Understanding Competitive Models in Economics

1. CDAE 254 - Class 28 Dec 7 Last class: 9. Applying the competitive models Quiz 8 (Chapters 7 and 8) Quiz 9 (optional and take home, due 12:00noon, Friday, Dec. 8 ) Today: 9. Applying the competitive models Review for the final exam Reading: Chapter 9 Important dates: Final exam: 12:00-3:00pm, Tuesday, Dec. 12, Lafayette L403 3:30 – 6:30pm, Friday, Dec. 15, our classroom

2. 9. Applying the competitive model 9.1. Consumer and producer surplus 9.2. Impact of price interventions 9.3. Tax incidence analysis 9.4. Trade restrictions 9.5. Applications

3. 9.1. Consumer and producer surplus (1) Consumer surplus (review) (2) Producer surplus

4. 9.1. Consumer and producer surplus (3) Economic efficiency (Fig. 9.1.) The sum of producer surplus and consumer surplus is at the maximum when the market is at equilibrium. (4) How to estimate consumer & producer surplus? e.g., QD = 10 - P and QS = 0.5 P - 2 At the equilibrium: Q* = 2 and P* = 8 Consumer surplus = 0.5 x 2 x 2 = 2 Producer surplus = 0.5 x 4 x 2 = 4 What will be the change in CS and PS if Q is restricted to be 1.5 units by a quota? If the government wants to reduce Q to 1.5 units by a sales tax, what should be the tax rate per unit?

5. 9.2. Impact of price interventions (1) Price interventions: (2) Impacts of a price ceiling -- If the ceiling price is above the equ. price -- If the ceiling price is below the equ. price Quantity Price Consumer surplus Producer surplus Efficiency -- Examples:

6. 9.2. Impact of price interventions (3) Impacts of a price floor -- If the floor price is below the equilibrium price -- If the floor price is above the equ. price Quantity Price Consumer surplus Producer surplus Efficiency -- Examples

7. 9.3. Tax incidence (1) Tax incidence theory: The study of the final burden of a tax after considering all market reactions to it. (2) Graphical analysis -- A general analysis -- Importance of demand and supply elasticities -- who will share more of a tax? -- If demand is relatively more elastic, consumers will share relatively less of a tax. -- If supply is relatively more elastic, producers will share relatively less of a tax.

8. 9.3. Tax incidence (3) Mathematical analysis Supply: Qs = -4 + 0.5P Demand: Qd = 20 - 1P (a) Market equilibrium: Q* = P* = CS = PS = CS + PS = (b) Impacts of a tax of $1.5 per unit Q** = Pc = Pp = New CS = New PS = Tax revenue = Changes in CS = Change in PS = Change in efficiency (deadweight loss) =

9. Take home exercise Suppose a market has the following supply & demand: Supply: Qs = -3 + 1.5P Demand: Qd = 22 - 1P (a) Market equilibrium without any tax: Q* = P* = CS = PS = CS + PS = (b) Impacts of a tax of $2.5 per unit Q** = Pc = Pp = New CS = New PS = Tax revenue = Changes in CS = Change in PS = Change in (CS+PS) =

10. 9.4. Trade restrictions (1) Trade between two countries (2) Excess supply and excess demand (3) Impact of international trade Importer Exporter Domestic supply   Domestic demand   Domestic price   Consumer surplus (CS)   Producer surplus (PS)   Sum of CS and PS  

11. 9.4. Trade restrictions (4) Impact of trade restrictions (e.g., import tax) (compared to free trade) Importer Exporter Domestic supply  Domestic demand  Domestic price  Consumer surplus (CS)  Producer surplus (PS)  Tax revenue (T)  Sum of CS, PS and T 

12. CDAE 254 Final Exam 1. What will be covered in the exam? 2. What will be the format? 3. What are the study materials and practice problems? 4. What do you need to bring to the exam? 5. Suggestions

13. CDAE 254 Final Exam 1. What will be covered in the exam? Approximate distribution: Chapter 5 20 -- 25% Chapter 6 20 -- 2540% Chapter 7 20 -- 25% Chapter 8 Chapter 9

14. CDAE 254 Final Exam 2. What will be the format? -- Multiple-choice questions 40 -- 50% -- Short-answer questions 20 -- 25% -- Problems 20 -- 25% -- Graphical analysis 10 -- 15%

15. CDAE 254 Final Exam 3. What are the study materials and practice problems? Quiz 6 and Quiz 7 Practice quiz of Chapter 8 Class exercises Class examples Lecture note handout (class 20 – class 26) Problem set 6 Reading package (textbook)

16. CDAE 254 Final Exam 4. What do you need to bring to the exam? -- Your calculator -- A ruler will be helpful -- No formula sheet is needed

17. CDAE 254 Final Exam 5. Suggestions -- Understand each question in each quiz -- Go over class examples and exercises -- Read each question carefully and answer it directly -- Study hardand be confident! ……

18. Practice quiz of Chapter 8 • 1. If a small firm’s total cost function is TC = 20 + 10 Q - 0.5 Q2 and the market price is P = 6, how many units should the firm produce? • If a firm’s supply increased from 60 to 69 units when the market price increased from $2 to • $2.4 per unit, what is the supply elasticity? • 3. If a firm’s supply elasticity is 0.5 and the firm’s supply is 500 kg when the price is $10/kg, • what will be the firm’s supply when the market price drops to $9 per unit? . • 4. A company is expected to shut down when the price is below its average variable cost, • why are many firms like some steel firms in the U.S. still in the market even when the • prices of their products are significantly below their average variable costs? • 5. Suppose a firm’s SMC = -2 + 0.5 q and the market price (P) is always greater than the • short-run average variable cost, what is the firm’s supply function (q as a function of P)? • 6. For the DVD player market, the market supply has increased significantly and the market • price has decreased significantly in the past 10 years. What are the possible factors for • this “negative” relation between supply and price?

19. Practice quiz of Chapter 8 • Suppose there are only two firms in a market with the following supply functions: • Firm A: qa = -2 + 0.5 P • Firm B: qb = -3 + 0.8 P • (a) Draw the supply curves of Firm A, Firm B and the market • (b) What will be the total supply in the market when the market price is P=$10