SU Analisys of Competitive Market_ch9

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Copyright 2013 Pearson Education, Inc. Microeconomics Pindyck/Rubinfeld, 8e. 1 of 33

9.1 Evaluating the Gains andLosses from GovernmentPoliciesConsumer and

Producer Surplus9.2 The Efficiency of

Competitive Markets

9.3 Minimum Prices

C H A P T E R 9

Prepared by:

Fernando Quijano, Illustrator

The Analysis ofCompetitive Markets

CHAPTER OUTLINE


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2 of 33Copyright 2013 Pearson Education, Inc. Microeconomics Pindyck/Rubinfeld, 8e.

Evaluating the Gains and Losses

from Government Policies

Consumer and Producer Surplus

9.1

In this chapter, we return to supplydemand analysis and show how it can beapplied to a wide variety of economic problemsproblems that might concerna consumer faced with a purchasing decision, a firm faced with a long-rangeplanning problem, or a government agency that has to design a policy andevaluate its likely impact.

We begin by showing how consumer and producer surplus can be used tostudy the welfare effects of a government policyin other words, who gainsand who loses from the policy, and by how much.

We also use consumer and producer surplus to demonstrate the efficiency of acompetitive market.

You will see how to calculate the response of markets to changing economicconditions or government policies and to evaluate the resulting gains andlosses to consumers and producers.


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Review of Consumer and Producer Surplus

ConsumerAwould pay $10 for a goodwhose market price is $5 andtherefore enjoys a benefit of $5.

Consumer Benjoys a benefit of $2,

and Consumer C, who values thegood at exactly the market price,enjoys no benefit.

Consumer surplus, which measuresthe total benefit to all consumers, isthe yellow-shaded area between the

demand curve and the market price.

CONSUMER ANDPRODUCER SURPLUS

FIGURE 9.1 (1 OF 2)


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CONSUMER ANDPRODUCER SURPLUS

FIGURE 9.1 (2 of 2)

Producer surplus measures the totalprofits of producers, plus rents tofactor inputs.

It is the benefit that lower-cost

producers enjoy by selling at themarket price, shown by the green-shaded area between the supplycurve and the market price.

Together, consumer and producersurplus measure the welfare benefit of

a competitive market.


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Application of Consumer and Producer Surplus

CHANGE IN CONSUMER

AND PRODUCER SURPLUS

FROM PRICE CONTROLS

FIGURE 9.2

welfare effects Gains and losses to consumers and producers.

The price of a good has beenregulated to be no higher than Pmax,which is below the market-clearingprice P0.

The gain to consumers is thedifference between rectangleAand

triangle B.The loss to producers is the sum ofrectangleAand triangle C.

Triangles Band Ctogethermeasure the deadweight loss fromprice controls.

deadweight loss Net loss of total (consumer plus producer) surplus.


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Application of Consumer and Producer Surplus

EFFECT OF PRICE CONTROLS

WHEN DEMAND IS INELASTIC

FIGURE 9.3

If demand is sufficiently inelastic,

triangle Bcan be larger thanrectangleA. In this case,consumers suffer a net loss fromprice controls.


7/167 of 33Copyright 2013 Pearson Education, Inc. Microeconomics Pindyck/Rubinfeld, 8e.

EFFECTS OF NATURAL

GAS PRICE CONTROLS

FIGURE 9.4

EXAMPLE 9.1 PRICE CONTROLS AND NATURAL GAS SHORTAGES

Supply: QS= 15.90 + 0.72PG+ 0.05PO

Demand: QD= 0.02 1.8PG+ 0.69PO

The market-clearing price ofnatural gas was $6.40 permcf, and the (hypothetical)

maximum allowable price is$3.00.

A shortage of 29.1 20.6 =

8.5 Tcf results.

The gain to consumers isrectangleAminus triangleB,

and the loss to producers isrectangleAplus triangle C.

The deadweight loss is thesum of triangles Bplus C.



EFFECTS OF NATURAL

GAS PRICE CONTROLS

FIGURE 9.4 (supplement)

EXAMPLE 9.1 PRICE CONTROLS AND NATURAL GAS SHORTAGES

A = (20.6 billion mcf ) ($3.40/mcf) = $70.04 billionB = (1/2) x (2.4 billion mcf) ($1.33/mcf ) = $1.60 billionC = (1/2) x (2.4 billion mcf ) ($3.40/mcf ) = $4.08 billion

The annual change in consumer surplusthat would result from these hypotheticalprice controls would therefore beA B =70.04 1.60 = $68.44 billion.

The change in producer surplus wouldbe A C = 70.04 4.08 = $74.12billion.

And finally, the annual deadweight loss.would be B C = 1.60 4.08 =$5.68 billion.



The Efficiency of a Competitive Market9.2

MARKET FAILURE

economic efficiency Maximization of aggregate consumer andproducer surplus.

market failure Situation in which an unregulated competitive market isinefficient because prices fail to provide proper signals to consumers andproducers.

externality Action taken by either a producer or a consumer which affects

other producers or consumers but is not accounted for by the market price.

There are two important instances in which market failure can occur:

1. Externalities

2. Lack of Information

Market failure can also occur when consumers lack information about thequality or nature of a product and so cannot make utility-maximizing purchasingdecisions. Government intervention (e.g., requiring truth in labeling) may then

be desirable.



Review of Consumer and Producer Surplus

WELFARE LOSS WHEN PRICE ISHELD ABOVE MARKET-CLEARING

LEVEL

FIGURE 9.5

When price is regulated to be no lowerthan P2, only Q3will be demanded.

If Q3is produced, the deadweight loss

is given by triangles Band C.

At price P2, producers would like toproduce more than Q3. If they do, thedeadweight loss will be even larger.



EXAMPLE 8.2 THE MARKET FOR HUMAN KIDNEYS

Even at a price of zero (the effective price under the law),donors supply about 16,000 kidneys per year. It has beenestimated that 8000 more kidneys would be supplied if the price

were $20,000.

We can fit a linear supply curve to this datai.e., a supply curveof the form Q = a + bP. When P = 0, Q = 16,000, so a = 16,000.If P = $20,000, Q = 24,000, so b = (24,000 16,000)/20,000 =0.4.

Thus the supply curve is Supply: QS= 16,000 + 0.4P

Note that at a price of $20,000, the elasticity of supply is 0.33. Itis expected that at a price of $20,000, the number of kidneys

demanded would be 24,000 per year. Like supply, demand isrelatively price inelastic; a reasonable estimate for the priceelasticity of demand at the $20,000 price is 0.33. This impliesthe following linear demand curve:

Demand: QD= 32,000 0.4P



THE MARKET FOR KIDNEYS AND

THE EFFECT OF THE NATIONAL

ORGAN TRANSPLANTATION ACT

FIGURE 9.6

EXAMPLE 8.2 THE MARKET FOR HUMAN KIDNEYS

Economics, the dismal science, shows us that human organs have economicvalue that cannot be ignored, and prohibiting their sale imposes a cost onsociety that must be weighed against the benefits.

The market-clearing price is$20,000; at this price, about24,000 kidneys per year would besupplied.

The law effectively makes the price

zero. About 16,000 kidneys peryear are still donated; thisconstrained supply is shown as S.

The loss to suppliers is given byrectangle A and triangle C.

If consumers received kidneys at

no cost, their gain would be givenby rectangle A less triangle B.



PRICE MINIMUM

FIGURE 9.7

Minimum Prices9.3

The total change in consumer surplus is: CS = A BThe total change in producer surplus is: PS = A C D

Price is regulated to be no lower thanPmin.

Producers would like to supply Q2,

but consumers will buy only Q3.

If producers indeed produce Q2, theamount Q2 Q3 will go unsold andthe change in producer surplus willbeA C D. In this case, producersas a group may be worse off.



THE MINIMUM WAGE

FIGURE 9.8

Although the market-clearing wageis w0,

firms are not allowed to pay lessthan wmin.

This results in unemployment of anamount L2 L1

and a deadweight loss given bytriangles Band C.



EFFECT OF AIRLINE

REGULATION BY THE CIVIL

AERONAUTICS BOARD

FIGURE 9.9

EXAMPLE 8.2 AIRLINE REGULATION

Airline deregulation in 1981 led to major changes inthe industry. Some airlines merged or went out ofbusiness as new ones entered. Although prices fell

considerably (to the benefit of consumers), profitsoverall did not fall much.

At price Pmin, airlines would like tosupply Q2, well above the quantityQ1that consumers will buy.

Here they supply Q3. Trapezoid Disthe cost of unsold output.

Airline profits may have been loweras a result of regulation becausetriangle Cand trapezoid Dcantogether exceed rectangleA.

In addition, consumers loseA+ B.


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EXAMPLE 8.2 AIRLINE REGULATION

Because airlines have no control over oil prices, itis more informative to examine a corrected realcost index which removes the effects of changing

fuel costs.

TABLE 9.1 AIRLINE INDUSTRY DATA

1975 1980 1990 2000 2010

Number of U.S. carriers 36 63 70 94 63

Passenger Load Factor (%) 54.0 58.0 62.4 72.1 82.1

Passenger-Mile Rate (constant 1995 dollars) 0.218 0.210 0.149 0.118 0.094

Real Cost Index (1995 = 100) 101 145 119 89 148

Real Fuel Cost Index (1995 = 100) 249 300 163 125 342

Real Cost Index w/o Fuel Cost Increases (1995 = 100) 71 87 104 85 76

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SU Analisys of Competitive Market_ch9