MicroEconomics theory and application 12th by browning an zupan chapter 10

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MICROECONOMICS: Theory & Applications

By Edgar K Browning & Mark A Zupan

John Wiley & Sons, Inc.

Chapter 10: Using the Competitive Model

Prepared by Dr Della Lee Sue, Marist College

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Learning Objectives (continued)

 Explain how the entry restrictions imposed by most major U.S cities on taxis affect fares and the profits earned by licensed taxi owners

 Understand the effects of international trade on consumer and producer surplus and why a net gain results to a country from either imports or exports

 Explore how government-specified maximum quantities, or quotas, on sugar imports affect consumers, domestic producers, and the net

welfare of the United States as well as other countries that produce

sugar

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10.1 THE EVALUATION OF GAINS AND LOSSES

Show how changes in market conditions or government policies affect the welfare of consumers, producers, and market participants as a whole

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The Evaluation of Gains and Losses

 Consumer surplus – a measure of the net gain to a consumer or group

of consumers from purchasing a good arising from cost being below the maximum that consumers are willing to pay

 Producer surplus – gains to producers from the sale of output to

consumers, arising from price exceeding the minimum necessary to

compensate the seller

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Producer Surplus

Who gets the producer surplus?

Suppliers of inputs to the industry if the supply curve is upward-sloping

Owners of inputs with horizontal supply curves to the industry receive no producer surplus

There is no aggregate producer surplus for a constant-cost competitive industry in long-run equilibrium

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Figure 10.1 - Producer Surplus

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Consumer Surplus, Producer Surplus,

and Efficient Output

 Total surplus – 2 approaches:

 the sum of producer and consumer surplus

 the sum of total surplus associated with each unit of output, added over all units of output

 Efficiency in output – the condition in which output is expanded to the

point where marginal benefit equals marginal cost

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Figure 10.2 - Competition Maximizes

Total Surplus

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The Deadweight Loss of a Price Ceiling

 Deadweight loss – also called welfare cost, a measure of the aggregate

loss in well-being of participants in a market resulting from an

inefficient output level

 Comparison of changes in consumer surplus and producer surplus

indicate who gains and who loses

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Figure 10.3 - A Price Ceiling Reduces

Total Surplus

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10.2 EXCISE TAXATION

Analyze the effects of an excise tax on a specific good on the welfare of consumers, producers, and market participants as a whole

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Excise Taxation

Excise tax – a tax levied on a specific good

 Per unit tax: does not depend on the market price

 Ad valorem tax: an excise tax that is levied as a certain percentage

of the market price

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Figure 10.4 - Effects of a Per-Unit

Excise Tax

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The Consequences of an Excise Tax

 Short-Run Effects

 Firms reduce output

 Market price rises

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Who Bears the Burden of the Tax?

When an excise tax is imposed on a good, elasticity determines how much output falls and how much the price to consumers rises

curve:

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Figure 10.5 - How Elasticities Affect the Tax Burden

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When the Consumer Bears the Entire

Burden of the Tax

 Situations of extreme elasticity:

 If the demand is perfectly inelastic, the demand curve is vertical

 If the supply curve is perfectly elastic, the supply curve is

horizontal, which is the constant-cost case

 In both cases,

 the price to consumers rises by the amount of the tax

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The Deadweight Loss of Excise

Taxation

 Any deviation from the competitive level of output is inefficient and results in a decrease in consumer surplus and producer surplus (total loss)

 Tax revenue: gain to the government

 Excess burden –deadweight loss produced by a tax

 Total loss = tax revenue + excess burden

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Figure 10.6 - The Deadweight Loss of

an Excise Tax

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Figure 10.7 – Supply Elasticity and the Deadweight Loss of Rent Control

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10.3 AIRLINE REGULATION AND

DEREGULATION

Detail how regulation of the U.S airline industry affected fares, airline company profits, and service quality

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Airline Regulation and Deregulation

 1938-1978: period of regulation in the airline industry by the Civil Aeronautics Board (CAB)

 Factors that were regulated:

 Fares

 Routes between 2 cities

 Entry of new firms into the industry

 Support for deregulation:

 Fares were set above the market equilibrium fare

 Accounting profits for the airline industry were below the national average for all industries over the 20 years prior to deregulation in 1978

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What Happened to the Profits?

[in the airline industry]

 Profitable routes covered the loss from unprofitable routes that airlines were required to operate

 Airline employee unions bargained for higher wages when fares were above competitive levels

 Nonprice competition increased costs

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Figure 10.8 - Airline Regulation by the CAB

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The Airline Industry After Deregulation

Since the domestic airline industry was deregulated, several changes have occurred:

 The cost of air travel to consumers has fallen

 A major restructuring of the industry has taken place

 New entrants into the industry have been able to operate at lower costs than the established carriers

 Air service to small communities has increased but fares have also gone up

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The Contestability of Airline Markets

Contestable markets – markets in which competition is so perfect that

the market price is independent of the number of firms currently serving

a market, because the mere possibility of entry suffices to discipline the actions of incumbent suppliers

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The Push for Reregulation

 Concerns after deregulation:

 Greater congestion at airports

 Issues of airline safety

 Possible solutions:

 Re-regulation

 Expand airport capacity

 Implement peak-load pricing

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10.4 CITY TAXICAB MARKETS

Explain how the entry restrictions imposed by most major U.S cities on taxis affect fares and the profits earned by licensed taxi owners

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City Taxicab Markets

 Medallion – a city-issued taxi license; fixed supply

 Value of medallion: determined by expected profitability of

operating a taxi

 Results include higher fares and lower output than under unregulated conditions

 Alternative regulation: maximum fares (price ceiling)

 Illegal markets in transportation services develop

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Figure 10.9 – Licensing Taxicabs

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10.5 CONSUMER AND PRODUCER

SURPLUS, AND THE NET GAINS FROM TRADE

Understand the effects of international trade on consumer and producer surplus and why a net gain results to a country from either imports or

exports

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Consumer and Producer Surplus,

and the Net Gains from Trade

 Why examine international trade?

 Interdependency between economies of nations

 Address the question: Is free trade harmful to a nation’s welfare?

 Why does international trade arise?

 Sellers and buyers in different countries find it in their interests to deal with one another

 When will market equilibrium occur?

 When the price is the same in both the domestic market and the international market

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Figure 10.10 - International Trade

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The Gains from International Trade

 “(A) net gain to the United States as a whole” does not mean that every U.S citizen gains

 Compare the change in the consumer surplus with the change in the producer surplus

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Figure 10.11 - The Gains from Free

Trade [International Trade]

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The Link Between Imports and Exports

Both nations are better off from trading

 When nations trade, one country’s imports are the other country’s exports

 When the U.S imports goods from the rest of the world, the dollars used to pay international suppliers for those goods come back to the U.S economy in the form of international demand for U.S exports

 Currency is a medium of exchange between imports and exports - Free trade neither creates or destroys currency

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10.6 GOVERNMENT INTERVENTION

IN MARKETS: QUANTITY CONTROLS

Explore how government-specified maximum quantities, or quotas, on sugar imports affect consumers, domestic producers, and the net welfare

of the United States as well as other countries that produce sugar

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Government Intervention in Markets:

Quantity Controls

 Quotas – government-imposed maximum quantities of goods

 Application: sugar import quota in the United States

 Effect of quotas:

 Deadweight loss occurs

 Markets of related products are affected

 Price differentials between countries arise in the regulated market

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Figure 10.12 - The Sugar Import Quota

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