Chapter 3 - Market Analysis Flashcards
Define consumer and producer surplus.
Consumer surplus is the difference between the price consumers would be willing to pay for a good and the price they actually have to pay. Producer surplus is the difference between the price at which producers would be willing to sell their good or service and the price they actually receive.
Key factor in determining amount of potential consumer surplus in a new market - the steepness of the demand curve (the steeper the bigger the surplus, all else equal)
What is the demand choke price? How does this price relate to consumer surplus?
The demand choke price is the price at which quantity demanded is reduced to zero. Consumer surplus is equal to the area of the triangle with its base equal to the quantity sold and its height the difference between the market price and the demand choke price
What is the supply choke price? How does this price relate to producer surplus?
The supply choke price is the price at which quantity supplied is reduced Lo zero. Producer surplus is equal to the area of the triangle with its base equal to the quantity sold and its height the difference between the market price and the supply choke price.
What happens to the producer and consumer surplus if there is a decrease in the demand curve?
An decrease in the demand curve decreases the equilibrium price and decreases the equilibrium quantity in the market.
This causes:
• producer surplus to decrease.
• consumer surplus to decrease.
What happens to the producer and consumer surplus if there is an increase in the demand curve?
An increase in the demand curve increases the equilibrium price and increases the equilibrium quantity in the market.
This causes:
• producer surplus to increase.
• Both the increase in price and increase in quantity increase PS.
• consumer surplus to also increase.
• The increase in price decreases CS, but the increase in quantity increases CS. The net effect is positive due to the upward sloping supply (Because the equilibrium price rises less than the willingness to pay, the surplus to due higher willingness to pay is larger than loss due to a higher price.)
What is a price ceiling? Why does a price ceiling create excess demand for (shortage of) a good? What affects how much surplus there is in the market and who obtains it?
A price ceiling sets the highest price that can be paid legally for a good. If this price is set below the equilibrium price, consumers will demand more of the good than producers are willing to supply, resulting in excess demand for the good.
Excess demand can create incentives for buyers to come into the market who wouldn’t have even been interested in the product if not for the price ceiling, because these buyers hope to obtain the good at the low, controlled price and resell it to high-value buyers at a higher price
How many such buyers come into the market, what they resell the good for, and any additional costs of this reselling process all affect how much surplus there is in the market and who obtains it
What is a price floor? Why does a price floor create an excess supply of (surplus of) a good?
A price floor sets the lowest price that can be paid legally for a good. If this price is set above the equilibrium price, producers will supply more of the good than consumers are willing to buy, resulting in excess supply for the good.
What is a deadweight loss? If the price elasticity of a good is large, would you expect the deadweight loss to be large or small?
Deadweight loss is the reduction in total surplus that results from a market inefficiency. A large price elasticity indicates that supply or demand is sensitive to price. As a result, the resulting deadweight loss in a market with a large price elasticity will be relatively large.
When is a price ceiling nonbinding? When is a price floor nonbinding?
A nonbinding price ceiling is set at a level above equilibrium price, and a nonbinding price floor is set at a level below equilibrium price.
What is a quota? How does it differ from a price ceiling or a price floor? (not part of curriculum)
A quota directly regulates the quantity of a good or service that can be provided, unlike a price floor or price ceiling that directly regulates the price of a good or service.
What happens to the equilibrium price and quantity of a good when a tax is imposed on the good? Why does a tax create a wedge between the price the consumer pays and the price the producer receives?
A tax causes quantity to decrease and the price that consumers pay to increase. A tax wedge occurs because the price suppliers receive for the good is lower than the price consumers pay by the amount of the tax.
After a supply shift there are two equilibrium prices - the price the consumers pay (including the tax) and the price the suppliers receive after taking the tax out of the higher market price and sending it to the government
Because it is an extra cost to the suppliers, the supply curve shifts inward with the amount of the tax (as it does with an increase in production costs)
No surplus transfer between producers and consumers (instead they transfer some of their surplus to the government)
How does a tax affect consumer and producer surplus? Why does a tax create a deadweight loss?
The tax wedge reduces both consumer and producer surplus in the market, creating the deadweight loss of a tax
The main determinant of the DWL from a tax as a share of revenue is how much the quantity changes when the tax is added
The size of that change depends on the elasticity of the demand and supply
What is the tax incidence? What factors determine the tax incidence?
The tax incidence is who- the producers or the consumers - actually bears the burden of a tax. The tax incidence is determined by the elasticity of supply and demand.
What is a subsidy and how does it affect CS and PS? (not part of curriculum)
A subsidy is the opposite of a tax-it is a payment by the government to a buyer or seller of a good or service. A subsidy increases both producer and consumer surplus
Who bears the largest burden of a tax?
The ultimate tax burden depends on the elasticities of the supply and demand curve. The more elastic curve bears less of the tax burden.
If the demand curve is more elastic than supply curve, the consumers bear less of the tax burden.
