CHAPTER-8: THE ANALYSIS

OF COMPETITIVE MARKETS
Course instructor:
Dr. Tamgid Ahmed Chowdhury

CHAPTER OBJECTIVES

We will:
Evaluate the Gains and Losses from Government
PoliciesConsumer and Producer Surplus
Discuss the Efficiency of a Competitive Market
Analyze Minimum Pricing policies
Analyze Price Supports and Production Quotas
Discuss Import Quotas and Tariffs
Analyze the Impacts of a Tax or Subsidy

CONSUMER SURPLUS
It is the difference
between what consumer
is willing to pay and what
he/she is actually paying
In this diagram,
consumer A is ready to
pay 10 taka but actually
paying 5 taka (market
price) thus has a surplus
of (10-5) = 5 taka.
For consumer B, the
amount is 2 taka. But for
consumer-C, there is no
surplus.

PRODUCER SURPLUS
Its the difference
between the market
price and the
production cost of a
specific quantity.
In other words its the
area between supply
curve and the price
line.

EFFICIENCY IN THE MARKET

EQUILIBRIUM
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.
The price of a good has been
regulated to be no higher
than Pmax, which is below
the market-clearing price P0.
And this action creates dead
weighted loss

EVALUATING THE IMPACTS OF

GOVERNMENT INTERVENTION
Price ceiling or price
control: Government sets
a price which is lower
than the equilibrium
price. Charging a price
higher than the ceiling
price is illegal.
Government intervention
through Price ceiling is
inefficient because it
creates DWL.
Example: Rent control,
rationing the price of gas
or electricity etc.

PRICE CEILING: MATHEMATICAL

IMPLICATION
Supply and demand equations for government
housing are given below.
Supply: QS = 16,000 + 0.4P
Demand: QD = 32,000 - 0.4P
Now assume that, government has set a price ceiling
of 15000 Taka by considering the social need of
the product/service. What will be the impacts of
this intervention. Do you support this type of
intervention by government? Why or why not?

PRICE FLOOR OR MINIMUM

PRICE
A price minimum is
a regulation that
makes it illegal to
trade at a price
lower than a
specified level.
If the price minimum
< the equilibrium
price, no effect
If the price minimum
> the equilibrium
price, powerful effects
Example is minimum
wage rule.

PRICE SUPPORT BY THE

GOVERNMENT
price support: Price set
by government above
free market level and
maintained by
governmental purchases
of excess supply.
To maintain a price Ps
above the market-clearing
price P0, the government
buys a quantity Qg.
The gain to producers is A
+ B + D. The loss to
consumers is A + B.
Change in welfare = CS +
PS Cost to Govt.

PRICE SUPPORT: MATHEMATICAL

EXAMPLE
1981 Supply of rice: QS = 1800 + 240P
1981 Demand for rice: QD = 3550 - 266P
What is the market clearing price?
Assume now that government wants to support a
price of $3.70/kg and thus buys the additional
amount from the market. Find the change in
consumer surplus, cost to the government and
gain of the producer.
(Hint: To set the price at $3.70, government must
buy Qg= 506P 1750.)

IMPORT QUOTAS AND TARIFFS

When imports are
reduced, the
domestic price is
increased from Pw
to P*.
This can be
achieved by a
quota, or by a
tariff T = P* Pw.

MATHEMATICAL EXAMPLE ON
TARIFF
U.S. supply: QS = -7.48
+ 0.84P
U.S. demand: QD = 26.7
- 0.23P
Price was initially 12
cents/pound.
Government has
imposed a tariff of 15
cents/pound. Show the
change in consumer
surplus, producer
surplus, government
revenue gain and DWL
according to new tariff.

IMPACT OF TAX
Who really pays these
taxes?
Income tax (Direct tax)
- deducted from your
pay,
GST (Indirect tax) added to the price of
most things you buy
Direct tax reduces the
buying power of the
individuals and thus
shifts the demand curve
to the left.

INCIDENCE OF INDIRECT
TAX
Figure shows the effects of this
tax.
With no tax: Equil. price = $3.00
a packet
With tax on sellers of $1.50 a
packet
Indirect tax amount equals the
vertical distance between two
supply curves
The market price paid by buyers
rises to $4.00 a packet and the
quantity bought decreases.
The price received by the sellers
falls to $2.50 a packet.
Lets see the change in consumer
and producer surplus and DWL.

INEFFICIENCY CREATED BY
INDIRECT TAX
Tax revenue takes part of the total surplus.
The decreased quantity creates a deadweight loss

MATHEMATICAL EXAMPLE ON
INDIRECT TAX
Demand equation is Q = 9 P
Supply equation is Q = -1 + P
Government has imposed an indirect tax of 2 Taka on
the product. Find the new equilibrium, change in
consumer and producer surplus and amount of
government revenue and DWL.
First convert the Supply equation to: P =1 + Q
And Demand equation to: P = 9 -Q .

THE IMPACT OF A TAX OR SUBSIDY

Impact of a Tax Depends on Elasticities of Supply and Demand

If demand is very inelastic relative to

supply, the burden of the tax falls
mostly on buyers.

If demand is very elastic relative to

supply, it falls mostly on sellers.

EFFECTS OF SUBSIDY
Price = $40 a tonne
and the Quantity
produced = 40 million
tonnes a year.
With a subsidy of $20
a tonne: Marginal cost
minus subsidy falls by
$20 a tonne and the
curve S subsidy is
the new supply curve.
Market Price falls to
$30 a tonne