1. MICROECONOMICS by Robert S. Pindyck Daniel Rubinfeld Ninth Edition
Copyright © 2016, 2012, 2009 Pearson Education, Inc. All Rights Reserved

2. Chapter 9 The Analysis of Competitive Markets
In this chapter we return to supply–demand analysis to show how it can be applied to a wide variety of problems, including situations in which: a consumer faced with a purchasing decision a firm faced with a long-range planning problem a government agency that has to design a policy and evaluate its likely impact We also use consumer and producer surplus to demonstrate the efficiency of a competitive market.
CHAPTER OUTLINE 9.1 Evaluating the Gains and Losses from Government Policies—Consumer and Producer Surplus 9.2 The Efficiency of Competitive Markets 9.3 Minimum Prices 9.4 Price Supports and Production Quotas 9.5 Import Quotas and Tariffs 9.6 The Impact of a Tax or Subsidy LIST OF EXAMPLES 9.1 Price Controls and Natural Gas Shortages 9.2 The Market for Human Kidneys 9.3 Airline Regulation 9.4 Supporting the Price of Wheat 9.5 Why Can’t I Find a Taxi? 9.6 The Sugar Quota 9.7 A Tax on Gasoline

3. 9.1 Evaluating the Gains and Losses from Government Policies—Consumer and Producer Surplus (1 of 4)
Review of Consumer and Producer Surplus
FIGURE 9.1 (1 of 2) CONSUMER AND PRODUCER SURPLUS Consumer A would pay $10 for a good whose market price is $5 and therefore enjoys a benefit of $5. Consumer B enjoys a benefit of $2, and Consumer C, who values the good at exactly the market price, enjoys no benefit. Consumer surplus, which measures the total benefit to all consumers, is the yellow-shaded area between the demand curve and the market price.
For a review of consumer surplus, see §4.4, where it is defined as the difference between what a consumer is willing to pay for a good and what the consumer actually pays when buying it.

4. 9.1 Evaluating the Gains and Losses from Government Policies—Consumer and Producer Surplus (2 of 4)
Review of Consumer and Producer Surplus
FIGURE 9.1 (2 of 2) CONSUMER AND PRODUCER SURPLUS Producer surplus measures the total profits of producers, plus rents to factor inputs. It is the benefit that lower-cost producers enjoy by selling at the market price, shown by the green-shaded area between the supply curve and the market price. Together, consumer and producer surplus measure the welfare benefit of a competitive market.

5. 9.1 Evaluating the Gains and Losses from Government Policies—Consumer and Producer Surplus (3 of 4)
Application of Consumer and Producer Surplus
welfare effects Gains and losses to consumers and producers.
deadweight loss Net loss of total (consumer plus producer) surplus.
FIGURE 9.2 CHANGE IN CONSUMER AND PRODUCER SURPLUS FROM PRICE CONTROLS The price of a good has been regulated to be no higher than Pmax, which is below the market-clearing price P0. The gain to consumers is the difference between rectangle A and triangle B. The loss to producers is the sum of rectangle A and triangle C. Triangles B and C together measure the deadweight loss from price controls.

6. 9.1 Evaluating the Gains and Losses from Government Policies—Consumer and Producer Surplus (4 of 4)
FIGURE 9.3 EFFECT OF PRICE CONTROLS WHEN DEMAND IS INELASTIC If demand is sufficiently inelastic, triangle B can be larger than rectangle A. In this case, consumers suffer a net loss from price controls.

7. EXAMPLE 9.1 (1 of 2) PRICE CONTROLS AND NATURAL GAS SHORTAGES
FIGURE 9.4 EFFECTS OF NATURAL GAS PRICE CONTROLS The market-clearing price of natural gas was $6.40 per mcf, and the (hypothetical) maximum allowable price is $3.00. A shortage of 29.1 − 20.6 = 8.5 Tcf results. The gain to consumers is rectangle A minus triangle B, and the loss to producers is rectangle A plus triangle C. The deadweight loss is the sum of triangles B plus C.

8. EXAMPLE 9.1 (2 of 2) PRICE CONTROLS AND NATURAL GAS SHORTAGES
FIGURE 9.4 (supplement) EFFECTS OF NATURAL GAS PRICE CONTROLS A = (20.6 billion mcf ) × ($3.40/mcf) = $70.04 billion B = (1/2) x (2.4 billion mcf) × ($1.33/mcf ) = $1.60 billion C = (1/2) x (2.4 billion mcf ) × ($3.40/mcf ) = $4.08 billion The annual change in consumer surplus that would result from these hypothetical price controls would therefore be A − B = − 1.60 = $68.44 billion. The change in producer surplus would be −A − C = −70.04 − 4.08 = −$74.12 billion. And finally, the annual deadweight loss. would be −B − C = −1.60 − 4.08 = −$5.68 billion.

9. 9.2 The Efficiency of a Competitive Market (1 of 2)
economic efficiency Maximization of aggregate consumer and producer surplus.
MARKET FAILURE
market failure Situation in which an unregulated competitive market is inefficient because prices fail to provide proper signals to consumers and producers.
There are two important instances in which market failure can occur:
Externalities
Lack of Information
externality Action taken by either a producer or a consumer which affects other producers or consumers but is not accounted for by the market price. Market failure can also occur when consumers lack information about the quality or nature of a product and so cannot make utility-maximizing purchasing decisions. Government intervention (e.g., requiring “truth in labeling”) may then be desirable.

10. 9.2 The Efficiency of a Competitive Market (2 of 2)
Review of Consumer and Producer Surplus
FIGURE 9.5 WELFARE LOSS WHEN PRICE IS HELD ABOVE MARKET-CLEARING LEVEL When price is regulated to be no lower than P2, only Q3 will be demanded. If Q3 is produced, the deadweight loss is given by triangles B and C. At price P2, producers would like to produce more than Q3. If they do, the deadweight loss will be even larger.

11. EXAMPLE 8.2 (1 of 2) THE MARKET FOR HUMAN KIDNEYS
Even at a price of zero (the effective price under the law), donors supply about 16,000 kidneys per year. It has been estimated that 8000 more kidneys would be supplied if the price were $20,000. We can fit a linear supply curve to this data—i.e., a supply curve of the form Q = a + bP. When P = 0, Q = 16,000, so a = 16,000. If P = $20,000, Q = 24,000, so b = (24,000  16,000)/20,000 = 0.4. Thus the supply curve is Supply: QS = 16, P Note that at a price of $20,000, the elasticity of supply is It is expected that at a price of $20,000, the number of kidneys demanded would be 24,000 per year. Like supply, demand is relatively price inelastic; a reasonable estimate for the price elasticity of demand at the $20,000 price is −0.33. This implies the following linear demand curve:

12. EXAMPLE 9.2 (2 of 2) THE MARKET FOR HUMAN KIDNEYS
FIGURE 9.6 THE MARKET FOR KIDNEYS AND THE EFFECT OF THE NATIONAL ORGAN TRANSPLANTATION ACT The market-clearing price is $20,000; at this price, about 24,000 kidneys per year would be supplied. The law effectively makes the price zero. About 16,000 kidneys per year are still donated; this constrained supply is shown as S’. The loss to suppliers is given by rectangle A and triangle C. If consumers received kidneys at no cost, their gain would be given by rectangle A less triangle B. Economics, the dismal science, shows us that human organs have economic value that cannot be ignored, and prohibiting their sale imposes a cost on society that must be weighed against the benefits.
In practice, kidneys are often rationed on the basis of willingness to pay, and many recipients pay most or all of the $40,000 price that clears the market when supply is constrained. Rectangles A and D measure the total value of kidneys when supply is constrained.

13. 9.3 Minimum Prices (1 of 2)
FIGURE 9.7 PRICE MINIMUM Price is regulated to be no lower than Pmin. Producers would like to supply Q2, but consumers will buy only Q3. If producers indeed produce Q2, the amount Q2 − Q3 will go unsold and the change in producer surplus will be A − C − D. In this case, producers as a group may be worse off.

14. 9.3 Minimum Prices (2 of 2)
FIGURE 9.8 THE MINIMUM WAGE Although the market-clearing wage is w0, firms are not allowed to pay less than wmin. This results in unemployment of an amount L2 − L1 and a deadweight loss given by triangles B and C.

15. EXAMPLE 9.3 (1 of 3) AIRLINE REGULATION
Airline deregulation in 1981 led to major changes in the industry. Some airlines merged or went out of business as new ones entered. Although prices fell considerably (to the benefit of consumers), profits overall did not fall much.
FIGURE 9.9 EFFECT OF AIRLINE REGULATION BY THE CIVIL AERONAUTICS BOARD At price Pmin, airlines would like to supply Q2, well above the quantity Q1 that consumers will buy. Here they supply Q3. Trapezoid D is the cost of unsold output. Airline profits may have been lower as a result of regulation because triangle C and trapezoid D can together exceed rectangle A. In addition, consumers lose A + B.

16. EXAMPLE 9.3 (2 of 3) AIRLINE REGULATION
Because airlines have no control over oil prices, it is more informative to examine a “corrected” real cost index which removes the effects of changing fuel costs.
TABLE 9.1AIRLINE INDUSTRY DATA
Blank Cell
1975
1980
1990
2000
2010
2015
Number of U.S. carriers 36 63 70 94 98
Passenger Load Factor (%)
54.0
58.0
62.4
72.1
82.1
84.4
Passenger-Mile Rate (constant 1995 dollars)
0.218
0.210
0.149
0.118
0.094
0.090
Real Cost Index (1995 = 100)
101
145
119 89
148 93
Real Fuel Cost Index (1995 = 100)
249
300
163
125
342
196
Real Cost Index w/o Fuel Cost Increases (1995 = 100) 71 87
104 85 76 82

17. EXAMPLE 9.3 (3 of 3) AIRLINE REGULATION
FIGURE 9.10 AIRLINE PROFIT MARGINS Following deregulation in 1980, new airlines entered and price competition became intense, so that profits were very low. After 2000, profit margins increased as airlines merged and reduced seat capacity.

18. 9.4 Price Supports and Production Quotas (1 of 4)
price support Price set by government above free-market level and maintained by governmental purchases of excess supply. FIGURE 9.11 PRICE SUPPORTS To maintain a price Ps above the market- clearing price P0, the government buys a quantity Qg. The gain to producers is A + B + D. The loss to consumers is A + B. The cost to the government is the speckled rectangle, the area of which is Ps(Q2 − Q1).

19. 9.4 Price Supports and Production Quotas (2 of 4)
Resulting gains and losses to consumers, producers, and the government in Figure CONSUMERS Some consumers pay a higher price, while others no longer buy the good.
PRODUCERS Producers are now selling a larger quantity Q2 instead of Q0, and at a higher price Ps.
THE GOVERNMENT The cost to the government (which is ultimately a cost to consumers) is
The total change in welfare is

20. 9.4 Price Supports and Production Quotas (3 of 4)
FIGURE 9.12 SUPPLY RESTRICTIONS To maintain a price Ps above the market- clearing price P0, the government can restrict supply to Q1, either by imposing production quotas (as with taxicab medallions) or by giving producers a financial incentive to reduce output (as with acreage limitations in agriculture). For an incentive to work, it must be at least as large as B + C + D, which would be the additional profit earned by planting, given the higher price Ps. The cost to the government is therefore at least B + C + D.

21. 9.4 Price Supports and Production Quotas (4 of 4)
INCENTIVE PROGRAMS In U.S. agricultural policy, output is reduced by incentives rather than by outright quotas. Acreage limitation programs give farmers financial incentives to leave some of their acreage idle. Figure 9.11 also shows the welfare effects of reducing supply in this way. As with direct production quotas, the change in consumer surplus is
Farmers receive a higher price, produce less, and receive an incentive to reduce production. Thus, the change in producer surplus is now
The cost to the government is at least B + C + D, and the total change in producer surplus is
An acreage-limitation program is more costly to society than simply handing the farmers money. The total change in welfare

22. EXAMPLE 9.4 (1 of 2) SUPPORTING THE PRICE OF WHEAT
FIGURE 9.13 THE WHEAT MARKET IN 1981 To increase the price to $3.70, the government must buy a quantity of wheat Qg. By buying 122 million bushels of wheat, the government increased the market-clearing price from $3.46 per bushel to $3.70.
1981 Total demand: QD = 3550  266P + Qg Qg= 506P  1750 Qg= (506)(3.70)  1750 = 122 million bushels Loss to consumers = −A − B = $624 million Cost to the government = $3.70  122 million = $451.4 million Total cost of the program = $624 million + $451.4 million = $1075 million Gain to producers = A + B + C = $638 million

23. EXAMPLE 9.4 (2 of 2) SUPPORTING THE PRICE OF WHEAT
In 1996, the U.S. Congress passed a new farm bill, nicknamed the “Freedom to Farm” law. The law eliminated production quotas (for wheat, corn, rice, and other products) and gradually reduced government purchases and subsidies through In Example 2.5, we saw that the market-clearing price of wheat in 2007 had increased to about $6.00 per bushel. The supply and demand curves in 2007 were as follows:
You can check to see that the market-clearing quantity is 2150 million bushels. in 2002, the Farm Security and Rural Investment Act reinstated subsidies for most crops, in particular grain and cotton. It called for the government to issue “fixed direct payments” to producers. Congress revisited agricultural subsidies in 2007, and the subsidies were either maintained or increased, thus making the burden on U.S. taxpayers even higher. Recently, however, the pendulum has swung back toward eliminating subsidies. The 2014 Farm Bill eliminated “direct payments,” which had been provided annually to producers and landowners of covered commodities.
Using U.S. wheat acreage and
production levels in 2001, we can calculate that this bill cost taxpayers nearly
$1.1 billion in annual payments to wheat producers alone.10 The 2002 farm bill
was projected to cost taxpayers $190 billion over 10 years.

24. EXAMPLE 9.5 (1 of 3) WHY CAN’T I FIND A TAXI?
The city of New York limits the number of taxis by issuing a limited number of medallions. In 2011 there were 13,150 medallions in New York—roughly the same number as in Medallions can be bought and sold by the companies that own them. In 1937, there were plenty of medallions to go around, so they had little value. By 1947, the value of a medallion had increased to $2,500, by 1980 to $55,000, and by 2011 to $880,000! But of course that value would drop sharply if the city starting issuing more medallions. So the New York taxi companies that collectively own the 13,150 available medallions have done everything possible to prevent the city from issuing any more—and have succeeded in their efforts. If the city were to issue another 7,000 medallions for a total of about 20,000, demand and supply would equilibrate at a price of about $350,000 per medallion– still a lot, but just enough to lease cabs, run a taxi business, and still make a profit. The entry of Uber, Lyft, and other “ride-share” services that allow you to use an app on your smartphone to request a ride to a destination of your choice. These services have taken a good deal of business away from traditional taxi cabs, reducing the demand for medallions.

25. EXAMPLE 9.5 (2 of 3) WHY CAN’T I FIND A TAXI?
FIGURE 9.14 TAXI MEDALLIONS IN NEW YORK CITY The demand curve D shows the quantity of medallions demanded by taxi companies as a function of the price of a medallion. The supply curve S shows the number of medallions that would be sold by current owners as a function of price. New York limits the quantity to 13,150, so the supply curve becomes vertical and intersects demand at $880,000, the market price of a medallion in By 2016 the demand curve had shifted to the left because the entry of Uber and Lyft provided an alternative to traditional taxis, so the price of a medallion fell to $500,000, at the new intersection with the supply curve.

26. EXAMPLE 9.5 (3 of 3) WHY CAN’T I FIND A TAXI?
FIGURE 9.15 THE PRICES OF TAXI MEDIALLIONS IN NEW YORK CITY, CHICAGO, AND BOSTON The prices of medallions increased from 2006 to 2012 because supply was constrained and demand was growing. But then ride-share services like Uber and Lyft entered the market, shifting the demand curve to the left. The result was a sharp decline in medallion prices.

27. 9.5 Import Quotas and Tariffs (1 of 2)
import quota Limit on the quantity of a good that can be imported.
Tariff Tax on an imported good.
FIGURE 9.16 IMPORT TARIFF OR QUOTA THAT ELIMINATES IMPORTS In a free market, the domestic price equals the world price Pw. A total Qd is consumed, of which Qs is supplied domestically and the rest imported. When imports are eliminated, the price is increased to P0. The gain to producers is trapezoid A. The loss to consumers is A + B + C, so the deadweight loss is B + C.

28. 9.5 Import Quotas and Tariffs (2 of 2)
FIGURE 9.17 IMPORT TARIFF OR QUOTA (GENERAL CASE) When imports are reduced, the domestic price is increased from Pw to P*. This can be achieved by a quota, or by a tariff T = P* − Pw. Trapezoid A is again the gain to domestic producers. The loss to consumers is A + B + C + D. If a tariff is used, the government gains D, the revenue from the tariff. The net domestic loss is B + C. If a quota is used instead, rectangle D becomes part of the profits of foreign producers, and the net domestic loss is B + C + D.

29. EXAMPLE 9.6 (1 of 2) THE SUGAR QUOTA
In recent years, the world price of sugar has been between 10 and 28 cents per pound, while the U.S. price has been 30 to 40 cents per pound. Why? By restricting imports, the U.S. government protects the $4 billion domestic sugar industry, which would virtually be put out of business if it had to compete with low-cost foreign producers. This policy has been good for U.S. sugar producers, but bad for consumers. Sugar market in 2016:
U.S. production:
17.9 billion pounds
U.S. consumption:
24 billion pounds
U.S. price:
27 cents per pound
World price
17 cents per pound
At the 17-cent world price, U.S. production would have been only about 8 billion pounds and U.S. consumption about 26.7 billion pounds, of which 26.7 − 8 = 18.7 billion pounds would have been imported. But fortunately for U.S. producers, imports were limited to only 6.1 billion pounds.

30. EXAMPLE 9.6 (2 of 2) THE EFFECTS OF A SPECIFIC TAX
FIGURE 9.18 SUGAR QUOTA IN 2016 At the world price of 17 cents per pound, about 26.7 billion pounds of sugar would have been consumed in 2016, of which all but 8 billion pounds would have been imported. Restricting imports to 6.1 billion pounds caused the U.S. price to go up by 10 cents. The cost to consumers, A + B + C + D, was about $2.5 billion. The gain to domestic producers was trapezoid A, about $1.3 billion. Rectangle D, $610 million, was a gain to those foreign producers who obtained quota allotments. Triangles B and C represent the deadweight loss of about $631 million.

31. 9.6 The Impact of a Tax or Subsidy (1 of 3)
THE EFFECTS OF A SPECIFIC TAX
specific tax Tax of a certain amount of money per unit sold. FIGURE 9.19 INCIDENCE OF A TAX Pb is the price (including the tax) paid by buyers. Ps is the price that sellers receive, less the tax. Here the burden of the tax is split evenly between buyers and sellers. Buyers lose A + B. Sellers lose D + C. The government earns A + D in revenue. The deadweight loss is B + C.
Market clearing requires four conditions to be satisfied after the tax is in place:
(9.1a)
(9.1b)
(9.1c)
(9.1d)

32. 9.6 The Impact of a Tax or Subsidy (2 of 3)
FIGURE 9.20 IMPACT OF A TAX DEPENDS ON ELASTICITIES OF SUPPLY AND DEMAND (a) If demand is very inelastic relative to supply, the burden of the tax falls mostly on buyers. (b) If demand is very elastic relative to supply, it falls mostly on sellers. By using the following “pass-through” formula, we can calculate the percentage of the tax that is “passed through” to consumers: Pass-through fraction = Es/(Es  Ed)

33. 9.6 The Impact of a Tax or Subsidy (3 of 3)
The Effects of a Subsidy
subsidy Payment reducing the buyer’s price below the seller’s price; i.e., a negative tax. FIGURE 9.21 SUBSIDY A subsidy can be thought of as a negative tax. Like a tax, the benefit of a subsidy is split between buyers and sellers, depending on the relative elasticities of supply and demand. Conditions needed for the market to clear with a subsidy:
(9.2a)
(9.2b)
(9.3c)
(9.4d)

34. EXAMPLE 9.7 (1 of 2) A TAX ON GASOLINE (Demand) (Supply)
(Supply must equal demand)
(Government must receive $1.00/gallon)
Annual revenue from the tax tQ = (1.00)(130) = $130 billion per year Deadweight loss: (1/2) × ($1.00/gallon) × (10 billion gallons/year = $5 billion per year

35. EXAMPLE 9.7 (2 of 2) A TAX ON GASOLINE
FIGURE 9.22 IMPACT OF $1 GASOLINE TAX The price of gasoline at the pump increases from $3.00 per gallon to $3.45, and the quantity sold falls from 140 to 130 bg/yr. Annual revenue from the tax is (1.00)(130) = $130 billion (areas A + D). The two triangles show the deadweight loss of $5 billion per year.

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