Specific tax:
● Ad valorem tax:
impact of a tax or subsidy
The effects of specific tax:
● Specific tax: tax of a certain amount of money per unit sold
● Ad valorem tax: proportional; state sales tax
Market clearing requires 4 conditions to be satisfied after tax is in place:
- Quantity sold and buyer’s price… (b/c buyers are interested only… )
- Quantity sold and seller’s price … (b/c sellers are only interested in…)
- …= ….
- Difference …must equal the tax
Conditions summarized as:
Q D = …
Q S = …
Q D = …
…= t
Tax results in:
● Revenue to government:
● ΔCS =
● ΔPS =
● DW loss=
Market clearing requires 4 conditions to be satisfied after tax is in place:
- Quantity sold and buyer’s price must lie on the demand curve (b/c buyers are interested only in price they must pay)
- Quantity sold and seller’s price must be on supply curve (b/c sellers are only interested in amount of money the receive net of tax)
- Quantity demanded must = quantity supplied
- Difference between price buyer pays and price seller receives must equal the tax
Conditions summarized as:
Q D = Q D (P D )
Q S = Q S (P S )
Q D = Q S
P D- P S = t
Tax results in:
● Revenue to government: t x Q * = A + D
● ΔCS = − A − B
● ΔPS =− C − D
● DW loss= ΔPS + ΔCS + rev to govt = − A − B − C − D + AD = − B − C
Pass-through fraction and Tax Impact on
Pass-through fraction
Used to calculate % …
…
Used to calculate %…
…
Tax Impact on:
● Not …to:
- *
Pass-through fraction:
- Used to calculate % of the tax borne by buyers ES /(ES − ED )
- Used to calculate % of tax borne by suppliers -ED/(ES − ED)
Tax Impact on:
● Not beneficial to:
○ Suppliers when E d /E S is large
○ Buyers when E d /E S is small
