Competitive Markets – Government Intervention (Quick-Review Notes)
Page 1
• Reference text: Besanko & Braeutigam, Microeconomics (6e), Ch. 10.1, 10.2, 10.5
Page 2 – Learning Objectives
- Excise taxes & subsidies to producers
- Price ceilings & price floors
- Import tariffs & quotas
Page 3 – Learning Objective 1
• Analyse excise taxes & producer subsidies in perfectly competitive markets.
Page 4 – Economic Efficiency
• Total surplus maximised ⇒ efficient allocation.
• Competitive equilibrium achieves this ("invisible hand").
Page 5 – Surplus at Competitive Equilibrium
• At (Q^,P^):
– Consumer surplus: area ABC
– Producer surplus: area DBC
– Total surplus: area ADC
Page 6 – Deadweight Loss (DWL)
• DWL = lost net benefits from inefficient output.
• At inefficient Q_1: DWL = area FCG.
Page 7 – Excise Tax Basics
• Specific tax T per unit.
• Price relation: Pd = Ps + T.
• Creates wedge between what buyers pay and sellers receive.
Page 8 – Excise Tax: Required Calculations
• Compute pre-/post-tax: consumer surplus, producer surplus, govt receipts (T\times Q_{tax}), net benefits, DWL.
Page 9 – Excise Tax: Key Outcome
• Tax lowers both surpluses; govt gains revenue; DWL > 0.
Page 10 – Excise Tax: Summary Effects
• Output ↓ (under-production).
• CS ↓, PS ↓.
• Govt revenue +.
• DWL: loss exceeds revenue gain.
Page 11 – Tax Incidence
• Incidence = change in prices relative to P^.
– On consumers: Pd - P^.
– On producers: P^* - Ps.
• Distribution depends on elasticities.
Page 12 – Incidence Cases
• Inelastic demand ⇒ consumers bear most of T.
• Inelastic supply ⇒ producers bear most.
Page 13 – (Illustrative Numbers)
• Highly inelastic demand: larger price rise to consumers.
Page 14 – Subsidy Basics
• Govt pays T per unit to sellers.
• Seller price: Ps = Pd + T.
• Supply curve shifts down by T.
Page 15 – Subsidy: Required Calculations
• Pre-/post-subsidy: CS, PS, govt outlay T\times Q_{sub}, net benefits, DWL.
Page 16 – Subsidy: Key Outcome
• Govt cost > combined surplus gain ⇒ DWL > 0.
Page 17 – Subsidy: Summary Effects
• Output ↑ (over-production).
• CS ↑, PS ↑.
• Govt budget − (expenditure).
• Deadweight loss from over-production.
Page 18 – Learning Objective 2
• Analyse price ceilings & floors.
Page 19 – Price Ceilings
• Legal max price.
• Binding if set < P^*.
• Example: rent control.
• Market does not clear (excess demand).
Page 20 – Ceiling: Max Consumer-Surplus Allocation
• 50 k units allocated to highest WTP consumers.
• CS = A+B+C, PS = G.
• DWL = E+F.
Page 21 – Ceiling: Min Consumer-Surplus Allocation
• 50 k units to lowest WTP consumers.
• CS = H, PS = G.
• DWL = A+B+C+E+F-H (larger).
Page 22 – Ceiling Summary
• Allocation uncertainty determines CS size.
• Producer surplus always falls; DWL present.
Page 23 – Ceiling: General Effects
• Excess demand; under-production.
• PS ↓, partial transfer to consumers.
• DWL inevitable.
Page 24 – Price Floors
• Legal minimum price; binding if > P^*.
• Example: minimum wage (labor market).
Page 25 – Floor Example (P_{floor} = 12)
• Causes excess supply of labor (unemployment).
• Lost surplus areas T,V,W etc.
Page 26 – Floor: General Effects
• Market does not clear; excess supply.
• CS ↓; some transferred to producers/workers.
• DWL present.
Page 27 – Learning Objective 3
• Analyse import tariffs & quotas.
Page 28 – Tariffs & Quotas Definitions
• Tariff = tax on imports.
• Quota = quantity limit on imports.
Page 29 – Quota Scenario (World Price 4)
• Free trade: price 4, domestic supply 2 m, imports 6 m.
• Quota (3 m): price 6, domestic supply 4 m, imports 3 m.
Page 30 – Quota Impact
• Relative to free trade:
– CS ↓, PS ↑.
– Net benefits ↓.
– DWL ↑.
– Foreign producers gain quota rents.
Page 31 – Tariff Impact (T = 2)
• Domestic price 6 (same as quota).
• Similar surplus shifts, but tariff revenue goes to domestic govt (not foreign suppliers).
• Still DWL.