1. The Analysis of Competitive Markets
Study Unit 9
The Analysis of Competitive Markets

2. Outcomes
Use consumer and producer surplus to evaluate government policies
Determine the efficiency of a competitive market.
Describe the effects of the implementation of minimum prices
Describe the effects of price support and production quotas
Describe the effects of import quotas and tariffs
Describe the effects of a tax or subsidy

3. Evaluating the gains and losses from government policies – consumer and producer surplus

4. Application of consumer and producer surplus
We evaluate welfare effects of government intervention.
I.e. gains and losses to consumers and producers
Look at price controls:
Ceiling price: Government makes it illegal to charge more than a set max price.
Increasing demand and decreasing production = creates a shortage/excess demand

5. Graph explained Change in consumer surplus
Some worse off others due to policy
Worse off: Rationed out of market due to ↓ production and sales Q0-Q1. Loose their surplus (green).
Better off: Can buy Pmax rather than P0. Enjoy an increase in consumer surplus (blue).

6. Graph explained Change in producer surplus:
Some producers will stay in the market others will leave, price control
Remain in market: Produce Q1 will receive lower price. Lose producer surplus (blue). Total production also lost (purple)

7. Graph explained Deadweight loss:
Net loss of total surplus (consumer and producer surplus)
Total loss = Green + Purple

8. Application of consumer and producer surplus

9. Effect of price controls when demand is inelastic

11. The efficiency of a competitive market
Evaluate market outcome = Do we achieve economic efficiency?
Max aggregate of consumer and producer surplus
Market failure:
A situation in which an unregulated competitive market
is inefficient because prices fail to provide proper signals
to consumers and producers

12. The efficiency of a competitive market
Why market failure occurs:
Externalities:
Action taken by producer/consumer
which affects other producers/consumers
but is not accounted for in market price
Lack of information:
Lack info on quality or nature of product
Can’t make max utility decisions

13. Welfare loss

14. Minimum price
Government seeks to raise priced above market-clearing levels.
One way is to raise price as a direct regulation – illegal to charge a lower price.

15. Minimum price

16. Price supports Definition: Price set by government
above free-market level
and maintained by governmental purchases
of excess supply

17. Price supports

18. Price supports Consumers: At Ps, quantity demanded fall to Q1
Quantity supplied rises to Q2
Avoid inventories piling up, government must buy Qg = Q2-Q1
Loss in consumer surplus = A
Others no longer buy, loss = B
Customers lose ∆CS = -A-B

19. Price Supports Producers: Government:
Producers gain hence price SUPPORT
Selling larger quantities Q2 at higher price Ps
Producer surplus: ∆PS = A+B+D
Government:
Cost to government to pay (Q2-Q1)Ps
Cost will lower if dump goods elsewhere – sell abroad
This will hurt domestic production
Change in welfare: ∆CS + ∆PS - (Q2-Q1)Ps
= D - (Q2-Q1)Ps

20. Production quotas
Government can cause price of a good to rise by reducing supply.
Setting a quota on how much firm can produce.

21. Production quotas

22. Incentive programs Output reduced by incentives rather that quotas.
Getting firms to agree to reduce.

23. Import Tariff or Quota
Import quota: Limit on the quantity of a good that can be imported.
Tariff: Tax on an imported good.
Without quota/tariff: Country will import at a world price below domestic price

24. Import quotas and tariffs

25. General case

26. Impact of a tax
Burden of a tax or benefit of a subsidy falls partly on the consumer and partly the producer.
Government collects in 2 ways:
Producer pay tax over to SARS.
The buyer will pay the tax.

27. Specific tax Definition:
Tax of a certain amount per money
Per unit sold
In contrast to ad volarem tax or proportional tax.

28. Incidence of a tax

29. Specific tax
Market clearing requires 4 conditions to be satisfied after tax is in place:
Qsold and Pbuyer must be lie on the demand curve
Qsold and Pseller must lie on the supply curve
Qdemanded = Qsupplied
Price buyer pay and Price seller receive = Tax (t)

30. Tax depend on elasticities
Tax shared evenly in previous graph
Not always the case.
Demand relatively inelastic and supply relatively elastic = Burden of tax mostly on buyers.
General: A tax falls mostly on the buyer if Ed/Es is small and mostly on the seller if Ed/Es is large

31. Tax depend on elasticities

32. Effects of a subsidy Definition:
Payment reducing buyer’s price
Below the seller’s price
A negative tax
The benefit of a subsidy accrues mostly on the buyer if Ed/Es is small and mostly on the seller if Ed/Es is large.

33. Subsidy