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

1. Excise taxes & subsidies to producers
2. Price ceilings & price floors
3. 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 $(Q^<em>,P^</em>)$:
– 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: $P<em>d = P</em>s + T$.
• 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 $P^<em>$. – On consumers: $P<em>d - P^</em>$.
– On producers: $P^* - P</em>s$.
• 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: $P<em>s = P</em>d + T$.
• 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.

Page 32 – (End)