Supply, Demand, and Government Policies

Price Ceiling:
- Definition: Legal maximum price for a good (e.g., rent control).
- Binding: If set below equilibrium price, causing a shortage.
- Non-binding: If set above equilibrium price, resulting in no effect.
- Effect on Market:
- Forces the market to operate at a price different from equilibrium.
Price Floor:
- Definition: Legal minimum price for a good (e.g., minimum wage).
- Binding: If set above equilibrium price, causing a surplus.
- Non-binding: If set below equilibrium price, resulting in no effect.
- Effect on Market:
- Similar to a price ceiling, it forces the market to operate away from equilibrium.

Binding Ceiling:
- Creates a shortage where quantity demanded exceeds quantity supplied.
- Adjustment occurs through quantities instead of price changes, leading to waiting, reduced quality, or unsold output.
Binding Floor:
- Creates a surplus where quantity supplied exceeds quantity demanded.
- Results in inefficiencies in the market.

Rent Control:
- Short-run Effect: Minor shortages.
- Long-run Effect: Severe shortages, reduced quality, potential discrimination in housing.
Minimum Wage:
- Effect: Acts as a binding floor leading to unemployment among low-skilled workers.

Definition: A tax that shifts the demand or supply curve by changing the effective price faced by one side of the market.
Tax on Buyers:
- Shifts the demand curve leftward.
- Results in a lowered willingness to pay, leading to a decrease in demand.
Tax on Sellers:
- Shifts the supply curve leftward.
- Increases their cost per unit, requiring a higher price to supply a given quantity.
Magnitude of Shift:
- Determined by the amount of the per-unit tax.
Tax Wedge:
- The difference between the price buyers pay and the price sellers receive, created due to taxation.
Tax Incidence:
- The distribution of the tax burden between buyers and sellers.
- Heavier burden falls on the less elastic side of the market.

Willingness to Pay (WTP):
- Definition: The maximum amount a buyer is willing to pay for a unit of a good.
- Represents the height of the demand curve at each quantity.
Consumer Surplus (CS):
- Definition: CS = WTP − Price.
- Market Consumer Surplus: Area under the demand curve and above the price level.
Willingness to Sell (WTS)/Cost:
- Definition: The seller's opportunity cost; represents the height of the supply curve at each quantity.
Producer Surplus (PS):
- Definition: PS = Price − Cost.
- Market Producer Surplus: Area above the supply curve and below the price level.
Total Surplus (TS):
- Definition: TS = CS + PS = value to buyers − cost to sellers.
Efficiency:
- An allocation is efficient when it maximizes TS.
- In competitive markets, equilibrium quantity maximizes total surplus.
Equity vs Efficiency:
- Policies often trade a change in total surplus for a redistribution of surplus.

Consumer Surplus (Individual):
- CS_{ ext{individual}} = WTP - P.
Producer Surplus (Individual):
- PS_{ ext{individual}} = P - ext{Cost}.
Total Surplus (Market):
- TS_{ ext{market}} = ext{Area between demand and supply from } Q = 0 ext{ to } Q = Q^*.

Achieving Social Optimum:
- Shift supply up by the external cost (for negative externalities) or shift demand up by the external benefit (for positive externalities).
- Alternatively, apply a tax or subsidy equal to the magnitude of the externality.
Permit Market:
- Calculation: Permit price × permits traded = transfers between firms.
- Total abatement cost minimized when marginal abatement costs are equalized.
Compute Externalities:
- Identify negative vs. positive externalities and graph supply/demand with social curves.
Corrective Tax/Subsidy Concept:
- Amount is conceptually equal to the marginal external cost (negative externality) or benefit (positive externality).

Tax Revenue Calculation:
- ext{Tax Revenue} = T imes Q_T.
Deadweight Loss (DWL):
- DWL = T imes (Q^* - QT) = TS^* - TST.
- Explains the fall in total surplus not captured by government revenue.

Externality:
- Definition: An uncompensated effect of one agent’s actions on another.
- Can be negative (e.g., social cost > private cost) or positive (e.g., social value > private value).
Social Marginal Cost (SMC):
- Formula: SMC = ext{Private Marginal Cost} + ext{Marginal External Cost}.
Social Marginal Value (SMV):
- Formula: SMV = ext{Private Marginal Value} + ext{Marginal External Benefit}.
Inefficiency Due to Externalities:
- Negative externality leads to market quantity (Q) greater than socially optimal quantity (Q_{ ext{social}}).
- Positive externality results in market quantity less than socially optimal quantity.
Internalizing Externalities:
- Use corrective (Pigouvian) tax to equal marginal external cost.
- Use a corrective subsidy for positive external benefits.
Tradable Permits (Cap-and-Trade):
- Fix aggregate quantity; allows a price to emerge, operating efficiently when permits are tradable.
Coase Theorem:
- States that when property rights are clearly defined and transaction costs are negligible, private bargaining will yield efficient outcomes.
- High transaction costs or numerous parties can hinder private solutions.

The demand curve represents the marginal value curve while the supply curve represents the marginal cost curve. The equilibrium that maximizes total surplus occurs where these two curves intersect.

Given a WTP table, derive staircase demand and compute consumer surplus at a specified price.
Given seller costs, derive supply and compute producer surplus at a specified price.
Graphical Analysis:
- On a supply/demand graph, shade areas representing consumer surplus, producer surplus, and identify total surplus and changes resulting from shifts or price controls.
Calculate values for consumer surplus, producer surplus, and total surplus using graphical data.