1. Policy Analysis

2. Outline Welfare Analysis –Consumer surplus –Producer surplus Welfare consequences of minimum wage Wage subsidy as alternative to minimum wage Tortillas as a Cautionary Tale

3. Economic Efficiency A situation is economically inefficient if there is some way to change it so that so that someone gains while no one else loses. A change is a Pareto improvement if at least one person gains and no one loses A change is economically efficient if the winners could compensate the losers by enough to make the change a Pareto improvement.

4. Assessing Benefits Consumer Sovereignty “Willingness to Pay” = Consumer Benefit Consumer Surplus “Willingness to Sell” =Opportunity Cost Producer Surplus

5. Consumer Surplus -- Difference between Willingness to Pay and Price Paid by Buyer 12 3 Price Quantity P0P0 Demand 11 22 33 4 5 44

6. Price Quantity P0P0 Demand 5 Consumer Surplus Total Expenditure Consumer Surplus Is Triangle Below Demand, Above Market Price.

7. Producer Surplus- Difference Between Opportunity Cost and Selling Price 11 22 33 44 55 1 2 3 4 5 P0=5P0=5 Price Quantity

8. Producer Surplus P0=5P0=5 Quantity Price Supply Producer Surplus

9. Consumer and Producer Surplus - Market Equilibrium Quantity Price Demand Supply P0P0 Consumer Surplus Producer Surplus Q0Q0

10. Impact of Price Floor on Efficiency A B C D E F Price Floor Market clearing price Q1Q1 Q0Q0 Supply Demand A -- New CS A+B+E -- Old CS B+C+D -- New PS C+F+D -- Old PS E+F is deadweight loss associated with the price floor.

11. Impact of Price Ceiling on Efficiency D A B C E F Market Clearing Price Price Ceiling Supply Demand A+B+C -- New CS A+B+E -- Old CS D -- New PS C+D+F -- Old PS E+F is the Deadweight Loss Associated with Price Ceiling

12. SUMMARY Market Equilibrium is Efficient. No Deadweight Loss. Price controls create a deadweight loss Also, there are costs associated with rationing mechanisms, black markets etc.

13. Impact of $12 Minimum Wage

14. $2 Wage Subsidy

15. Comparison If demand is elastic, minimum wage reduces employment Benefits accrue to workers who stay employed Costs borne by employers and consumers Wage subsidy increases employment Benefits shared by employers and workers Subsidy funded from general government revenues

16. Subsidy Benefits Employers and Workers

17. Impact of Subsidy on Efficiency Price buyers pay Price Sellers receive Pre Subsidy Price Pre Subsidy QPost Subsidy Q A B C F E G D A+B+F+E = CS after Subsidy A+B = CS before Subsidy B+C+F+G = PS after Subsidy F+G= PS before Subsidy B+C+D+E+F = Subsidy D=Deadweight Loss from Subsidy

18. Tortillas On New Year’s Day 1999, Mexico ended price controls on tortillas. The price stood at 3 pesos per kilo (31 cents for 2.2 pound stack). Some shops immediately raised their prices by 50%. In 1998, the government phased out subsidies to the tortilla industry that helped keep prices down. The tortilla subsidy was replaced with programs such as one that gives the 1.2 million poorest Mexicans free tortillas each day. Source: Smith, James, Los Angeles Times, Jan 7, 1999

19. Questions What does the price increase suggest about the elasticity of demand for tortillas? How does the impact of a subsidy to consumers differ from the impact of a subsidy to producers? What are the advantages of price controls as compared with subsidies?

20. Elasticity of Demand for Tortillas? Price ceiling Supply Demand A Demand B Kilos of tortillas P PAPA PBPB

21. Subsidy to Producers

22. Subsidy to Consumers

23. Another Approach

24. If All Consumers Received Subsidy: If all consumers receive the subsidy, output is same Price producers receive is same in two cases Price consumers pay is same in two cases

25. Disadvantages of Subsidies Control of subsidies by local bureaucrats created opportunties to exploit subsidies for political ends. Price controls anonymous. Consumers not eligible for subsidies, but still relatively poor will pay a higher price for tortillas.

26. Key Concepts Impact of price controls and of subsidies depends on elasticity of demand (and supply). Price floors lead to surpluses. Price ceilings to shortages. Price controls lead to a deadweight loss.