econ 7

The deadweight loss is smaller in the short run (less elastic supply) than in the long run (more elastic supply). why?

A city that enacts a rent-control program will not lose many rental units in the next week. That is, even at lowered legal prices, roughly the same number of units will be available this week as last week; thus, in the short run the supply of rental units is virtually fixed—relatively inelastic, as seen in Exhibit 6(a). In the long run, however, the supply of rental units is much more elastic; landlords respond to the lower rental prices by allowing rental units to deteriorate and by building fewer new rental units. In the long run, then, the supply curve is much more elastic, as seen in Exhibit 6(b). It is also true that demand becomes more elastic over time as buyers respond to the lower prices by looking for their own apartment (rather than sharing one) or moving to the city to try to rent an apartment below the equilibrium rental price.

Why does a decrease in a good's price increase the consumer surplus from consumption of that good?

A decrease in a good's price increases the consumer surplus from consumption of that good by lowering the price for those goods that were bought at the higher price and by increasing consumer surplus from increased purchases at the lower price.

What impact would a larger tax have on trade in the market? What will happen to the size of the deadweight loss?

A larger tax creates a larger wedge between the price including tax paid by consumers and the price net of tax received by producers, resulting in a greater increase in prices paid by consumers and a greater decrease in price received by producers, and the laws of supply and demand imply that the quantity exchanged falls more as a result. The number of mutually beneficial trades eliminated will be greater and the consequent welfare cost will be greater as a result.

What would be the effect of a price ceiling?

A price ceiling reduces the quantity exchanged because the lower regulated price reduces the quantity sellers are willing to sell.

Which of the following is not true about consumer surplus?

An increase in the market price due to a decrease in supply will increase consumer surplus.

Why do the earlier units produced at a given price add more producer surplus than the later units produced?

Because the earlier (lowest cost) units can be produced at a cost that is lower than the market price, but the cost of producing additional units rises, the earlier units produced at a given price add more producer surplus than the later units produced.

consumers cannot find many close substitutes in the short run, they reduce their consumption only slightly at the higher after-tax price.

Even though the deadweight loss is smaller, it is still positive because the reduced after-tax price received by sellers and the increased after-tax price paid by buyers reduces the quantity exchanged below the previous market equilibrium level.

What causes the welfare cost of subsidies?

Subsidies cause people to produce units of output whose benefits (without the subsidy) are less than the costs, reducing the total gains from trade.

What are the welfare effects of subsidies?

With a subsidy, the price producers receive is the price consumers pay plus the subsidy ($S). Because the subsidy leads to the production of more than the efficient level of output , a deadweight loss results. For each unit produced between and , the supply curve lies above the demand curve, indicating that the marginal benefits to consumers are less than society's cost of producing those units.

The demand curve represents

a collection of maximum prices that consumers are willing and able to pay for additional quantities of a good or service. It also shows the marginal benefits derived by consumers the demand curve represents the benefits that buyers receive from each marginal unit of the good consumed.

In competitive markets, with large numbers of buyers and sellers at the market equilibrium price and quantity, the net gains to society are _________ as possible.

as large

Refer to Exhibit 7-6. If the market is in equilibrium and then the government imposes a price floor equal to P1, buyers lose consumer surplus equal to area:

b + e

Refer to Exhibit 7-6. If the market is in equilibrium and then the government imposes a price ceiling equal to P3, sellers lose producer surplus equal to area:

c +f

With no alternative use of the government purchases from a price floor, a(n) ______ will result because consumers are consuming _____ than the previous market equilibrium output and sellers are producing______than is being consumed.

deadweight loss; less; more

The longer a price ceiling is left below the equilibrium price in a market, the _____ is the reduction in the quantity exchanged and the _____ is the resulting deadweight loss.

greater; greater

How do we measure the total gains from trade?

is the sum of the consumer and producer surpluses created. That is, consumers benefit from additional amounts of consumer surplus, and producers benefit from additional amounts of producer surplus

What happens to consumer surplus if there is a decrease in supply?

lower your consumer surplus.

We can think of the supply curve as a(n) ______ curve.

marginal cost

how is tax revenue collected measured

multiplying the amount of the tax times that quantity of the good sold after the tax is imposed

total welfare gains

the sum of consumer and producer surpluses

In a supply and demand graph, the triangular area under the demand curve but above the supply curve is

the net gain to society from trading that good.

With a subsidy,

the price producers receive is the price consumers pay plus the subsidy. the subsidy leads to the production of more than the efficient level of output. there is a deadweight loss.

some units can be produced at a cost that is lower than the market price

the seller receives a surplus, or a net benefit, from producing those units

Price controls are often advocated by special interest groups. Price controls reduce the quantity of goods and services produced, thus depriving consumers of some goods and services whose value would exceed their cost.

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Why does a reduction in output below the efficient level create a deadweight loss?

A reduction in output below the efficient level eliminates trades whose benefits would have exceeded their costs; the resulting loss in consumer surplus and producer surplus is a deadweight loss.

Could a tax be imposed without a welfare cost?

A tax would not impose a welfare cost only if the quantity exchanged did not change as a result—only when supply was perfectly inelastic or in the nonexistent case where the demand curve was perfectly inelastic. In all other cases, a tax would create a welfare cost by eliminating some mutually beneficial trades (and the wealth they would have created) that would otherwise have taken place.

Why does an expansion in output beyond the efficient level create a deadweight loss?

An expansion in output beyond the efficient level involves trades whose benefits are less than their costs; the resulting loss in consumer surplus and producer surplus is a deadweight loss.

Why does an increase in a good's price increase the producer surplus from production of that good?

An increase in a good's price increases the producer surplus from production of that good because it results in a higher price for the quantity already being produced and because the expansion in output in response to the higher price also increases profits.

a subsidy in an industry would result in:

An increase in consumer surplus and An increase in producer surplus

what happens to consumer surplus when the price of a good rises or falls, when demand remains constant.

An increase in supply and a lower price will increase your consumer surplus for each unit you were already consuming and will also increase your consumer surplus from additional purchases at the lower price.

Why do the earlier units consumed at a given price add more consumer surplus than the later units consumed?

Because what a consumer is willing to pay for a good declines as more of that good is consumed; the difference between what he is willing to pay and the price he must pay also declines for later units.

Why does a deficiency payment program have the same welfare cost analysis as a subsidy?

Both tend to increase output beyond the efficient level, so that units whose benefits (without the subsidy) are less than the costs, reducing the total gains from trade in the same way; furthermore, the dollar cost of the deficiency payments are equal to the dollar amount of taxes necessary to finance the subsidy, in the case where each increases production the same amount.

Why might the consumer surplus from purchases of diamond rings be less than the consumer surplus from purchases of far less expensive stones?

Consumer surplus is the difference between what people would have been willing to pay for the amount of the good consumed and what they must pay. Even though the marginal value of less expensive stones is lower than the marginal value of a diamond ring to buyers, the difference between the total value of the far larger number of less expensive stones purchased and what consumers had to pay may well be larger than that difference for diamond rings.

Wouldn't it cost less to give farmers money directly rather than through price supports?

Consumers are consuming less than the previous market equilibrium output, eliminating mutually beneficial exchanges (that is, exchanges for which the MB is greater than the MC), while sellers are producing more than is being consumed, with the excess production stored, destroyed, or exported. Note that the government can't sell the surplus domestically because it would drive the domestic price down. Since the objective of the policy is to support the higher price, it must either store it or ship it abroad. If the objective is to help the farmers, wouldn't it be less costly to just give them the money directly rather than through price supports? Then the program would only cost b + c + d. However, price supports may be more palatable from a political standpoint than an outright handout.

Who gains and who loses with rent controls? If the shortage of apartments leads tenants to pay rents that are higher than the law allows, what will happen to consumer and producer surplus?

If consumers use no additional resources, search costs, or side payments for a rent-controlled unit, the consumer gains area b − e of consumer surplus from rent control. The producer loses area d + e of producer surplus from rent control.

What if we placed a $0.50 tax on gasoline to reduce dependence on foreign oil and to raise the tax revenue?

If the demand and supply curves are both equally elastic, as in Exhibit 2, both consumers and producers will share the burden equally. the tax collected would be b + d, but total loss in consumer surplus (b + c) and producer surplus (d + e) would be greater than the gains in tax revenue. Not surprisingly, both consumers and producers fight such a tax every time it is proposed.

Why is total welfare maximized at the competitive equilibrium output?

Improvements in welfare come from additions to both consumer and producer surpluses. In competitive markets with large numbers of buyers and sellers, at the market equilibrium price and quantity, the net gains to society are as large as possible.

Which of the following are true statements?

Producer surplus is the difference between what a producer is paid for a good and the cost of producing that good. An increase in demand will lead to a higher market price and an increase in producer surplus; a decrease in demand will lead to a lower market price and a decrease in producer surplus. We can think of the demand curve as a marginal benefit curve and the supply curve as a marginal cost curve. Total welfare gains from trade to the economy can be measured by the sum of consumer and producer surpluses.

Why might the producer surplus from sales of diamond rings, which are expensive, be less than the producer surplus from sales of far less expensive stones?

Producer surplus is the difference between what a producer is paid for a good and the producer's cost. Even though the price, or marginal value, of a less expensive stone is lower than the price, or marginal value of a diamond ring to buyers, the difference between the total that sellers receive for those stones in revenue and the producer's cost of the far larger number of less expensive stones produced may well be larger than that difference for diamond rings.

Which of the following is not true about producer surplus?

Producer surplus is the difference between what sellers are paid and their cost of producing those units. Producer surplus is shown graphically as the area under the market price but above the supply curve. An increase in the market price due to an increase in demand will increase producer surplus.

Which of the following are true statements?

The difference between how much a consumer is willing and able to pay and how much a consumer has to pay for a unit of a good is called consumer surplus. An increase in supply will lead to a lower price and an increase in consumer surplus; a decrease in supply will lead to a higher price and a decrease in consumer surplus.

A Firm's Producer Surplus

The firm's supply curve looks like a staircase. The marginal cost is under the stairs and the producer surplus is above the red stair and below the market price for each unit.

The government sets a price floor that guarantees producers will get a certain price.

The intent of the law was to protect farmers from fluctuating prices. To ensure the support price, the government buys as much output as necessary to maintain the price at that level.

It is important to distinguish between deadweight loss, which measures the overall efficiency loss, and the distribution of the gains and losses from a particular policy.

The losers are the landlords that abide by the laws and the renters who cannot find apartments to rent at the controlled price. The deadweight loss exists because there are fewer apartments rented than would occur in a competitive market.

What are the welfare effects of a tax?

The net loss to society can be found by measuring the difference between the loss in consumer surplus (area b + c) plus the loss in producer surplus (area d + e) and the gain in tax revenue (area b + d). The reduction in total surplus is area c + e, or the shaded area in Exhibit 2. This deadweight loss from the tax is the reduction in producer and consumer surpluses minus the tax revenue transferred to the government.

How do taxes distort market incentives?

The price to buyers is higher than before the tax, so they consume less; and the price to sellers is lower than before the tax, so they produce less. These effects lead to deadweight loss, or market inefficiencies—the waste associated with not producing the efficient level of output. That is, the tax causes a deadweight loss because it prevents some mutual beneficial trade between buyers and sellers. And when the tax gets larger, the deadweight loss get much larger. So a big tax is much worse than a small tax.

Does the elasticity affect the size of the deadweight loss?

The size of the deadweight loss from a tax, as well as how the burdens are shared between buyers and sellers, depends on the price elasticities of supply and demand.

Why is the efficient level of output in an industry defined as the output where the sum of consumer and producer surplus is maximized?

The sum of consumer surplus plus producer surplus measures the total welfare gains from trade in an industry, and the most efficient level of output is the one that maximizes the total welfare gains.

The supply curve represents

a collection of minimum prices that suppliers require to be willing and able to supply each additional unit of a good or service. It also shows the marginal cost of production. It represents the costs that sellers must bear to produce each marginal unit for the market.

Once the equilibrium output is reached at the equilibrium price

all the mutually beneficial trade opportunities between the demander and supplier will have taken place, and the sum of consumer surplus and producer surplus is maximized. marginal benefit to buyers is equal to the marginal cost to producers. Both buyer and seller are better off from each of the units traded than they would have been if they had not exchanged them.

Part of the added producer surplus when the price rises as a result of an increase in demand is due to a higher price for the quantity ____being produced, and part is due to the expansion of ____made profitable by the higher price.

already ; output

The monetary difference between the price a consumer is willing and able to pay for an additional unit of a good and the price the consumer actually pays is called

consumer surplus

In the case of a price floor, if the government buys up the surplus,

consumer surplus decreases. producer surplus increases. a greater deadweight loss occurs than with a deficiency payment system.

The total welfare gain to the economy from trade in a good is the sum of the ________ and ________ created.

consumer surplus; producer surplus

After the imposition of a tax,

consumers pay a higher price, including the tax. consumers lose consumer surplus. producers receive a lower price after taxes. producers lose producer surplus.

A lower market price due to an increase in supply will _______ consumer surplus.

increase

for each unit produced, the producer surplus is the

difference between the market price and the marginal cost of producing that unit

deadweight loss occurs because the tax

educes the quantity exchanged below the original output level, , reducing the size of the total surplus realized from trade.

The size of the deadweight loss from a tax, as well as how the burdens are shared between buyers and sellers, depends on the relative _____________

elasticities of supply and demand.

With a price floor where the government buys up the surplus, the cost to the government is ______ than the gain to ______

greater; producers.

After a tax is imposed, consumers pay a(n) ______ price and lose the corresponding amount of consumer surplus as a result. Producers receive a(n)_______ price after tax and lose the corresponding amount of producer surplus as a result. The government _________ the amount of the tax revenue generated, which is transferred to others in society.

higher; lower; gains

How do we know when we have achieved market efficiency?

market efficiency occurs when we have maximized the sum of consumer and producer surplus, when the marginal benefits of the last unit produced is equal to the marginal cost of producing it, . MB = MC

The demand curve represents a collection of _______prices that consumers are willing and able to pay for additional quantities of a good or service, while the supply curve represents a collection of _________ prices that suppliers require to be willing to supply additional quantities of that good or service.

maximum ; minimum

think of subsidy as a

negative tax

Goods that are heavily taxed (alcohol, cigarettes, and gasoline)

often have a relatively inelastic demand curve in the short run, so the tax burden falls primarily on the buyer

With a(n) ___________, any possible gain to consumers will be more than offset by the losses to producers.

price ceiling,

A(n) _______ is the difference between what a producer is paid for a good and the cost of producing that unit of the good.

producer surplus

What would be the effect of a price floor if the government does not buy up the surplus?

reduces the quantity exchanged, thus causing a welfare cost equal to the net gains from the exchanges that no longer take place.

what increases producer surplus

rise in price

With a deficiency payment program, the deadweight loss is ________than with an agricultural price support program when the government buys the surplus.

smaller

When there is a __________, the market overproduces relative to the efficient level of output, a(n) ___________ results

subsidy; deadweight loss

how is the total producer surplus for the market obtained

summing all the producer surpluses of all the sellers

marginal cost

the change in total costs resulting from a one-unit change in output

increasing output beyond equilibrium decreases total welfare because

the cost of producing this extra output is greater than the value the buyer places on it

In a supply and demand graph, the triangular area between the demand curve and the supply curve lost because of the imposition of a tax, price ceiling, or price floor is

the deadweight loss.

If taxes cause deadweight loss, why don't subsidies cause welfare gains?

the deadweight or welfare loss to society from the subsidy because it results in the production of more than the competitive market equilibrium, and the market value of that expansion to buyers is less than the marginal cost of producing that expansion to sellers. In short, the market overproduces relative to the efficient level of output, .

the supply curve is the marginal cost curve

the demand curve is the marginal benefit curve.

welfare effects

the gains and losses associated with government intervention in markets (taxes and price controls)

At the market equilibrium price and quantity, the total welfare gains from trade are measured by

the sum of consumer surplus and producer surplus.

When there are a lot of producers

the supply curve is more or less smooth

What are the welfare effects of price controls?

the welfare effects of a price ceiling by observing the change in consumer and producer surpluses from the implementation of the price ceiling

With a deficiency payment program,

there is a deadweight loss because the program increases the output beyond the efficient level of output.

The measure of the deadweight loss in the price ceiling case may

underestimate the true cost to consumers

To get the total surplus, or total welfare

we add consumer and producer surpluses, area a + b + c + d + e + f. Without a tax, tax revenues are zero.

What is the relationship between a deadweight loss and price elasticities?

when the supply and/or demand curves become more elastic, the deadweight loss becomes larger because a given tax reduces the quantity exchanged by a greater amount, -That is, the more elastic the curves are, the greater the change in output and the larger the deadweight loss.