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1、Chapter 9: The Analysis of Competitive MarketsCHAPTER 9THE ANALYSIS OF COMPETITIVE MARKETSTEACHING NOTESWith the exception of Chapter 1, Chapter 9 is the most straightforward and easily understood chapter in the text. The chapter begins with a review of consumer and producer surplus in section 9.1.
2、If you have postponed these topics, you should carefully explain the definition of each. Section 9.2 discusses the basic concept of efficiency in competitive markets by comparing competitive outcomes with those under market failure. A more detailed discussion of efficiency is presented in Chapter 16
3、. Sections 9.3 to 9.6 present examples of government policies that cause the market equilibrium to differ from the competitive, efficient equilibrium. The instructor can pick and choose among sections 9.3 to 9.6 depending on time constraints and personal preference. The presentation in each of these
4、 sections follows the same format: there is a general discussion of why market intervention leads to deadweight loss, followed by the presentation of an important policy example. Each section is discussed in one review question and applied in at least one exercise. Exercise (1) focuses on minimum wa
5、ges presented in Section 9.3. Exercises (4) and (5) reinforce discussion of price supports and production quotas from Section 9.4. The use of tariffs and quotas, presented in Section 9.5, can be found in Exercises (3), (6), (7), (8), (11), and (12). Taxes and subsidies (Section 9.6) are discussed in
6、 Exercises (2), (9), and (14). Exercise (10) reviews natural gas price controls in Example 9.1, a continuation of Example 2.7. Exercise (4) may be compared to Example 9.4 and discussed as an extension of Example 2.2.REVIEW QUESTIONS1. What is meant by deadweight loss? Why does a price ceiling usuall
7、y result in a deadweight loss?Deadweight loss refers to the benefits lost to either consumers or producers when markets do not operate efficiently. The term deadweight denotes that these are benefits unavailable to any party. A price ceiling will tend to result in a deadweight loss because at any pr
8、ice below the market equilibrium price, quantity supplied will be below the market equilibrium quantity supplied, resulting in a loss of surplus to producers. Consumers will purchase less than the market equilibrium quantity, resulting in a loss of surplus to consumers. Consumers will also purchase
9、less than the quantity they demand at the price set by the ceiling. The surplus lost by consumers and producers is not captured by either group, and surplus not captured by market participants is deadweight loss.2. Suppose the supply curve for a good is completely inelastic. If the government impose
10、d a price ceiling below the market-clearing level, would a deadweight loss result? Explain.When the supply curve is completely inelastic, the imposition of an effective price ceiling transfers all loss in producer surplus to consumers. Consumer surplus increases by the difference between the market-
11、clearing price and the price ceiling times the market-clearing quantity. Consumers capture all decreases in total revenue. Therefore, no deadweight loss occurs.3. How can a price ceiling make consumers better off? Under what conditions might it make them worse off?If the supply curve is perfectly in
12、elastic a price ceiling will increase consumer surplus. If the demand curve is inelastic, price controls may result in a net loss of consumer surplus because consumers willing to pay a higher price are unable to purchase the price-controlled good or service. The loss of consumer surplus is greater t
13、han the transfer of producer surplus to consumers. If demand is elastic (and supply is relatively inelastic) consumers in the aggregate will enjoy an increase in consumer surplus.4. Suppose the government regulates the price of a good to be no lower than some minimum level. Can such a minimum price
14、make producers as a whole worse off? Explain.Because a higher price increases revenue and decreases demand, some consumer surplus is transferred to producers but some producer revenue is lost because consumers purchase less. The problem with a price floor or minimum price is that it sends the wrong
15、signal to producers. Thinking that more should be produced as the price goes up, producers incur extra cost to produce more than what consumers are willing to purchase at these higher prices. These extra costs can overwhelm gains captured in increased revenues. Thus, unless all producers decrease pr
16、oduction, a minimum price can make producers as a whole worse off.5. How are production limits used in practice to raise the prices of the following goods or services: (a) taxi rides, (b) drinks in a restaurant or bar, (c) wheat or corn?Municipal authorities usually regulate the number of taxis thro
17、ugh the issuance of licenses. When the number of taxis is less than it would be without regulation, those taxis in the market may charge a higher-than-competitive price.State authorities usually regulate the number of liquor licenses. By requiring that any bar or restaurant that serves alcohol have
18、a liquor license and then limiting the number of licenses available, the State limits entry by new bars and restaurants. This limitation allows those establishments that have a license to charge a higher price for alcoholic beverages.Federal authorities usually regulate the number of acres of wheat
19、or corn in production by creating acreage limitation programs that give farmers financial incentives to leave some of their acreage idle. This reduces supply, driving up the price of wheat or corn.6. Suppose the government wants to increase farmers incomes. Why do price supports or acreage limitatio
20、n programs cost society more than simply giving farmers money?Price supports and acreage limitations cost society more than the dollar cost of these programs because the higher price that results in either case will reduce quantity demanded and hence consumer surplus, leading to a deadweight loss be
21、cause the farmer is not able to capture the lost surplus. Giving the farmers money does not result in any deadweight loss, but is merely a redistribution of surplus from one group to the other.7. Suppose the government wants to limit imports of a certain good. Is it preferable to use an import quota
22、 or a tariff? Why?Changes in domestic consumer and producer surpluses are the same under import quotas and tariffs. There will be a loss in (domestic) total surplus in either case. However, with a tariff, the government can collect revenue equal to the tariff times the quantity of imports and these
23、revenues can be redistributed in the domestic economy to offset the domestic deadweight loss by, for example, reducing taxes. Thus, there is less of a loss to the domestic society as a whole. With the import quota, foreign producers can capture the difference between the domestic and world price tim
24、es the quantity of imports. Therefore, with an import quota, there is a loss to the domestic society as a whole. If the national government is trying to increase welfare, it should use a tariff.8. The burden of a tax is shared by producers and consumers. Under what conditions will consumers pay most
25、 of the tax? Under what conditions will producers pay most of it? What determines the share of a subsidy that benefits consumers?The burden of a tax and the benefits of a subsidy depend on the elasticities of demand and supply. If the ratio of the elasticity of demand to the elasticity of supply is
26、small, the burden of the tax falls mainly on consumers. On the other hand, if the ratio of the elasticity of demand to the elasticity of supply is large, the burden of the tax falls mainly on producers. Similarly, the benefit of a subsidy accrues mostly to consumers (producers) if the ratio of the e
27、lasticity of demand to the elasticity of supply is small (large).9. Why does a tax create a deadweight loss? What determines the size of this loss?A tax creates deadweight loss by artificially increasing price above the free market level, thus reducing the equilibrium quantity. This reduction in dem
28、and reduces consumer as well as producer surplus. The size of the deadweight loss depends on the elasticities of supply and demand. As the elasticity of demand increases and the elasticity of supply decreases, i.e., as supply becomes more inelastic, the deadweight loss becomes larger.EXERCISES1. In
29、1996, the U.S. Congress raised the minimum wage from $4.25 per hour to $5.15 per hour. Some people suggested that a government subsidy could help employers finance the higher wage. This exercise examines the economics of a minimum wage and wage subsidies. Suppose the supply of low-skilled labor is g
30、iven by, where LS is the quantity of low-skilled labor (in millions of persons employed each year) and w is the wage rate (in dollars per hour). The demand for labor is given by.a. What will the free market wage rate and employment level be? Suppose the government sets a minimum wage of $5 per hour.
31、 How many people would then be employed?In a free-market equilibrium, LS = LD. Solving yields w = $4 and LS = LD = 40. If the minimum wage is $5, then LS = 50 and LD = 30. The number of people employed will be given by the labor demand, so employers will hire 30 million workers. Figure 9.1.ab. Suppo
32、se that instead of a minimum wage, the government pays a subsidy of $1 per hour for each employee. What will the total level of employment be now? What will the equilibrium wage rate be? Let w denote the wage received by the employee. Then the employer receiving the $1 subsidy per worker hour only p
33、ays w-1 for each worker hour. As shown in Figure 9.1.b, the labor demand curve shifts to:LD = 80 - 10 (w-1) = 90 - 10w,where w represents the wage received by the employee.The new equilibrium will be given by the intersection of the old supply curve with the new demand curve, and therefore, 90-10W*
34、= 10W*, or w* = $4.5 per hour and L* = 10(4.5) = 45 million persons employed. The real cost to the employer is $3.5 per hour. Figure 9.1.b2. Suppose the market for widgets can be described by the following equations:Demand: P = 10 - QSupply: P = Q - 4where P is the price in dollars per unit and Q is
35、 the quantity in thousands of units.a.What is the equilibrium price and quantity?To find the equilibrium price and quantity, equate supply and demand and solve for QEQ:10 - Q = Q - 4, or QEQ = 7.Substitute QEQ into either the demand equation or the supply equation to obtain PEQ.PEQ = 10 - 7 = 3,orPE
36、Q = 7 - 4 = 3.b.Suppose the government imposes a tax of $1 per unit to reduce widget consumption and raise government revenues. What will the new equilibrium quantity be? What price will the buyer pay? What amount per unit will the seller receive?With the imposition of a $1.00 tax per unit, the dema
37、nd curve for widgets shifts inward. At each price, the consumer wishes to buy less. Algebraically, the new demand function is:P = 9 - Q.The new equilibrium quantity is found in the same way as in (2a):9 - Q = Q - 4, or Q* = 6.5.To determine the price the buyer pays, , substitute Q* into the demand e
38、quation: = 10 - 6.5 = $3.50.To determine the price the seller receives, , substitute Q* into the supply equation: = 6.5 - 4 = $2.50.c.Suppose the government has a change of heart about the importance of widgets to the happiness of the American public. The tax is removed and a subsidy of $1 per unit
39、is granted to widget producers. What will the equilibrium quantity be? What price will the buyer pay? What amount per unit (including the subsidy) will the seller receive? What will be the total cost to the government?The original supply curve for widgets was P = Q - 4. With a subsidy of $1.00 to wi
40、dget producers, the supply curve for widgets shifts outward. Remember that the supply curve for a firm is its marginal cost curve. With a subsidy, the marginal cost curve shifts down by the amount of the subsidy. The new supply function is:P = Q - 5.To obtain the new equilibrium quantity, set the ne
41、w supply curve equal to the demand curve:Q - 5 = 10 - Q, or Q = 7.5.The buyer pays P = $2.50, and the seller receives that price plus the subsidy, i.e., $3.50. With quantity of 7,500 and a subsidy of $1.00, the total cost of the subsidy to the government will be $7,500.3. Japanese rice producers hav
42、e extremely high production costs, in part due to the high opportunity cost of land and to their inability to take advantage of economies of large-scale production. Analyze two policies intended to maintain Japanese rice production: (1) a per-pound subsidy to farmers for each pound of rice produced,
43、 or (2) a per-pound tariff on imported rice. Illustrate with supply-and-demand diagrams the equilibrium price and quantity, domestic rice production, government revenue or deficit, and deadweight loss from each policy. Which policy is the Japanese government likely to prefer? Which policy are Japane
44、se farmers likely to prefer?Figure 9.3.a shows the gains and losses from a per-pound subsidy with domestic supply, S, and domestic demand, D. PS is the subsidized price, PB is the price paid by the buyers, and PEQ is the equilibrium price without the subsidy, assuming no imports. With the subsidy, b
45、uyers demand Q1. Farmers gain amounts equivalent to areas A and B. This is the increase in producer surplus. Consumers gain areas C and F. This is the increase in consumer surplus. Deadweight loss is equal to the area E. The government pays a subsidy equal to areas A + B + C + F + E.Figure 9.3.b sho
46、ws the gains and losses from a per-pound tariff. PW is the world price, and PEQ is the equilibrium price. With the tariff, assumed to be equal to PEQ - PW, buyers demand QT, farmers supply QD, and QT - QD is imported. Farmers gain a surplus equivalent to area A. Consumers lose areas A, B, C; this is
47、 the decrease in consumer surplus. Deadweight loss is equal to the areas B and C.Figure 9.3.aFigure 9.3.bWithout more information regarding the size of the subsidy and the tariff, and the specific equations for supply and demand, it seems sensible to assume that the Japanese government would avoid p
48、aying subsidies by choosing a tariff, but the rice farmers would prefer the subsidy.4. In 1983, the Reagan Administration introduced a new agricultural program called the Payment-in-Kind Program. To see how the program worked, lets consider the wheat market.a.Suppose the demand function is QD = 28 - 2P and the supply function is QS = 4 + 4P, where P is the price of wheat in dollars per bushel and Q is the quantity in billions of bushels. Find the free-market equilibrium price and quantity.Equating demand and supply, QD = QS,28 - 2P = 4 + 4P, or P = 4.To determine the equilibrium quantit
