Consumer and Producer Surplusyamamoto/files/Jun_20.pdf · consumer and producer surplus ... about...

Chapter 9 1©2005 Pearson Education, Inc.

Consumer and ProducerSurplus

� To determine the welfare effect of agovernmental policy, we can measurethe gain or loss in consumer andproducer surplus

�Welfare Effects�Gains and losses to producers and

consumers



�When government institutes a priceceiling (any real example?), the price of agood can’t go above that price

�With a binding price ceiling, producersand consumers are affected

�How much they are affected can bedetermined by measuring changes inconsumer and producer surplus



�When price is held too low, the quantitydemanded increases and quantitysupplied decreases

�Some consumers are worse off becausethey can no longer buy the good�Decrease in consumer surplus

�Some consumers are better off becausethey can buy it at a lower price�Increase in consumer surplus



�Producers sell less at a lower price

�Some producers are no longer in themarket

�Both of these producer groups lose andproducer surplus decreases

� The economy as a whole is worse offsince surplus that used to belong toproducers or consumers is simply gone


The loss to producersis the sum of

rectangle A andtriangle C

B

A C

Consumers that canbuy the good gain A

Price Control and SurplusChanges

Quantity

Price

S

D

P0

Q0

Pmax

Q1 Q2

Consumers thatcannot buy, lose B

Triangles B and C arelosses to society –dead weight loss


Price Controls and WelfareEffects

� The total loss is equal to area B + C

� The deadweight loss is the inefficiencyof the price controls – the total loss insurplus (consumer plus producer)


Price Controls andNatural Gas Shortages

� From example in Chapter 2, 1975 Pricecontrols created a shortage of naturalgas

�What was the effect of those controls?�Decreases in surplus and overall loss for

society

�We can measure these welfare effects fromthe demand and supply of natural gas



�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 $/thousandcubic feet (mcf)

�PO = price of oil in $/barrel



�Using PO = $8/b and givesequilibrium values for natural gas�PG = $2/mcf and QG = 20 Tcf

�Price ceiling was set at $1/mcf

�Showing this graphically, we can see andmeasure the effects on producer andconsumer surplus

GS

GD QQ =


B

A

C

The gain to consumersis

rectangle A minustriangle B, and the loss

to producers isrectangle A plus

triangle C.

SD

2.00

2.40

Price($/mcf)

Quantity (Tcf)0 5 10 15 20 25 3018

(Pmax)1.00




�Measuring the Impact of Price Controls�A = (18 billion mcf) x ($1/mcf) =

$18 billion

�B = (1/2) x (2 b. mcf) x ($0.40/mcf) =

$0.4 billion

�C = (1/2) x (2 b. mcf) x ($1/mcf) =

$1 billion



�Measuring the Impact of Price Controls in1975 (You may want to check byyourself.)�Change in consumer surplus

� = A - B = 18 - 0.4 = $17.6 billion Gain

�Change in producer surplus� = A + C = 18 + 1 = $19.0 billion Loss

�Dead Weight Loss� = B + C = 0.4 + 1 = $1.4 billion Loss


The Efficiency ofa Competitive Market

� In the evaluation of markets, we often talkabout whether it reaches economicefficiency�Maximization of aggregate consumer and

producer surplus

�Policies such as price controls that causedead weight losses in society are said toimpose an efficiency cost on theeconomy


The Efficiency ofa Competitive Market

� If efficiency is the goal, then you canargue that leaving markets alone is theanswer (Invisible hands bring efficiency!)

�However, sometimes market failuresoccur�Prices fail to provide proper signals to

consumers and producers

�Leads to inefficient unregulated competitivemarket


Types of Market Failures

1. Externalities� Costs or benefits that do not show up as part of the

market price (e.g. pollution, elementary education)� Costs or benefits are external to the market

2. Lack of Information� Imperfect information prevents consumers from

making utility-maximizing decisions

� Government intervention may be desirable inthese cases---e.g., imposing emissionregulations, compulsory education


The Efficiency of a CompetitiveMarket

�Other than market failures, unregulatedcompetitive markets lead to economicefficiency


The Market for Human Kidneys(pp. 307-9)

� The 1984 National Organ TransplantationAct prohibits the sale of organs fortransplantation

�What has been the impact of the Act?�We can measure this using the supply

and demand for kidneys from estimateddata (P: the price of a kidney)�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 theamount donated�Supply of donated kidneys is limited to 8,000

� The welfare effect of this supplyconstraint can be analyzed usingconsumer and producer surplus in thekidney market


D

A and D measure thetotal value of

kidneys when supplyis constrained.

A

C

The loss to suppliersis seen in areas A + C.

The Market for Kidneys (pp. 307-9)

Quantity

Price

4,0000

$10,000

$30,000

$40,000

8,000

S’

B

If kidneys are zerocost, receipients gainwould be A minus B.

S

D

12,000

$20,000



�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 equilibriumprice do not donate in the current market� Loss of surplus equal to area C = $40 million

�Total loss of A + C in producers’ surplus =$200 million



�Recipients:�Since they do not have to pay for the kidney,

they gain rectangle A ($140 million) sinceprice is $0

�Those who cannot obtain a kidney losesurplus equal to triangle B ($40 million)

�Net increase in surplus of recipients of $160- $40 = $120 million

�Dead Weight Loss of C + B = $80 million



�Other Inefficiency Costs�Allocation is not necessarily to those who

value the kidneys the most

�Price may increase to $40,000, theequilibrium price, with hospitals getting theprice



� Arguments in favor of prohibiting thesale of organs:

1. Imperfect information about donor’s healthand screening

2. Unfair to allocate according to the ability topay� Holding price below equilibrium will create

shortages

� Organs versus artificial substitutes


Minimum Prices

�Periodically, government policy seeks toraise prices above market-clearing levels�Minimum wage law

�Regulation of airlines

�Agricultural policies

�We will investigate this by looking at theminimum wage legislation


Minimum Prices

�When price is set above the marketclearing price:�Quantity demanded falls

�Suppliers may, however, choose to increasequantity supplied in face of higher prices

�This causes additional producer losses equalto the total cost of production above quantitydemanded


BA

The change in producersurplus will be

A - C - D. Producersmay be worse off.

C

D

Minimum Prices

Quantity

Price

S

D

P0

Q0Q3 Q2

Pmin

If producers produce Q2, the amount Q2 - Q3

will go unsold.

D measures total costof increased

production not sold.


Minimum Prices

� Losses in consumer surplus are still thesame [-(A+B)]�Increased price leading to decreased

quantity equals area A

�Those priced out of the market lose area B

�Producer surplus similar�Increases from increased price for units sold

equal to A

�Losses from drop in sales equal to C


Minimum Prices

�What if producers expand production toQ2 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 sototal cost of additional production is areaunder the supply curve for the increasedproduction (Q2-Q3) = area D

�Total change in producer surplus = A – C – D


Minimum Wages

�Wage is set higher than market clearingwage

�Decreased quantity of workersdemanded

� Those workers hired receive higherwages

�Unemployment results, since noteveryone who wants to work at the newwage can


B

The deadweight lossis given by

triangles B and C.

C

A

L1 L2

Unemployment

wmin

Firms are not allowed topay less than wmin. This

results in unemployment.

S

D

w0

L0

The Minimum Wage

L

w

A is gain to workerswho find jobs at

higher wage.


Airline Regulation

�Before 1970, the airline industry washeavily regulated by the Civil AeronauticsBoard (CAB)

�During 1976-1981, the airline industry inthe U.S. changed dramatically asderegulation led to major changes

�Some airlines merged or went out ofbusiness as new airlines entered theindustry


Airline Regulation

�Although prices in the industry fellconsiderably (helping consumers), profitsdid not.�Regulation caused significant inefficiencies

and artificially high costs

�We can show the effects of thisregulation by looking at the effects onsurplus from the controlled prices


BA

C

After deregulation:Prices fell to PO. Thechange in consumer

surplus is A + B.

Q3

D

Area D is the costof unsold output.

Effect of Airline Regulation

Quantity

Price S

D

P0

Q0Q1

Pmin

Q2

Prior to deregulationprice was at Pmin.

Production was Q3hoping to outsell

competitors.


Airline Industry Data


Airline Industry Data

� Airline industry data show:1. Long-run adjustment as the number of

carriers increased and prices decreased

2. Higher load factors indicating moreefficiency

3. Falling rates

4. Real cost increased slightly (adjusted fuelcost)

5. Large welfare gain


Effect of Airline Regulation

1. Large welfare gain

Consumers’ gain=A+B

Producers’ gain=C+D-A

Net welfare gain=B+C+D

Consumer and Producer Surplusyamamoto/files/Jun_20.pdf · consumer and producer surplus ... about...

Documents

Transcript of Consumer and Producer Surplusyamamoto/files/Jun_20.pdf · consumer and producer surplus ... about...