Chapter 11 APPLIED COMPETITIVE ANALYSIS. Lee, Junqing Department of Economics, Nankai University CONTENTS Economic Efficiency and Welfare Analysis Price.
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Chapter 11
APPLIED COMPETITIVE ANALYSIS
Lee, Junqing Department of Economics , Nankai University
CONTENTS
Economic Efficiency and Welfare Analysis
Price Controls and ShortagesTax Incidence analysisGains from International Trade
Economic Efficiency and Welfare Analysis
Lee, Junqing Department of Economics , Nankai University
Economic Efficiency and Welfare Analysis
The area between the demand and the supply curve represents the sum of consumer and producer surplus measures the total additional value obtained by
market participants by being able to make market transactions
This area is maximized at the competitive market equilibrium
Lee, Junqing Department of Economics , Nankai University
Economic Efficiency and Welfare Analysis
Quantity
Price
P *
Q *
S
D
Consumer surplus is thearea above price and belowdemand
Producer surplus is thearea below price andabove supply
Lee, Junqing Department of Economics , Nankai University
At output Q1, total surpluswill be smaller
Economic Efficiency and Welfare Analysis
Quantity
Price
P *
Q *
S
D
Q1
At outputs between Q1 andQ*, demanders would valuean additional unit more thanit would cost suppliers toproduce
Lee, Junqing Department of Economics , Nankai University
Economic Efficiency and Welfare Analysis
Mathematically, we wish to maximize
consumer surplus + producer surplus =
Q Q
dQQPQUdQQPPQPQQU0 0
)()(])([])([
Maximizing total surplus with respect to Q yields
U’(Q) = P(Q) = AC = MC maximization occurs where the marginal value
of Q to the representative consumer is equal to market price : the market equilibrium
Price Controls and Shortages
Lee, Junqing Department of Economics , Nankai University
Price Controls and Shortages
Quantity
PriceSS
D
LS
P1
Q1
Initially, the market isin long-run equilibriumat P1, Q1
Demand increases to D’
D’
Lee, Junqing Department of Economics , Nankai University
Price Controls and Shortages
Quantity
PriceSS
D
LS
P1
Q1
D’
Firms would begin toenter the industry
In the short run, pricerises to P2
P2
In the long run ,The price would endup at P3
P3
Lee, Junqing Department of Economics , Nankai University
Price Controls and Shortages
Quantity
PriceSS
D
LS
P1
Q1
D’
P3
There will be a shortage equal toQ2 - Q1
Q2
Suppose that thegovernment imposesa price ceiling at P1
Lee, Junqing Department of Economics , Nankai University
This gain in consumersurplus is the shadedrectangle
Price Controls and Shortages
Quantity
PriceSS
D
LS
P1
Q1
D’
P3
Q2
Some buyers will gain because they can purchase the good for a lower price
Lee, Junqing Department of Economics , Nankai University
The shaded rectangletherefore represents apure transfer fromproducers to consumers
Price Controls and Shortages
Quantity
Price
D
P1
Q1
D’
SS
LSP3
Q2
The gain to consumers is also a loss to producers who now receive a lower price
No welfare loss there
Lee, Junqing Department of Economics , Nankai University
This shaded trianglerepresents the value of additional consumer surplus that would have been attained without the price control
Price Controls and Shortages
Quantity
PriceSS
D
LS
P1
Q1
D’
P3
Q2
Lee, Junqing Department of Economics , Nankai University
This shaded trianglerepresents the value of additional producer surplus that would have been attained without the price control
Price Controls and Shortages
Quantity
PriceSS
D
LS
P1
Q1
D’
P3
Q2
Lee, Junqing Department of Economics , Nankai University
This shaded arearepresents the total value of mutually beneficial transactions that are prevented by the government
Price Controls and Shortages
Quantity
PriceSS
D
LS
P1
Q1
D’
P3
Q2
This is a measure of the pure welfare costs of this policy
Tax Incidence analysis
Lee, Junqing Department of Economics , Nankai University
Tax Incidence
To discuss the effects of a per-unit tax (t), we need to make a distinction between the price paid by buyers (PD) and the price received by sellers (PS)
PD - PS = t
In terms of small price changes, we wish to examine
dPD - dPS = dt
Lee, Junqing Department of Economics , Nankai University
Tax Incidence
Maintenance of equilibrium in the market requires
dQD = dQS
or
DPdPD = SPdPS
Substituting, we get
DPdPD = SPdPS = SP(dPD - dt)
Lee, Junqing Department of Economics , Nankai University
Tax Incidence
We can now solve for the effect of the tax on PD:
SP
P P S D
D eS
S D
d
dt e
P
e
Similarly,
P D
P P S D
S D e
S D
d
dt e
P
e
Lee, Junqing Department of Economics , Nankai University
Tax Incidence
Because eD 0 and eS 0, dPD /dt 0 and dPS /dt 0
If demand is perfectly inelastic (eD = 0),
the per-unit tax is completely paid by demanders If demand is perfectly elastic (eD = ),
the per-unit tax is completely paid by suppliers
1
0
S
S D
D
S
D
S
D
dP
dt
dP
dt
e
e e
e
e e
0
1
S
S D
D
S
D
S
D
dP
dt
d
e
e e
e
e
P
t ed
Lee, Junqing Department of Economics , Nankai University
Tax Incidence
In general, the actor with the less elastic responses (in absolute value) will experience most of the price change caused by the tax
S
D
D
S
e
e
dtdP
dtdP
/
/
Lee, Junqing Department of Economics , Nankai University
Tax Incidence
Quantity
PriceS
D
P*
Q*
PD
PS
A per-unit tax creates awedge between the pricethat buyers pay (PD) andthe price that sellers receive (PS)
t
Q**
Lee, Junqing Department of Economics , Nankai University
Buyers incur a welfare lossequal to the shaded area
Tax Incidence
Quantity
PriceS
D
P*
Q*
PD
PS
Q**
But some of this loss goesto the government in theform of tax revenue
Lee, Junqing Department of Economics , Nankai University
Sellers also incur a welfareloss equal to the shaded area
Tax Incidence
Quantity
PriceS
D
P*
Q*
PD
PS
Q**
But some of this loss goesto the government in theform of tax revenue
Lee, Junqing Department of Economics , Nankai University
Therefore, this is the dead-weight loss from the tax
Tax Incidence
Quantity
PriceS
D
P*
Q*
PD
PS
Q**
Lee, Junqing Department of Economics , Nankai University
Deadweight Loss and Elasticity
All nonlump-sum taxes involve deadweight losses the size of the losses will depend on the
elasticities of supply and demand A linear approximation to the deadweight
loss accompanying a small tax, dt, is given by
DW = -0.5(dt)(dQ)
Lee, Junqing Department of Economics , Nankai University
Deadweight Loss and Elasticity
From the definition of elasticity, we know that
dQ = eDdPD Q0/P0
This implies that
dQ = eD [eS /(eS - eD)] dt Q0/P0
Substituting, we get2
0 00
0.5 [ /( )]D S S DDW ed
Qt
e ee PP
Lee, Junqing Department of Economics , Nankai University
Transactions Costs
Transactions costs can also create a wedge between the price the buyer pays and the price the seller receives (explicit and implicit) real estate agent fees;broker fees for the sale of
stocks Working on purchasing used car
Effects on the attributes of transactions Different tax base( quantity, quality, information ),
different way to cut transaction cost
Gains from International Trade
Lee, Junqing Department of Economics , Nankai University
Gains from International Trade
Quantity
Price
S
D
Q*
P*
•In the absence ofinternational trade,the domesticequilibrium price would be P* andthe domesticequilibrium quantitywould be Q*
Lee, Junqing Department of Economics , Nankai University
Gains from International Trade
Quantity
Price
Q*
P*
S
D
•Quantity demanded willrise to Q1 and quantitysupplied will fall to Q2
Q1Q2
•If the world price (PW)is less than the domesticprice, the price will fallto PW
PW
Imports = Q1 - Q2
imports
Lee, Junqing Department of Economics , Nankai University
•Consumer surplus rises
•Producer surplus falls
•There is an unambiguouswelfare gain
Gains from International Trade
Quantity
Price
Q*
P*
S
D
Q2Q1
PW
Lee, Junqing Department of Economics , Nankai University
Effects of a Tariff
Quantity
Price
S
D
Q1Q2
PW
•Quantity demanded fallsto Q3 and quantity suppliedrises to Q4
Q4 Q3
Suppose that the government•creates a tariff that raisesthe price to PR
PR
Imports are now Q3 - Q4
imports
Lee, Junqing Department of Economics , Nankai University
•Consumer surplus falls•Producer surplus rises
•These two triangles represent deadweight loss
•The government getstariff revenue
Effects of a Tariff
Quantity
Price
S
D
Q1Q2
PW
Q4 Q3
PR
Lee, Junqing Department of Economics , Nankai University
Quantitative Estimates of Deadweight Losses
Estimates of the sizes of the welfare loss triangle can be calculated
Because PR = (1+t)PW, the proportional change in quantity demanded is
DDW
WR teeP
PP
Q
1
13
Lee, Junqing Department of Economics , Nankai University
The areas of these twotriangles are
Quantitative Estimates of Deadweight Losses
Quantity
Price
S
D
Q1Q2
PW
Q4 Q3
PR
))((. 311 50 QQPPDW WR 2
11 0.5 WDtD eW P Q
))((. 242 50 QQPPDW WR 2
22 0.5 WStD eW P Q
Lee, Junqing Department of Economics , Nankai University
Other Trade Restrictions
A quota that limits imports to Q3 - Q4 would have effects that are similar to those for the tariff same decline in consumer surplus same increase in producer surplus
One big difference is that the quota does not give the government any tariff revenue Captured by owners of import licenses
Lee, Junqing Department of Economics , Nankai University
CONTENTS
Economic Efficiency and Welfare Analysis
Price Controls and ShortagesTax Incidence analysisGains from International Trade
Lee, Junqing Department of Economics , Nankai University
Important Points to Note:
The concepts of consumer and producer surplus provide useful ways of analyzing the effects of economic changes on the welfare of market participants changes in consumer surplus represent changes
in the overall utility consumers receive from consuming a particular good
changes in long-run producer surplus represent changes in the returns product inputs receive
Lee, Junqing Department of Economics , Nankai University
Important Points to Note:
Price controls involve both transfers between producers and consumers and losses of transactions that could benefit both consumers and producers
Lee, Junqing Department of Economics , Nankai University
Important Points to Note:
Tax incidence analysis concerns the determination of which economic actor ultimately bears the burden of a tax this incidence will fall mainly on the actors who
exhibit inelastic responses to price changes taxes also involve deadweight losses that
constitute an excess burden in addition to the burden imposed by the actual tax revenues collected
Lee, Junqing Department of Economics , Nankai University
Important Points to Note:
Transaction costs can sometimes be modeled as taxes both taxes and transaction costs may affect the
attributes of transactions depending on the basis on which the costs are incurred
Lee, Junqing Department of Economics , Nankai University
Important Points to Note:
Trade restrictions such as tariffs or quotas create transfers between consumers and producers and deadweight losses of economic welfare the effects of many types of trade restrictions
can be modeled as being equivalent to a per-unit tariff
Chapter 11
APPLIED COMPETITIVE ANALYSIS
END
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