ECON201 Lecture Notes - Lecture 9: Price Support, Price Floor, Import Quota
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ECON 221 – Chapter #9 Notes
Recall: The consumer surplus is the area below the demand curve and above the
equilibrium price line (or in between the demand curve and the price line)
And that producer surplus is the area below above the supply curve and below the price
line.
We also see that Consumer A would pay $10 for a good whose market price is $5 and
therefore enjoys a benefit of $5.Consumer B enjoys a benefit of $2,
Note: Market clears when price is 5
The Demand curve is also the consumer willingness to pay curve and the marginal
benefit curve
The Supply curve is also the firm’s marginal cost of production curve
Total Surplus= Consumer Surplus + Producer Surplus
And Total Surplus is maximized in a free market. Also, Total surplus measures welfare
benefit of a competitive market
Welfare effects - Gains and losses to consumers and producers.
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Change in Consumer and Producer Surplus from Price Controls
Here we see that the price of a good has been regulated to be no higher than Pmax, which is
below the market-clearing price P0. this is a price ceiling, and in this case it a binding
price ceiling since a price ceiling sets a price level that cannot be surpassed and if the
equilibrium price level is above it then it lowers prices
Deadweight loss - Net loss of total (consumer plus producer) surplus
Observations:
•When the price is lower, suppliers only want to supply Q1, consumers want to
consume Q2 so we have a shortage
•Consumers will get area A (their gain)
•Consumers lose area B
•Producers SURPLUS Is smaller
•Change in total surplus = change in CS + change in PS so if we know the change in CS
and the change in TS then we can derive the change in PS
•Deadweight loss represents inefficiencies
•Only benefit if you can get a cheaper good
ΔC.S.= A-B
ΔP.S. = -(A+C)
ΔT.S. = -(B+C) Deadweight loss
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What if market demand Is Inelastic?
If demand is sufficiently inelastic, triangle B can be larger than rectangle A.
In this case, consumers suffer a net loss from price controls.
Observations:
•Demand curve is relatively steeper, so area B is bigger than A ==> The more inelastic
the demand curve the steeper thus the BIGGER the netloss in Consumer surplus
•A-B will be negative
•Consumers will lose
•Net change in CS is negative
The Efficiency of a Competitive Market
Economic efficiency - Maximization of aggregate consumer and producer surplus.
Market Failure - Situation in which an unregulated competitive market is inefficient because
prices fail to provide proper signals to consumers and producers.
2 important instances in which market failure can occur:
1. Externalities: Actions of consumers or producers result in costs or benefits to a
third party. Such an impact is not accounted for by the market price.
2. Lack of Information: Asymmetric information.
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