Partial Eq PDF

Market Demand
We start by studying the demand of the

market
Chapter 10
THE PARTIAL EQUILIBRIUM
COMPETITIVE MODEL:
-Market demand
-Market supply
Copyright 2005 by South-Western, a division of Thomson Learning. All rights reserved.
Market Demand
Market Demand
Assume that there are only two goods

(x and y)
To construct the market demand curve,

PX is allowed to vary while Py and the
income of each individual are held
constant
If each individuals demand for x is
downward sloping, the market demand
curve will also be downward sloping
An individuals demand for x is

Quantity of x demanded = x(px,py,I)
If we use i to reflect each individual in the
market, then the market demand curve is
n
Market demand for X = x i ( px , py , Ii )

i =1
Shifts in the Market

Demand Curve
Market Demand
To derive the market demand curve, we sum the
quantities demanded at every price
px
px
Individual 1s
demand curve
Individual 2s
demand curve
px
The market demand summarizes the ceteris

paribus relationship between X and px
Market demand
curve
changes in other determinants of the demand for X

cause the demand curve to shift to a new position
(change in demand)
px*
x1
x1*
x2
x2*
X*
x1* + x2* = X*
changes in px result in movements along the curve

(change in quantity demanded)
See example 10.1 in the book to see how to do it

mathematically
Elasticity of Market Demand

The price elasticity of market demand is
measured by
eQ,P =
Elasticity of Market Demand

The cross-price elasticity of market
demand is measured by
QD (P, P ' , I ) P
QD
P
eQ,P =
QD (P, P ' , I ) P '
QD
P '
The income elasticity of market demand is

measured by
Market demand is characterized by

whether demand is elastic (eQ,P <-1) or
inelastic (0> eQ,P > -1)
eQ,I =
7
QD (P, P ' , I ) I
I
QD
Perfect Competition
A perfectly competitive industry is one that
obeys the following assumptions:
We will study supply of the market and

the market equilibrium
The way the equilibrium is determined
depends on whether we are studying
short run, or long run
From the time being, we will focus our
attention on studying the equilibrium in
perfectly competitive industries
each firm attempts to maximize profits

there are a large number of firms, each producing
the same homogeneous product
each firm is a price taker
its actions have no effect on the market price
information is perfect
Product characteristics, technology, prices are common
knowledge
transactions are costless

Buyers and sellers incur no costs in making exchanges
9
10
Timing of the Supply Response
Market Supply in the short run
In the analysis of competitive pricing, the time period

under consideration is important
The time period will be important to determine the supply
curve
The quantity of output supplied to the

entire market in the short run is the sum
of the quantities supplied by each firm
very short run (not very interesting, we will not study it)
short run
the amount supplied by each firm depends

on price
existing firms can alter their quantity supplied by

altering the quantity of the variable input (labour),
but quantity of fixed inputs cannot be changed,
hence no new firms can enter the industry
The short-run market supply curve will

be upward-sloping because each firms
short-run supply curve has a positive
slope
long run
new firms may enter an industry
11
12
Determination of the eq. Price

in the short run
The number of firms in an industry is
fixed
These firms are able to adjust the
quantity they are producing
Short-Run Market Supply

Function
The short-run market supply function
shows total quantity supplied by each
firm to a market
n
Qs (P,v ,w ) = qi (P,v ,w )
they can do this by altering the levels of the

variable inputs they employ
i =1
Firms are assumed to face the same

market price and the same prices for
inputs
13
14
Short-Run Market Supply Curve
Short-Run Supply Elasticity
To derive the market supply curve, we sum the

quantities supplied at every price
The short-run supply elasticity describes

the responsiveness of quantity supplied
to changes in market price
Firm As
supply curve
sB
sA
Firm Bs
supply curve
Market supply
curve
eS,P =
P1
q1 A
quantity
q1 B
quantity
Q1
Quantity
q1A + q1B = Q1
15
% change in Q supplied QS P
=
% change in P
P QS
Because price and quantity supplied are

positively related, eS,P > 0
See example 10.2 in the book
16
Equilibrium Price
Determination in the SR
Equilibrium Price
Determination in the SR
An equilibrium price is one at which quantity
demanded is equal to quantity supplied
In an equilibrium price:
We have studied the market demand

We have studied the short run supply
curve
So, we can study the short run market
equilibrium
suppliers are supplying the optimal quantity given

the price and constraints, and demanders are
demanding their optimal quantity
neither suppliers nor demanders have an incentive
to alter their economic decisions
An equilibrium price (P*) solves the equation:
QD (P *, P ' , I ) = QS (P *,v ,w )
17
18
Equilibrium Price
Determination
The equilibrium price depends on many
exogenous factors:
Demand curves depend on other goods prices,
income, preferences (utility function)
Supply curves depend on inputs prices
changes in any of these factors will likely result in
a new equilibrium price
Economists predict the new situation by

computing the new equilibrium. The
equilibrium is an economists prediction of the
new situation after a change has taken place 19
Equilibrium Price
Determination
The interaction between
market demand and market
supply determines the
equilibrium price
Price
S
P1
D
Q1
Quantity
20
Market Reaction to a
Shift in Demand
Market Reaction to a
Shift in Demand
If many buyers experience

an increase in their demands,
the market demand curve
will shift to the right
Price
S
If the market price rises,

firms will increase their
level of output
Price
SMC
SAC
P2
P1
Equilibrium price and

equilibrium quantity will
both rise
P2
P1
This is the short-run

supply response to an
increase in market price
D
Q1
Q2
Quantity
q1
q2
Quantity
21
Shifts in Supply and

Demand Curves
22
Shifts in Supply and

Demand Curves
Demand curves shift because

incomes change
prices of substitutes or complements change
preferences change
Supply curves shift because

input prices change
technology changes
number of producers change
23
When either a supply curve or a

demand curve shift, equilibrium price
and quantity will change
The relative magnitudes of these
changes depends on the shapes of the
supply and demand curves (elasticity is
very important !!!!)
24
Shifts in Supply
Small increase in price,
large drop in quantity
Price
Shifts in Demand
Large increase in price,

small drop in quantity
Price
Large increase in price,

small rise in quantity
Price
Small increase in price,

large rise in quantity
Price
P
P
P
Elastic Demand
Quantity
Q Q
Inelastic Demand
Quantity
25
D
Q
Quantity
Inelastic Supply
26
Quantity
Elastic Supply
Mathematical Model of
Supply and Demand
Putting it together
Using econometrics, we can estimate the
demand and supply curve, and how they
depend on other factors (input prices, other
goods prices)
Compute the new equilibrium when these other
factors change
This would be our prediction
However, it could be enough to estimate the
different elasticities rather than the whole new
curves
27
Suppose that the demand function is

represented by
QD = D(P,)
is a parameter that shifts the demand curve
D/ = D can have any sign
D/P = DP < 0
28
Supply and Demand
Supply and Demand
The supply relationship can be shown as

QS = S(P,)
is a parameter that shifts the supply curve
S/ = S can have any sign
To analyze the comparative statics of

this model, we need to use the total
differentials of the supply and demand
functions:
dQD = DPdP + Dd
dQS = SPdP + Sd
S/P = SP > 0
Maintenance of equilibrium requires that
Equilibrium requires that QD = QS
dQD = dQS
29
30
Supply and Demand
Supply and Demand
Suppose that the demand parameter ()

changed while remains constant
The equilibrium condition requires that
We can convert our analysis to elasticities
DPdP + Dd = SPdP
eP , =
Dividing numerator and denominator by Q
D
P
=
SP DP
Because SP - DP > 0, P/ will have the

same sign as D
31
D
P
=
P SP DP P
eP , =
P
(SP DP )
Q
eQ,
eS,P eQ,P
32
Long-Run Analysis
Long-Run Analysis
So far, we have studied short run

In the long run, a firm may adapt all of its
inputs to fit market conditions
New firms will be lured into any market

for which economic profits are greater
than zero
profit-maximization for a price-taking firm

implies that price is equal to long-run MC
entry of firms will cause the short-run

industry supply curve to shift outward
market price and profits will fall
the process will continue until economic
profits are zero
Firms can also enter and exit an industry

in the long run
perfect competition assumes that there are
no special costs of entering or exiting an
industry
33
34
Long-Run Competitive
Equilibrium
Long-Run Analysis
Existing firms will leave any industry for
which economic profits are negative
exit of firms will cause the short-run industry
supply curve to shift inward
market price will rise and losses will fall
the process will continue until economic
profits are zero
35
A perfectly competitive industry is in

long-run equilibrium if there are no
incentives for profit-maximizing firms to
enter or to leave the industry
That is, if profits are are zero in the longrun equilibrium
this will occur when the number of firms is
such that P = MC = AC and each firm
operates at minimum AC
36
Long-Run Competitive
Equilibrium
Long-Run Equilibrium:
Constant-Cost Case
We will assume that all firms in an

industry have identical cost curves
Assume that the entry of new firms in an

industry has no effect on the cost of
inputs
no firm controls any special resources or

technology
no matter how many firms enter or leave

an industry, a firms cost curves will remain
unchanged
The equilibrium long-run position

requires that each firm earn zero
economic profit
This is referred to as a constant-cost

industry (Example 10.5)
37
38
Constant-Cost Case
Constant-Cost Case
This is a long-run equilibrium for this industry
Price
SMC
MC
Suppose that market demand rises to D

P = MC = AC
Price
Price
SMC
Price
MC
Market price rises to P2
AC
AC
P2
P1
P1
D
D
q1
A Typical Firm
Quantity
Q1
Total Market
D
39
Quantity
q1
A Typical Firm
Quantity
Q1 Q2
40
Quantity
Total Market
10
Constant-Cost Case
Constant-Cost Case
In the short run, each firm increases output to q2

Economic profit > 0
Price
SMC
Price
MC
In the long run, new firms will enter the industry

Economic profit will return to 0
Price
SMC
Price
MC
AC
AC
P2
P1
P1
D
q1
q2
Quantity
A Typical Firm
D
41
Quantity
Q1 Q2
Total Market
Constant-Cost Case
Price
Price
MC
AC
LS
P1
D
D
q1
A Typical Firm
Quantity
Q1
Q3
Quantity
Q1
Q3
42
Quantity
Total Market
Shape of the Long-Run

Supply Curve
The long-run supply curve will be a horizontal line

(infinitely elastic) at p1
SMC
q1
A Typical Firm
43
Quantity
The zero-profit condition is the factor that

determines the shape of the long-run cost
curve
if average costs are constant as firms enter,
long-run supply will be horizontal
if average costs rise as firms enter, long-run
supply will have an upward slope
if average costs fall as firms enter, long-run
supply will be negatively sloped
44
Total Market
11
Increasing-Cost Industry
Suppose that we are in long-run equilibrium in this industry

P = MC = AC
The entry of new firms may cause the

average costs of all firms to rise
Price
SMC
Price
MC
prices of scarce inputs may rise

new firms may impose external costs on
existing firms
new firms may increase the demand for
tax-financed services
AC
P1
D
q1
45
Quantity
A Typical Firm (before entry)
SMC
MC
Total Market

Market price rises to P2 and firms increase output to q2
Price
46
Quantity
Q1
Positive profits attract new firms and supply shifts out

Entry of firms causes costs for each firm to rise
Price
Price
SMC
Price
MC
AC
AC
P2
P3
P1
P1
D
q1
q2
Quantity
Q1 Q2
Total Market
D
47
Quantity
q3
A Typical Firm (after entry)
Quantity
Q1
Q3
48
Quantity
Total Market
12
Decreasing-Cost Industry
The long-run supply curve will be upward-sloping
Price
SMC
The entry of new firms may cause the

average costs of all firms to fall
Price
MC
new firms may attract a larger pool of

trained labor
entry of new firms may provide a critical
mass of industrialization
AC
LS
p3
permits the development of more efficient

transportation and communications networks
p1
D
D
q3
Quantity
A Typical Firm (after entry)
Q1
49
Quantity
Q3
50
Total Market
Decreasing-Cost Case
Market price rises to P2 and firms increase output to q2
Suppose that we are in long-run equilibrium in this industry

Price
SMC
P = MC = AC
Price
MC
Price
SMC
Price
MC
AC
AC
P2
P1
P1
D
q1
Quantity
Q1
Total Market
D
51
Quantity
q1
q2
Quantity
Q1 Q2
D
52
Quantity
Total Market
13
Positive profits attract new firms and supply shifts out

Entry of firms causes costs for each firm to fall
Price
SMC
The long-run industry supply curve will be downward-sloping

Price
Price
Price
SMC
MC
MC
AC
AC
P1
P1
P3
q1 q3
Quantity
Q1
P3
D
Q3
53
Quantity
Total Market
D
q1 q3
Quantity
Classification of Long-Run
Supply Curves
Q1
LS
54
Q3 Quantity
Total Market
Classification of Long-Run
Supply Curves
Constant Cost
Decreasing Cost
entry does not affect input costs

the long-run supply curve is horizontal at
the long-run equilibrium price
entry reduces input costs

the long-run supply curve is negatively
sloped
Increasing Cost
entry increases inputs costs
the long-run supply curve is positively
sloped
55
56
14
Long-Run Elasticity of Supply

The long-run elasticity of supply (eLS,P)
records the proportionate change in longrun industry output to a proportionate
change in price
eLS ,P =
% change in Q QLS P
=
% change in P
P QLS
eLS,P can be positive or negative

the sign depends on whether the industry
exhibits increasing or decreasing costs
Comparative Statics Analysis

of Long-Run Equilibrium
Comparative statics analysis of long-run
equilibria can be conducted using
estimates of long-run elasticities of
supply and demand
Remember that, in the long run, the
number of firms in the industry will vary
from one long-run equilibrium to another
57
58


Assume that we are examining a

constant-cost industry
Suppose that the initial long-run
equilibrium industry output is Q0 and the
typical firms output is q* (where AC is
minimized)
The equilibrium number of firms in the
industry (n0) is Q0/q*
A shift in demand that changes the

equilibrium industry output to Q1 will
change the equilibrium number of firms to
59
n1 = Q1/q*
The change in the number of firms is

n1 n0 =
Q1 Q0
q*
completely determined by the extent of the

demand shift and the optimal output level for
60
the typical firm
15

The effect of a change in input prices
can also be studied
Important Points to Note:

In the short run, equilibrium prices are
established by the intersection of what
demanders are willing to pay (as reflected
by the demand curve) and what firms are
willing to produce (as reflected by the
short-run supply curve)
these prices are treated as fixed in both
demanders and suppliers decision-making
processes
61
62
A shift in either demand or supply will

cause the equilibrium price to change
In the long run, the number of firms is

variable in response to profit opportunities
the extent of such a change will depend on

the slopes of the various curves
Firms may earn positive profits in the

short run
because fixed costs must always be paid,
firms will choose a positive output as long as
revenues exceed variable costs
63
the assumption of free entry and exit implies

that firms in a competitive industry will earn
zero economic profits in the long run (P = AC)
because firms also seek maximum profits, the
equality P = AC = MC implies that firms will
operate at the low points of their long-run
average cost curves
64
16
The shape of the long-run supply curve

depends on how entry and exit affect
firms input costs
Changes in long-run market equilibrium

will also change the number of firms
in the constant-cost case, input prices do not

change and the long-run supply curve is
horizontal
if entry raises input costs, the long-run supply
curve will have a positive slope
precise predictions about the extent of these

changes is made difficult by the possibility
that the minimum average cost level of
output may be affected by changes in input
costs or by technical progress
65
66

If changes in the long-run equilibrium in a
market change the prices of inputs to that
market, the welfare of the suppliers of
these inputs will be affected
such changes can be measured by changes
in the value of long-run producer surplus
67
Chapter 11
APPLIED COMPETITIVE
ANALYSIS
Copyright 2005 by South-Western, a division of Thomson Learning. All rights reserved.
68
17
Economic Efficiency and

Welfare Analysis

Welfare Analysis
Price
The area between the demand and the

supply curve represents the sum of
consumer and producer surplus
Consumer surplus is the

area above price and below
demand
measures the total additional value

obtained by market participants by being
able to make market transactions
P*
Producer surplus is the

area below price and
above supply
This area is maximized at the

competitive market equilibrium
Quantity
Q*
69

Welfare Analysis

Welfare Analysis
Price
S
At output Q1, total surplus

will be smaller
At outputs between Q1 and
Q*, demanders would value
an additional unit more than
it would cost suppliers to
produce
P*
70
Mathematically, we wish to maximize

consumer surplus + producer surplus =
Q
[U (Q ) PQ ] + [PQ P (Q )dQ ] = U (Q ) P (Q )dQ
In long-run equilibria along the long-run

supply curve, P(Q) = AC = MC
Quantity
Q1
Q*
71
72
18

Welfare Analysis
Welfare Loss Computations

Use of consumer and producer surplus
notions makes possible the explicit
calculation of welfare losses caused by
restrictions on voluntary transactions
Maximizing total surplus with respect to Q

yields
U(Q) = P(Q) = AC = MC
maximization occurs where the marginal value of
Q to the representative consumer is equal to
market price
So, in the market equilibrium in the long run
This tell us that under the assumptions that we

have used (competitive industry), the government
must argue why she was to alter the equilibrium
73
price through policy
in the case of linear demand and supply

curves, the calculation is simple because
the areas of loss are often triangular
74
Suppose that the demand is given by
Restriction of output to Q0 = 3 would

create a gap between what demanders
are willing to pay (PD) and what
suppliers require (PS)
QD = 10 - P
and supply is given by

QS = P - 2
Market equilibrium occurs where P* = 6

and Q* = 4
75
PD = 10 - 3 = 7
PS = 2 + 3 = 5
76
19

The welfare loss from restricting output
to 3 is the area of a triangle
Price
The loss = (0.5)(2)(1) = 1

6
5

The welfare loss will be shared by
producers and consumers
In general, it will depend on the price
elasticity of demand and the price
elasticity of supply to determine who
bears the larger portion of the loss
the side of the market with the smallest
price elasticity (in absolute value)
D
3
Quantity
77
Price Controls and Shortages
78

Price
Sometimes governments may seek to

control prices at below equilibrium
levels
Initially, the market is

in long-run equilibrium
at P1, Q1
SS
LS
this will lead to a shortage
We can look at the changes in producer

and consumer surplus from this policy
to analyze its impact on welfare
P1
Demand increases to D
D
D
Q1
79
Quantity
80
20

Price
SS
In the short run, price

rises to P2
P2
LS
P3
Firms would begin to

enter the industry
P1

Price
Suppose that the

government imposes
a price ceiling at P1
SS
LS
P3
P1
The price would end

up at P3
Quantity
Q1
There will be a
shortage equal to
Q2 - Q1
Q1
Quantity
Q2
81

Price
Some buyers will gain

because they can
purchase the good for
a lower price
SS
82

Price
The gain to consumers

is also a loss to
producers who now
receive a lower price
SS
LS
LS
P3
P3
P1
This gain in consumer

surplus is the shaded
rectangle
P1
D
Q1
Q2
Quantity
Q1
83
Q2
The shaded rectangle

therefore represents a
pure transfer from
producers to consumers
No welfare loss there
Quantity
84
21

Price
SS
LS
P3
P1
This shaded triangle

represents the value
of additional
consumer surplus
that would have
been attained
without the price
control

Price
SS
LS
P3
P1
D
Q1
Quantity
Q2
This shaded triangle

represents the value
of additional
producer surplus
that would have
been attained
without the price
control
Q1
Q2
Quantity
85

Price
SS
LS
P3
This shaded area

represents the total
value of mutually
beneficial transactions
that are prevented by
the government
86
Disequilibrium Behavior
Notice that there are customers
willing to pay more to buy the good
This could lead to a black market
P1
D
Q1
Q2
This is a measure of
the pure welfare
costs of this policy
Quantity
87
88
22
Tax Incidence
Tax Incidence
To discuss the effects of a per-unit tax

(t), we need to make a distinction
between the price paid by buyers (PD)
and the price received by sellers (PS)
Maintenance of equilibrium in the

market requires
dQD = dQS
or
PD - PS = t
DPdPD = SPdPS
In terms of small price changes, we

wish to examine
Substituting, we get
DPdPD = SPdPS = SP(dPD - dt)
dPD - dPS = dt
89
Tax Incidence
90
Tax Incidence
Because eD 0 and eS 0, dPD /dt 0
and dPS /dt 0
If demand is perfectly inelastic (eD = 0),
the per-unit tax is completely paid by
demanders
If demand is perfectly elastic (eD = ), the
per-unit tax is completely paid by
suppliers
We can now solve for the effect of the

tax on PD:
dPD
SP
eS
=
=
dt
SP DP eS eD
Similarly,
dPS
DP
eD
=
=
dt
SP DP eS eD
91
92
23
Tax Incidence
Tax Incidence
In general, the actor with the less elastic

responses (in absolute value) will
experience most of the price change
caused by the tax
Price
S
P*
dPS / dt
e
= D
dPD / dt
eS
A per-unit tax creates a

wedge between the price
that buyers pay (PD) and
the price that sellers
receive (PS)
PD
t
PS
Q**
Quantity
Q*
93
94
Tax Incidence
Tax Incidence
Price
Price
S
Buyers incur a welfare loss

equal to the shaded area
PD
P*
Sellers also incur a welfare

loss equal to the shaded area
PD
But some of this loss goes

to the government in the
form of tax revenue
P*
But some of this loss goes

to the government in the
form of tax revenue
PS
PS
Q**
Q*
Quantity
Q**
95
Q*
Quantity
96
24
Deadweight Loss and

Elasticity
Tax Incidence
Price
All nonlump-sum taxes involve

deadweight losses
PD
Therefore, this is the deadweight loss from the tax
P*
A linear approximation to the deadweight

loss accompanying a small tax, dt, is
given by
PS
Q**
DW = -0.5(dt)(dQ)
Quantity
Q*
the size of the losses will depend on the

elasticities of supply and demand
97
Deadweight Loss and

Elasticity
98
Deadweight Loss and

Elasticity
From the definition of elasticity, we know

that
dQ = eDdPD Q0/P0
Deadweight losses are zero if either eD

or eS are zero
the tax does not alter the quantity of the
good that is traded
This implies that
Deadweight losses are smaller in

situations where eD or eS are small
dQ = eD [eS /(eS - eD)] dt Q0/P0
Substituting, we get
2
dt
DW = 0.5 [eD eS /(eS eD )]P0Q0
P0
99
100
25
Gains from International Trade
Transactions Costs
Transactions costs can also create a
wedge between the price the buyer pays
and the price the seller receives
real estate agent fees
broker fees for the sale of stocks
Price
S
P*
If the transactions costs are on a per-unit

basis, these costs will be shared by the
buyer and seller
Price
S
If the world price (PW)

is less than the domestic
price, the price will fall
to PW
Quantity demanded will
rise to Q1 and quantity
supplied will fall to Q2
P*
PW
Q2
Q*
Q1
imports
Quantity
Q*
depends on the specific elasticities involved

101
In the absence of
international trade,
the domestic
equilibrium price
would be P* and
the domestic
equilibrium quantity
would be Q*
102

Price
S
Consumer surplus rises

Producer surplus falls
There is an unambiguous
welfare gain
P*
PW
Imports = Q1 - Q2
Quantity
Q1
103
Q*
Q2
Quantity
104
26
Effects of a Tariff
Price
S
Effects of a Tariff
Suppose that the government

creates a tariff that raises
the price to PR
Quantity demanded falls
to Q3 and quantity supplied
rises to Q4
PR
PW
Imports are now Q3 - Q4
Price
Consumer surplus falls

S
Producer surplus rises

The government gets
tariff revenue
PR
PW
These two triangles

represent deadweight loss
Q2 Q4
Q3 Q1
Quantity
imports
Q2 Q4
Quantity
Q3 Q1
105
Quantitative Estimates of
Deadweight Losses
106
Price
Quantitative Estimates of
Deadweight Losses
Estimates of the sizes of the welfare

loss triangle can be calculated
Because PR = (1+t)PW, the proportional
change in quantity demanded is
DW1 = 0.5(PR PW )(Q1 Q3 )

DW1 = 0.5t 2eD PW Q1
PR
PW
Q3 Q1 PR PW
eD = teD
=
Q1
PW
DW2 = 0.5(PR PW )(Q4 Q2 )

D
Q2 Q4
107
The areas of these two

triangles are
Q3 Q1
DW2 = 0.5t 2eS PW Q2

Quantity
108
27
Other Trade Restrictions
Trade and Tariffs
A quota that limits imports to Q3 - Q4

would have effects that are similar to
those for the tariff
If the market demand curve is

QD = 200P-1.2
and the market supply curve is
same decline in consumer surplus

same increase in producer surplus
QS = 1.3P,
One big difference is that the quota

does not give the government any tariff
revenue
the deadweight loss will be larger
the domestic long-run equilibrium will

occur where P* = 9.87 and Q* = 12.8
109
Trade and Tariffs
110
Trade and Tariffs
If the world price was PW = 9, QD would

be 14.3 and QS would be 11.7
imports will be 2.6
The welfare effect of the tariff can be

calculated
DW1 = 0.5(0.5)(14.3 - 13.4) = 0.225
If the government placed a tariff of 0.5

on each unit sold, the world price will be
PW = 9.5
imports will fall to 1.0
111
DW2 = 0.5(0.5)(12.4 - 11.7) = 0.175
Thus, total deadweight loss from the

tariff is 0.225 + 0.175 = 0.4
112
28
The concepts of consumer and producer

surplus provide useful ways of analyzing
the effects of economic changes on the
welfare of market participants
changes in consumer surplus represent
changes in the overall utility consumers
receive from consuming a particular good
changes in long-run producer surplus
represent changes in the returns product
inputs receive
Price controls involve both transfers

between producers and consumers and
losses of transactions that could benefit
both consumers and producers
113

Tax incidence analysis concerns the
determination of which economic actor
ultimately bears the burden of a tax
this incidence will fall mainly on the actors
who exhibit inelastic responses to price
changes
taxes also involve deadweight losses that
constitute an excess burden in addition to
the burden imposed by the actual tax
revenues collected
115
114

Transaction costs can sometimes be
modeled as taxes
both taxes and transaction costs may affect
the attributes of transactions depending on
the basis on which the costs are incurred
116
29

Trade restrictions such as tariffs or
quotas create transfers between
consumers and producers and
deadweight losses of economic welfare
the effects of many types of trade
restrictions can be modeled as being
equivalent to a per-unit tariff
117
30

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Market Demand

We start by studying the demand of the

Copyright 2005 by South-Western, a division of Thomson Learning. All rights reserved.

Assume that there are only two goods

To construct the market demand curve,

An individuals demand for x is

Market demand for X = x i ( px , py , Ii )

Shifts in the Market

The market demand summarizes the ceteris

changes in other determinants of the demand for X

changes in px result in movements along the curve

See example 10.1 in the book to see how to do it

Elasticity of Market Demand

Elasticity of Market Demand

QD (P, P ' , I ) P '

The income elasticity of market demand is

Market demand is characterized by

We will study supply of the market and

each firm attempts to maximize profits

transactions are costless

Timing of the Supply Response

Market Supply in the short run

In the analysis of competitive pricing, the time period

The quantity of output supplied to the

the amount supplied by each firm depends

existing firms can alter their quantity supplied by

The short-run market supply curve will

Determination of the eq. Price

Short-Run Market Supply

they can do this by altering the levels of the

Firms are assumed to face the same

Short-Run Market Supply Curve

Short-Run Supply Elasticity

To derive the market supply curve, we sum the

The short-run supply elasticity describes

Because price and quantity supplied are

We have studied the market demand

suppliers are supplying the optimal quantity given

An equilibrium price (P*) solves the equation:

Economists predict the new situation by

If many buyers experience

If the market price rises,

Equilibrium price and

This is the short-run

Shifts in Supply and

Shifts in Supply and

Demand curves shift because

Supply curves shift because

When either a supply curve or a

Large increase in price,

Large increase in price,

Small increase in price,

Suppose that the demand function is

The supply relationship can be shown as

To analyze the comparative statics of

Maintenance of equilibrium requires that

Equilibrium requires that QD = QS

Suppose that the demand parameter ()

We can convert our analysis to elasticities

Dividing numerator and denominator by Q

Because SP - DP > 0, P/ will have the

So far, we have studied short run

New firms will be lured into any market