Consumer and Producer Surplus HOW MUCH DO CONSUMERS AND PRODUCERS BENEFIT FROM AN EXCHANGE?

Consumer and Producer Surplus HOW MUCH DO CONSUMERS AND PRODUCERS BENEFIT FROM AN EXCHANGE?

How much do consumers and producers benefit from an exchange? Consumer Surplus is the difference between what you are willing to pay and what you actually pay. CS = Buyer s Maximum Price Darren and Edwina are not willing If a person s maximum price is less than the market price, he or she will not buy and will gain no consumer surplus.

Consumer Surplus - the area below the demand curve and above the price. Price $10 Cons umer Surplus $5 What is paid D $0 50 100 150 Quantity

Change in Consumer Surplus: Price Increase Price New Consumer Surplus Original Consumer Surplus P 1 P o Los s in Surplus: Consumers paying more Loss in Surplus: Consumers buying less D Q 1 Q o Quantity

Producer s Surplus is the difference between the price the seller received and the cost of producing the good. PS = Price Production Cost Donna and Engelbert s prod costs are too high

Producer Surplus - the area above the supply curve and below the price. Price S Producer Surplus P o What is paid Minimum Amount Needed to Supply Q o Q o Quantity

Efficiency - allocation that results in the maximization the total surplus (TS = CS + PS). Both consumers and producers can not increase their welfare without making each other worse off. Price P o Total Surplus = CS + PS Consumer Surplus Producer Surplus D S Free markets allocate the supply of goods to the buyers who value them most highly. the demand for goods to the sellers who can produce them at least cost. Q o Quantity A competitive free market maximizes total surplus!

Consumer and Producer Surplus P $10 S 8 6 $5 4 Calculate the area of: 1. Consumer Surplus 2. Producer Surplus 3. Total Surplus 2 1 2 4 6 8 10 D Q

Consumer and Producer Surplus P $10 S 8 6 $5 4 CS PS 1. CS= $25 2. PS= $20 3. Total= $45 2 1 2 4 6 8 10 D Q

GOVERNMENT INTERVENTION AND MARKET OUTCOMES

Government Intervention PRICE CONTROLS: CEILINGS AND FLOORS

Should the government place a price ceiling (maximum price) to make housing more affordable?

The Market for Apartments Rental price of apts $3500 P S What price should the price ceiling be set at? $2800 $2500 300 D Q Quantity of apartments

How Price Ceilings Affect Market Outcomes A price ceiling above the equilibrium price is not binding it has no effect on the market outcome. $3500 $2800 P S Price ceiling 300 D Q

How Price Ceilings Affect Market Outcomes The price ceiling must below the market price to be effective. $2800 P S A PC of $2500 would actually make housing more affordable. $2500 250 400 D Price ceiling Q

How Price Ceilings Affect Market Outcomes What is the unintended consequence of this price ceiling? P S $2800 What happens to the quality of apartments that remain on the market? $2500 shortage 250 400 300 D Price ceiling Q

Price Ceiling Government imposes a maximum price less than P e. Generally on essential items that have a very high market equilibrium price. ex. housing rent control This generates a shortage (Q d > Q s ). The market mechanism cannot clear the market. A permanent shortage exists. P P e Price ceiling Q s Q e S Shortage Q d D Q

Shortages and Rationing With a shortage, sellers must ration the goods among buyers. Some rationing mechanisms: (1) long lines (2) discrimination according to sellers biases These mechanisms are often unfair, and inefficient: the goods don t necessarily go to the buyers who value them most highly. In contrast, when prices are not controlled, the rationing mechanism is efficient (the goods go to the buyers that value them most highly) and impersonal (and thus fair).

How Price Ceilings Affect Market Outcomes How many apartments would have been rented if there was no price ceiling? 300 How many apartments are rented with this price ceiling? P $2800 $2500 S 250 400 300 D Price ceiling Q 250 only 250 can be rented if only 250 are supplied

How Price Ceilings Affect Market Outcomes This price ceiling caused a loss of trades. $2800 P S $2500 Price ceiling MISSED OPPORTUNITIES!!! 250 400 300 D Q

How Price Ceilings Affect Market Outcomes There is a loss of TS (CS & PS) P S deadweight loss value of transactions that could have been made, but are not made. $2800 $2500 DWL Price ceiling CS increases at the expense of PS 250 400 300 D Q

Loss in Efficiency Too Low of Price (Price Ceiling) Price New Consumer Surplus Lost Consumer Surplus S Deadweight Loss P o Los t Producer Surplus New Producer Surplus P C D QC Q o Quantity

Price Floor Government imposes a minimum price greater than P e. Generally on essential items that have a very low market equilibrium price ex. agricultural price supports, minimum wage This generates a surplus (Q s > Q d ). Price floor P P e Surplus S The market mechanism cannot clear the market. D A permanent surplus exists. Q d Q e Q s Q

Minimum Wage Should the government raise the federal minimum wage to $10?

How Price Floors Affect Market Outcomes The floor is a binding constraint on the wage, and causes a surplus of labor (unemployment). W $5 $4 labor surplus S Price floor 400 550 500 D L

The Minimum Wage Min wage laws do not affect highly skilled workers. They do affect teen workers. $5 $4 W unemployment S Min. wage WHY? Studies: A 10% increase in the min wage raises teen unemployment by 1-3%. 400 550 D L

How Price Floors Affect Market Outcomes Surplus of how many workers? # of loss trades? W $5 labor surplus S Price floor DWL? $4 PS? CS? 400 550 500 D L

Loss in Efficiency Too High of Price (Price Floor) Price New Consumer Surplus Lost Consumer Surplus S Deadweight Loss P F P o Los t Producer Surplus New Producer Surplus D QF Q o Quantity

What are the effects of price controls? Persistent shortages/surpluses A loss of gains from trades (DWL) Reduction in quality or inefficiently high quality Misallocation of resources The person that needs the good may not end up getting it. Wasted time, effort and resources Emergence of black markets WHY? Price controls take away incentives that would otherwise regulate markets.

Prices efficiently allocate resources. Resources will only be used for only the most valuable purposes. Prices as Signals and Incentives Prices tell consumers and suppliers how to adjust. High prices are an incentive to suppliers to supply more. Low prices tell producers that a good is being over produced. Low prices to consumers signal to buy more of a good. A high price is a sign to stop and think carefully before buying.

Government Intervention TRADE TARIFFS Purpose: To protect domestic producers from a cheaper world price. To prevent domestic unemployment.

International Trade and Quotas Identify the following: 1. Equilibrium P & Q 2. CS with no trade 3. PS with no trade With Trade (World Price) 4. Quantity of imported grain? Q5 Q1 This graphs show the domestic supply and demand for grain. The letters represent area. With Tariff (PT) 5. Domestic production 6. Domestic consumption 7. CS Loss of LMNRS to tax 8. PS Gains L since the price increased Will produce at Q2. Change = Q2-Q1 Will consume at Q4. Change = Q4-Q5

= Q3 Q1. US production drops to Q1 but QD rises Q3

Government Intervention QUANTITY CONTROLS THE GOVERNMENT REGU LATES THE QU AN TITY OF A GOOD THAT C AN BE BOU GHT AN D SOL D RATHER THAN REGU L ATING THE PRI C E. Licenses Import quotas

International Trade and Quotas At the PW, what is CS and PS? If the government sets a quota on imports of Q 2, what happens to CS? (at Pw) This graphs show the domestic supply and demand for grain. The letters represent area. DEADWEIGHT LOSS Lost CS. INEFFICIENT!