Lecture # 15 Competitive Markets: Applications Lecturer: Martin Paredes

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 Q1 Q*

11. Example: Deadweight Loss P Supply A Pd C B P* D Demand Q Q1 Q*

12. Example: Deadweight Loss P Supply A Pd C B P* Ps D Demand Q Q1 Q*

13. Example: Deadweight Loss P Supply A Pd : Deadweight Loss C B P* Ps D Demand Q Q1 Q*

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.

17. 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.

27. 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.

28. 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 Qd Q*

31. Example: Price Floors P S PMIN P* D Q Qd Q* Qs

32. Example: Price Floors P S PMIN P* Qs – Qd : ExcessSupply D Q Qd Q* Qs

33. Example: Price Floors P S : Consumer Surplus PMIN P* D Q Qd Q* Qs

34. Example: Price Floors P S : Consumer Surplus PMIN : Producer Surplus P* D Q Qd Q* Qs

35. Example: Price Floors P S : Consumer Surplus PMIN : Producer Surplus P* : Deadweight Loss D Q Qd Q* 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.

37. 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?

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

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

44. 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.

46. 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

49. Example: Subsidies P S S’ = S – T T P* Pd D Q Q* Q2

50. Example: Subsidies P S S’ = S – T T Ps P* Pd D Q Q* Q2