chapter 3 part 2 from class: government market controls Flashcards
how do you calculate the gain to consumers when the government implements a price ceiling?
- find the rectangle created by the reduced quantity supplied (Q1), the price equilibrium (P0), and the Pmax (the price ceiling)
calculate its area (rectangle A)
- find the triangle created just below the demand curve and above the price equilibrium (P0), by the reduced quantity supplied (Q1), and the equilibrium quantity (Q0)
calculate its area (triangle B)
The gain to consumers is the difference between the area of said rectangle and triangle
how do you calculate the loss to producers when the government implements a price ceiling?
- find the rectangle created by the reduced quantity supplied (Q1), the price equilibrium (P0), and the Pmax (the price ceiling)
calculate its area (rectangle A)
- find the triangle created just above the supply curve and below the price equilibrium (P0), by the reduced quantity supplied (Q1), and the equilibrium quantity (Q0)
calculate its area (triangle C)
The loss to producers is the sum of said rectangle and triangle
how do you calculate the deadweight loss created by a price ceiling?
- find the triangle created just below the demand curve and above the price equilibrium (P0), by the reduced quantity supplied (Q1), and the equilibrium quantity (Q0)
calculate its area (triangle B)
- find the triangle created just below the demand curve and above the price equilibrium (P0), by the reduced quantity supplied (Q1), and the equilibrium quantity (Q0)
calculate its area (triangle C)
the two triangles are the deadweight loss
what is deadweight loss?
loss of total (consumer plus producer) surplus
price ceiling with inelastic demand
triangle B can be larger than rectangle A
consumers suffer a net loss from price controls
economic efficiency
maximization of total benefit to the society
maximization of consumer and producer surplus, and government revenue
market failure
situation in which an unregulated competitive market is inefficient
prices fail to provide proper signals to consumers and producers
what can cause market failures?
Externalities
Lack of Information
externality:
action taken by either a producer or a consumer which affects other producers or consumers
not accounted for by the market price
how can lack of information create market failures
consumers cannot make utility-maximizing purchasing decisions
in this case, government intervention (e.g., requiring “truth in labeling”) may then be desirable
how to calculate deadweight loss with price floor?
sum of triangles B and C
what are the dangers of a price floor and suppliers supplying the amount that they should with the new price?
basically overproduction because the consumers will definitely not buy that amount
there will clearly be a quantity surplus
but total surplus will now be completely negative
suppliers will take an absolute L
price support
price set by government above free-market level
maintained by governmental purchases of excess supply
creates a new equilibrium
what is the danger of price support for consumers?
Some consumers pay a higher price, while others no longer buy the good
consumer surplus = - A - B
what is the W of price support for suppliers?
Producers are now selling a larger quantity Q2 instead of Q0, and at a higher price Ps
producer surplus: A + B + D
what is the L of price support for government?
The cost to the government (which is ultimately a cost to consumers) is D
it is (Q2 - Q1)Ps
what is the total change in welfare due to price support?
𝜟𝑪𝑺 + 𝜟𝑷𝑺 − 𝑪𝒐𝒔𝒕 𝒕𝒐 𝑮𝒐𝒗𝒕. = 𝑫−(𝑸𝟐−𝑸𝟏)𝑷𝒔
production quotas
supply restrictions
what is the deadweight loss with or without incentives of a production quota?
DWL = - B - C
in a production quota, what must happen so that incentives work?
it must be at least as large as B + C + D
what is the cost of a production quota to the government?
B + C + D
what is the change in consumer surplus due to production quotas?
- A - B
what would need to happen to avoid the deadweight loss to a production quota?
government should give suppliers the amount of A + B + C
output should not be controlled
and everyone wins
import quota
limit on the quantity of a good that can be imported
tariff
tax on an imported good
in a free market, is the domestic price the same as the work equilibrium price?
ye bruuuv
in a free market, is the demand of a certain small economy for a product the same as the world demand? what about the supply curve? what does the quota do then?
demand curve it is not the same
supply curve it is not the same
knowing that supply and demand curves in a small economy are not the same as in the world, what happens when imports are eliminated
it makes the small economy market reach an equilibrium, hence why the price increases
gains for producers is trapeze A
loss to consumers is A + B + C
deadweight loss is B + C
when is an economy considered small? so what if we impose Tarif?
small when it does not have any effect on world price
will not have effect on world price
what is the deadweight loss to society
import tarifs
triangles b + d
how do you find the Tarif imposed when looking at a graph
you look at the difference between new increased price and previous price (world price)
how are the gains for producers found with import tariff?
with the trapeze A
basically by how much the producer surplus increased
how are the losses for consumers found with import tariff?
trapeze A + two triangles of deadweight loss of B and C + the rectangle D in between the two triangles
basically, by how much the consumer surplus decreased
if a tariff is used, what does the rectangle D between the deadweight loss triangles represent?
the government gains
if a quota is used, what does the rectangle D between the deadweight loss triangles represent?
becomes part of the profits of foreign producers
it means deadweight loss now D + C + B
what is the effect of tax?
consumers pay more for a reduced quantity supplied
producers can’t supply as much
how do you calculate the revenue from tax?
the area of the rectangle created by the Quantity supplied and the size of the tax
how do you calculate the size of a tax imposed?
price consumers pay - price suppliers receive
by how much is the total surplus reduced when imposing tax?
surplus is reduced by triangles C and E
C + E is deadweight loss
basically, by the triangles in between the rectangle representing tax revenue and the normal equilibrium
specific tax
tax of a certain amount of money per unit sold
how much consumer surplus do consumers lose with tax?
the top part of the government revenue rectangle as well as the top deadweight triangle right next
how much producer surplus do producers lose with tax?
the bottom part of the government revenue rectangle as well as the bottom deadweight triangle right next
If demand is very inelastic relative to supply, on who does the burden of specific tax fall on the most?
the burden of the tax falls mostly on buyers
If demand is very elastic relative to supply, on who does the burden of specific tax fall on the most?
it falls mostly on sellers
what is the pass through formula? what do we use it for
we can calculate the percentage of the tax that is “passed through” to consumers
Es / (Es - Ed)
subsidy
payment reducing the buyer’s price below the seller’s price
can be thought of as a negative tax
how is the benefit of a subsidy split?
split between buyers and sellers
depends on the elasticities of supply and demand
what are the conditions needed for a subsidy to work?
QD = QD * (Pb)
QS = QS * (Ps)
QD = QS
Ps - Pb = S
S = subsidy
how does a subsidy affect the suppliers, consumers, and government
supplier surplus and consumer surplus increase
the government costs are the increases in surplus and the random triangle to the right
