Principles of Economics Week 2

Covers surplus, welfare, government controls, and externalities

Collective Welfare

well-being of buyers and sellers in the market of a specific good.

Goal of the market

to maximize collective welfare

when is the market at max. collective welfare

at equilibrium, there is no surplus on either side (prod or con)

Consumer Surplus

what buyers are willing to pay (WTP) - what they actually paid (P*)

Producer Surplus

how much a seller is paid (P*) - what price they were willing to sell at

Total Surplus

Consumer Surplus + Producer Surplus

When WTP is [above or below] market price

above: sale

below: no sale

When cost to producers is [above, below, at] P*

above: no sale, cost to producer is greater than price receiver

below or at: producer will sell

Expanded Total Surplus Equation

TS= (WTP-P*) + (P*-WTS)

Goals of Producers and Consumers (2)

Goal of consumers is to receive high value

Goal of producers is to receive low cost

State of efficiency

Total surplus is maximized, collective welfare is as high as it can possibly be

The supply curve shows:

the minimum price that a producer will accept, at any price above that the producer is happy to sell!

The demand curve shows:

The maximum price a consumer will pay, any price below that the consumer is happy to buy!

Effect of Taxes

Drives up the cost of a good without any benefit to producers or consumers

Tax Price for Consumers, P_c

P_c= P_p+ t (Price Paid + Tax)

Buyers receive a higher price

Tax Price for producers (P_p)

P_p= P_c- T (Consumer Price - Tax)

Sellers receive a lower price (think about change in q)

Three rules of taxes

Q_tax < Q_equilibrium

P_consumers > P_equilibrium

P_producers < P_equilibrium

Loss in total surplus

Tax Revenue + Deadweight loss

Burden of Taxes (elasticity) (2)

Falls on the curve with less elasticity (greater inelasticity)

the side that is less resistant to price change will shoulder more of the burden.

Subsidies (3)

Gov provides incentives for a good

results in an overproduction

buyers can buy at a lower price

Subsidies effect on supply and demand

Subsidies create an excess consumer and producer surplus

Rule for Subsidies (3)

Q_subsidy> Q_equilibrium

P_consumer < P_equilibrium

P_producer > P_equilibrium

Price Floors effect (2)

Price floors create an excess on supply, or surplus

Buyers don’t want to buy at a higher $, but sellers want to sell

Price ceilings effect

Price ceilings create an excess demand, or shortage

Buyers want to buy at a lower $, sellers don’t want to sell