Supply, Demand, and Government Policies

Chapter 6: Supply, Demand, and Government Policies

• A price ceiling is a legal maximum on the price at which a good can be sold.
• A price floor is a legal minimum on the price at which a good can be sold.
• Tax incidence refers to how the burden of a tax is shared among market participants.

Price Ceilings

• A price ceiling is a maximum price at which a product can be legally sold.
• If a price ceiling is set above the equilibrium price, it is considered non-binding and has no impact on the market's outcome.
• A price ceiling set below the equilibrium price makes any price above it illegal.
• A binding price ceiling leads to a shortage, causing the price to be lower than the equilibrium price, specifically at $500.
• At a price of $500, the quantity demanded is 400, while the quantity supplied is 250, indicating a shortage.

Price Floors

• A price floor is a minimum price at which a good or service can be sold.
• A price floor below the equilibrium price is non-binding and does not affect the market.
• An equilibrium wage of $7 is below a price floor of $7, making it illegal.
• A binding price floor cause a surplus
• If the wage set at $9.25, the quantity of labor demanded is 400, while the quantity supplied is 550, resulting in unemployment.

Tax Incidence

• Levying a tax impacts both price (P) and quantity (Q), with tax incidence remaining consistent irrespective of whether the tax is imposed on buyers or sellers.
• Taxes create a gap between the price buyers pay and what sellers receive.
• When supply is inelastic and demand is elastic, sellers bear a larger portion of the tax burden.
• A tax burden falls more heavily on the side of the market that is less elastic.

Efficiency of Markets

• Willingness to pay (WTP) represents the maximum amount a buyer will spend on a good or service and reflects the value the buyer places on it.
• Consumer surplus (CS) is calculated as WTP minus the actual price (P).
• Lower prices result in increased consumer surplus.
• If the price is $320, Fatima's CS is $80 and Alexis' CS is $30, making the total CS $110.
• Consumer surplus is the area below the demand curve and above the price level.
• The area of the consumer surplus triangle = 1/2 x base x height
• With a price of $30 and quantity demanded being 15, and area above the triangle being $30, the consumer surplus is $225.
• Higher prices reduce consumer surplus.
• When prices increase there will be fewer buyers and a lower CS.

Producer Surplus

• Cost indicates the value a seller must give up to produce a good, therefore including also opportunity cost.
• Willingness to sell (WTS) is equal to the cost, representing the lowest price a seller will accept.
• A seller produces and sells only if the price is greater than the cost.
• Producer surplus is the area above the supply curve and below the price.
• PS = 1/2 x base x height in a graphical representation
• If the height is 40 and h = 30, the producer surplus = $312.50
• Lower prices reduce producer surplus.
• There will be fewer buyers when prices decrease, and PS will fall.

Evaluating the Market Equilibrium

• Market equilibrium occurs where P = $30 and Q = 15.
• Total surplus (TS) is the sum of consumer surplus (CS) and producer surplus (PS).

The Effects of Taxation

• Analysis for the effects of a tax must happen with a constant market.
• The analysis of the with trade will also have these values, DWL and tac revenue to consider.
• Deadweight loss (DWL) of a tax represents the reduction in total surplus due to market distortion.
• The tax reduces total producer surplus by C + E.
• Elasticity of supply and demand impact DWL with a tax.
• The more elastic the supply, the greater the DWL.
• The more elastic the demand, the greater the DWL.

International Trade

• PW is the world price.
• PD is the domestic price without trade.
• If PD < PW, the domestic country has comparative advantage and exports the good.
• If PD > PW, the domestic country does not have comparative advantage and imports the good.
• Exports of goods lead to higher domestic prices
• Free trade may lead to domestic consumers demand of QD = 1,600 instead of the regular QD = 2,000
• Exports can be calculated with the equation: Exports = Quantity Supplied - Quantity Demanded.
• If a country has $900PW, exports might be 2,700 − 1,600 = 1,100 pineapple tons

Welfare Analysis for International Trade

• Without trade, there is CS = A + B and PS = C
• Total surplus = A+B+C
• With trade the CS = A and PS = B+C+D
• The area represents the welfare effect for a state, either gained or lost.
• Regardless of the area, whenever a good is either imaprted or exported, the trade creates winners and losers.

Import Tarrifs Example

• When Brazil imposes a tariff on imports, it reduces free trades of $2500 as the tariff is $300/ton
• The quantity of cocoa beans is now QD = 200 and the quantity for QS is 150
• The market might now have P = $2800 and The market can now import imports = 50 due to tariff.
• Deadweight loss (DWL) results from tariffs.

Externalities

• An externality is the effect of a person's actions on the well-being of a bystander, for which no compensation is paid.
• A negative externality is considered one type of market failure
• A negative externality has an adverse impact on a bystander.
• A positive externality is beneficial to the bystander.
• Market equilibrium is not efficient as buyers and sellers do not consider the external effects of their actions.
• Government action can improve upon market outcomes.
• Market efficiency is affected as policy makers sometimes fail to allocate resources efficiently.

Analysis of Externalities

• If the social value falls below the equilibrium.
• Negative production externalities in the paper market lead the social optimum (Q = 20) to be less than the market equilibrium (Q = 25).
• Positive externality the market equilibrium (Q = 20) is lower than the social optimum (Q = 25).
• A correction is to shift the demand curve up by $10 thru subsidizing buyers by that amount (external benefit).

Public Policies Towards Externalities

• The 1st approach to dealing with externalities is Command-and-Control, which is achieved thru certain regulations.
• Regulating certain behaviors is not always desired by civilians, because all will not agree.
• It is is impossible to prohibit all polluting activity.
• "Dictate a maximum level of pollution" is a common regulation.
• Regulation is also achieved thru "Require that firms adopt a particular technology to reduce emissions"
• The 2nd approach is Market-based policies, which aims to align private incentives with social efficiency.
• Alighment is normally achieved thru one of two avenues

1. Corrective taxes and subsidies
2. Tradable pollution permits

• Corrective taxes and subsidies have values and need to be calculated correctly.

Chapter 11: Public Goods and Common Resources

• Excludability means that people can be prevented from using a good.
• Rivalry in consumption signifies that one person's use reduces another's ability to use it.

Types of Goods

• Private goods are excludable and rival in consumption (e.g., pizza).
• Public goods are not excludable and not rival in consumption (e.g., national defense).
• Common resources are not excludable but are rival in consumption (e.g., deer in the forest).
• Club goods are excludable but not rival in consumption (e.g., cable TV).

Public Goods and Free Riders

• A free rider is someone who benefits from a public good without paying for it.
• The free-rider problem arises, because public goods are not excludable, giving people an incentive to be free riders.
• The free-rider problem prevents the private market from supplying public goods, leading to market failure.

Chapter 14: The Costs of Production

• The primary assumption is that the firm's goal is to optimize profits.
• Total Revenue (TR) = Price × Quantity, the revenue a firm nets from the sale of its output.
• Profit equals Total Revenue minus Total Cost.
• Total cost consists of a market's cost multiplied by inputs.

Opportunity Costs

• "The cost of something is what you give up to get it.”
• Explicit costs require an outlay of money (e.g., wages).
• Implicit costs do not require an outlay of money (e.g., opportunity cost of the owner’s time).
• Total cost = Explicit + Implicit Costs
• Economic profit is total revenue minus total costs.
• Because accounting profit ignores implicit costs, accounting profit is greater than economic profit.

Marginal Product

• Marginal product is the rise in output from an additional unit of input.
• The slope and function of the function dictates product.
• MPL = AQ / AL dictates if the marginal product of labor.
• Diminishing marginal product means the the quantity increases inversely to the input.
• Production function gets flatter as more inputs are being used with slope.

Cost Measurement

• "Rational people think at the margin.”
• Hiring each worker provides output by MPL
• Each worker increases cost with the wage paid.
• The total for all values is dictated by the function TC = FC + VC as producing all measurements cost.
• There is a constant variance that is dictated with "Do not vary with the quantity of output produced"
• Some production must even happen even if production is is zero.
• Other factors relate inversely as "Vary with the quantity of output produced"

Average and Marginal Cost

• Average fixed cost, AFC = FC / Q has an inverse effect
• Average variable cost, AVC = VC / Q = Direct relationship
• Average total cost, ATC = TC / Q = AFC + AVC must be even
• Must be the cost of a typical unit produced.
• Total cost is divided by quantity output.
• Marginal cost, MC = ∆TC / ∆Q - The increase in total cost