![Price Control
• Net Effect = Change in Producer Surplus +
Change in Consumer Surplus
• = (-) [Area A+ B] + Area A – Area C
• Net Loss of Area B + C = $0.4+1 mn
• DEADWEIGHT LOSS](https://image.slidesharecdn.com/policyimplications-121004053315-phpapp01/85/Policy-implications-13-320.jpg)
![The Market for Human Kidneys
• Net Effect = Change in Producer Surplus +
Change in Consumer Surplus
• = (-) [Area A+ C] + Area A – Area B
• Net Loss of Area B + C = $80 mn
• DEADWEIGHT LOSS](https://image.slidesharecdn.com/policyimplications-121004053315-phpapp01/85/Policy-implications-22-320.jpg)
Policy implications
- 2. OIL AND PRICE CONTROL • Estimated subsidy on LPG, 2011-12 : Rs 25,000 crores • Government provides subsidy to - Kerosene: Rs 31/ltr - Diesel : Rs 13.64/ltr - One LPG cylinder (14.6kg): Rs 479 • Reduction in subsidy : average Rs 7.5/ltr
- 3. OIL AND PRICE CONTROL • How does price control effect the society? • Who benefits from this? • Who looses? • When is price control effective?
- 4. Price Controls and Natural Gas Shortages • QS = 14 + 2PG + 0.25PO – Quantity supplied in trillion cubic feet (Tcf) • QD = -5PG + 3.75PO – Quantity demanded (Tcf) • PG = price of natural gas in $/mcf • PO = price of oil in $/b 4
- 5. Price Controls and Natural Gas Shortages • Using PO = $8/b and Q DG G QS gives equilibrium values for natural gas – PG = $2/mcf and QG = 20 Tcf • Price ceiling was set at $1/mcf 5
- 6. Price Controls and Natural Gas Shortages Price ($/mcf) D S 2.40 B 2.00 C A (Pmax)1.00 0 5 10 15 18 20 25 30 Quantity (Tcf) Chapter 9 6
- 7. No Regulation • What is the consumer surplus? • What is the producer surplus? • What is the total surplus in the economy?
- 8. Price Control • Price control will be effective only if the price is no higher than the equilibrium price
- 9. Price Controls and Natural Gas Shortages Price ($/mcf) D S The gain to consumers is 2.40 rectangle A minus triangle B, and the loss to producers is rectangle A plus triangle C. B 2.00 C A (Pmax)1.00 0 5 10 15 18 20 25 30 Quantity (Tcf) 9
- 10. Price Controls and Natural Gas Shortages • What will be effect of price control of $1 on the amount traded? • Will there be shortage or surplus? • How will the producers get effected?
- 11. Price Controls Effect on Producer Surplus - Decrease in Producer Surplus - Value: A+C = (-)$18+1 billion - Loss due to lower per unit price :- Area A - Loss due to seller selling fewer units- Area C
- 12. Price Controls Effect on Consumer Surplus - Gain due to lower per unit price :- Area A - Loss due to seller selling fewer units- Area B - Net Change in consumer surplus:- A-B= $18- 0.4 = $17.6 bn
- 13. Price Control • Net Effect = Change in Producer Surplus + Change in Consumer Surplus • = (-) [Area A+ B] + Area A – Area C • Net Loss of Area B + C = $0.4+1 mn • DEADWEIGHT LOSS
- 14. Price Control • Can society ever benefit with a price control? • When will the deadweight loss decrease? • Lower subsidy • Lower demand and supply elasticity
- 15. Price Control • Measuring effects of government price controls on the economy can be estimated by measuring these two triangles • To measure the effect of government price control one needs information on elasticity of demand and supply 15
- 16. MARKET FOR HUMAN KIDNEYS
- 17. The Market for Human Kidneys • The 1984 National Organ Transplantation Act prohibits the sale of organs for transplantation • What has been the impact of the Act? 17
- 18. The Market for Human Kidneys • We can measure this using the supply and demand for kidneys from estimated data – Supply: QS = 8,000 + 0.2P – Demand: QD = 16,000 - 0.2P • Since the sale of organs is not allowed, the amount available depends on the amount donated – Supply of donated kidneys is limited to 8,000 18
- 19. The Market for Kidneys Price S’ The loss to suppliers is seen in areas A & C. S $40,000 $30,000 D If kidneys are zero cost, consumer gain would B be A minus B. $20,000 A and D measure the total value of kidneys C when supply is constrained. $10,000 A D 0 4,000 8,000 12,000 Quantity 19
- 20. The Market for Human Kidneys • Recipients: – Since they do not have to pay for the kidney, they gain rectangle A ($140 million) since price is $0 – Those who cannot obtain a kidney lose surplus equal to triangle B ($40 million) – Net increase in surplus of recipients of $160 - $40 = $120 million 20
- 21. The Market for Human Kidneys • Suppliers: – Those who supply them are not paid the market price, estimated at $20,000 • Loss of surplus equal to area A = $160 million – Some who would donate for the equilibrium price do not donate in the current market • Loss of surplus equal to area C = $40 million – Total SUPPLIER loss of A + C = $200 million 21
- 22. The Market for Human Kidneys • Net Effect = Change in Producer Surplus + Change in Consumer Surplus • = (-) [Area A+ C] + Area A – Area B • Net Loss of Area B + C = $80 mn • DEADWEIGHT LOSS
- 23. The Market for Human Kidneys • Arguments in favor of prohibiting the sale of organs: 1. Imperfect information about donor’s health and screening 2. Unfair to allocate according to the ability to pay 23
- 24. MINIMUM PRICES
- 25. Support Price for Rice farmers • Support price for common rice, 2012: Rs 1,250/kg • Increase from 2011 : Rs 1,080/kg
- 27. Minimum Support Price • What is the effect of Minimum Support Price on the economy? • Who benefits from it and who looses? • When is Minimum Support Price effective?
- 28. Minimum Prices • When price is set above the market clearing price. • Effective minimum price only operates when minimum price support is above the equilibrium price. 28
- 29. Minimum Prices Price S If producers produce Q2, the amount Q2 - Q3 will go unsold. Pmin A D measures total cost of B increased production P0 C not sold. The change in producer D surplus will be A - C - D. Producers may be worse off. D Q3 Q0 Q2 Quantity 29
- 30. Minimum Prices • Losses in consumer surplus are – Increased price leading to decreased quantity equals area A – Those priced out of the market lose area B • Producer surplus – Increases from increased price for units sold equal to A – Losses from drop in sales equal to C 30
- 31. Minimum Prices • Net Effect of the price control on the society • DEADWEIGHT LOSS OF B+C • Deadweight loss decreases as - Subsidy is smaller - Elasticity of demand and supply is lower
- 32. Minimum Prices • What if producers expand production to Q2 from the increased price? 32
- 33. Minimum Prices Price S If producers produce Q2, the amount Q2 - Q3 will go unsold. Pmin A D measures total cost of B increased production P0 C not sold. The change in producer D surplus will be A - C - D. Producers may be worse off. D Q3 Q0 Q2 Quantity 33
- 34. Minimum Prices • What if producers expand production to Q2 from the increased price? – Since they only sell Q3, there is no revenue to cover the additional production (Q2-Q3) – Supply curve measures MC of production so total cost of additional production is area under the supply curve for the increased production (Q2-Q3) = area D – Total change in producer surplus = A – C – D 34
- 35. Supporting the Price of Wheat • The supply and demand for wheat in 1981 was – Supply: QS = 1,800 + 240P – Demand: QD = 3,550 - 266P – Equilibrium price and quantity was $3.46 and 2,630 million bushels • Government raised the price to $3.70 through government purchases 35
- 36. The Wheat Market in 1981 Price •AB consumer loss •ABC producer gain S Qg By buying 122 million bushels, PS = $3.70 the government A C increased the B P0 = $3.46 market-clearing price. D D + Qg 1,800 2,566 2,630 2,688 Quantity 36
- 37. Supporting the Price of Wheat • How much would the government have had to buy to keep price at $3.70? – QDTotal = QD + Q g = 3,550 - 266P + Q g – QS = QDT • 1,800 + 240P = 3,550 - 266P + Qg • Qg = 506P - 1,750 • At a price of $3.70, government would buy • Qg = (506)(3.70) - 175 = 122 million bushels 37
- 38. Supporting the Price of Wheat • We can quantify the effects on CS – The change in consumer surplus = (-A -B) • A = (3.70 - 3.46)(2,566) = $616 million • B = (1/2)(3.70 - 3.46)(2,630 - 2,566) = $8 million – CS = -$624 million 38
- 39. Supporting the Price of Wheat • Cost to the government: – $3.70 x 122 million bushels = $451.4 million – Total cost of program = $624 + 451 = $1,075 million • Gain to producers – A + B + C = $638 million – Government also paid 30 cents/bushel = $806 million 39
- 40. Supporting the Price of Wheat • In 1996, Congress passed the Freedom to Farm law – Goal was to reduce the role of government and make agriculture more market-oriented – Eliminated production quotas, gradually reduced government purchases and subsidies through 2003 44
- 41. Supporting the Price of Wheat • In 2002, Congress and President Bush reversed the effects of the 1996 bill by reinstating subsidies for most crops – Calls for “fixed direct payments” – New bill would cost taxpayers almost $1.1 billion in annual payments to wheat producers alone – 2002 farm bill expected to cost taxpayers $190 billion over 10 years • Estimated $83 billion over existing programs 45
- 42. MINIMUM WAGES
- 43. Minimum Wages • Wage is set higher than market clearing wage • Decreased quantity of workers demanded • Those workers hired receive higher wages • Unemployment results, since not everyone who wants to work at the new wage can 47
- 44. The Minimum Wage w Firms are not allowed to pay less than wmin. This results in unemployment. S wmin A is gain to workers A who find jobs at B higher wage. w0 C The deadweight loss is given by triangles B and C. Unemployment D L1 L0 L2 L 48
- 45. EFFECT OF TAX AND SUBSIDY
- 46. The Impact of a Tax or Subsidy • The government wants to impose a $1.00 tax on movies. It can do it two ways: – Make the producers pay $1.00 for each movie ticket they sell – Make consumers pay $1.00 when they buy each movie • In which option are consumers paying more? 50
- 47. The Impact of a Tax or Subsidy • The burden of a tax (or the benefit of a subsidy) falls partly on the consumer and partly on the producer • How the burden is split between the parties depends on the relative elasticities of demand and supply 51
- 48. The Effects of a Specific Tax • For simplicity we will consider a specific tax on a good – Tax of a particular amount per unit sold • For our example, consider a specific tax of $t per cigarette sold 52
- 49. Incidence of a Specific Tax • Four conditions that must be satisfied after the tax is in place: 1. Quantity sold and buyer’s price, Pb, must be on the demand curve • Buyers only concerned with what they must pay 2. Quantity sold and seller’s price, PS, must be on the supply curve • Sellers only concerned with what they receive 53
- 50. Incidence of a Specific Tax 3. QD = QS 4. Difference between what consumers pay and what buyers receive is the tax 54
- 51. Incidence of a Specific Tax Price S Pb price •Buyers lose A + B buyers pay A •Sellers lose D + C Tax = B $1.00 P0 •Government gains A + C D D in tax revenue. PS price producers •The deadweight get loss is B + C. D Q1 Q0 Quantity 55
- 52. Incidence of a Specific Tax • In the previous example, the tax was shared almost equally by consumers and producers • If demand is relatively inelastic, however, burden of tax will fall mostly on buyers – Cigarettes • If supply is relatively inelastic, the burden of tax will fall mostly on sellers 56
- 53. Impact of Elasticities on Tax Burdens Burden on Buyer Burden on Seller Price D Price S Pb S t Pb P0 P0 PS t D PS Q1 Q0 Quantity Q1 Q0 Quantity
- 54. The Impact of a Tax or Subsidy • We can calculate the percentage of a tax borne by consumers using pass-through fraction – ES/(ES - Ed) – Tells fraction of tax “passed through” to consumers through higher prices – For example, when demand is perfectly inelastic (Ed = 0), the pass-through fraction is 1 – consumers bear 100% of tax 58
- 55. A Tax on Gasoline • The goal of a large gasoline tax is to: – Raise government revenue – Reduce oil consumption and reduce US dependence on oil imports • We will consider a gas tax in the market during mid-1990’s 59
- 56. A Tax on Gasoline • Measuring the Impact of a 50 Cent Gasoline Tax • QD = 150 - 50P • QS = 60 + 40P – QS = QD at $1 and 100 billion gallons per year (bg/yr) 60
- 57. A Tax on Gasoline • With a 50 cent tax: QD = QS 150 - 50Pb = 60 + 40PS 150 - 50(PS+ 0.50) = 60 + 40PS PS = .72 Pb = PS + 0.50 = $1.22 QD = QS = 89 bg/yr Chapter 9 61
- 58. A Tax on Gasoline • With a 50 cent tax: – Q falls by 11% – Price to consumers increases by 22 cents per gallon – Producers receive about 28 cents per gallon less – Government revenue would be significant at $44.5 billion per year 62
- 59. The Impact of a 50 Cent Gasoline Tax D S Price ($ per gallon) Consumer Loss = A + B B Producer Loss = C + D Pb = 1.22 A The buyer pays 22 cents of the $0.50 P0 = 1.00 tax, and Tax C the producer pays 28 cents. D PS = .72 Government revenue = A + D = 0.50(89) = $44.5 billion. 11 Quantity (billion 50 60 89 100 150 gallons per year) Chapter 9 63
- 60. The Effects of Subsidy • A subsidy can be analyzed in much the same way as a tax – Payment reducing the buyer’s price below the seller’s price • It can be treated as a negative tax • The seller’s price exceeds the buyer’s price • Quantity increases 64
- 61. Effects of a Subsidy Price S Like a tax, the benefit PS of a subsidy is split between buyers and Subsidy P0 sellers, depending upon the elasticities of Pb supply and demand. D Q0 Q1 Quantity Chapter 9 65
- 62. Effects of a Subsidy • The benefit of the subsidy accrues mostly to buyers if ED /ES is small • The benefit of the subsidy accrues mostly to sellers if ED /ES is large 66