Economic Analysis for Business Session X: Consumer Surplus, Producer Surplus and Market Efficiency-2

1
Economic Analysis for BusinessSession X
Consumer Surplus, Producer Surplus and Market
Efficiency-2
InstructorSandeep Basnyat 9841892281 Sandeep_basn
yat_at_yahoo.com
2

• How do taxes affect the economic well-being of
  market participants?

3
Tax Effect
Governments tax revenue T ? Q where T the
size of the tax Q the quantity of the good sold
Price
CS
??
PS
Quantity
0
4
How a Tax Effects Welfare? Deadweight Loss !
Price

A deadweight loss is the fall in total surplus
that results from a market distortion, such as a
tax.


Quantity
0
5
Tax Wedge
P
S
PE
D
Q
6
Welfare Effect of a Tax
A
B
C
E
D
F
7
Welfare Matrix
Before Tax
After Tax
Net ?
Consumer Surplus
Producer Surplus
Tax Revenue
Total Surplus
8
Consumer Surplus Before Tax
P
S
A
B
C
PE
E
D
D
F
Q
9
Welfare Matrix
A B C
10
Producer Surplus Before Tax
P
S
A
B
C
PE
E
D
D
F
Q
11
Welfare Matrix
D E F
0
A B C D E F
12
Consumer Surplus After Tax
P
S
A
B
C
PE
E
D
D
F
Q
13
Welfare Matrix
A
-(B C)
14
Producer Surplus After Tax
P
S
A
B
C
PE
E
D
D
F
Q
15
Welfare Matrix
F
-(D E)
16
Revenue After Tax
P
S
A
B
C
PE
E
D
D
F
Q
17
Welfare Matrix
B D
B D
-(C E)
A B D F
18
-(C E)
P
S
A
B
C
PE
E
D
D
F
Q
19
Is there any relationship between Elasticity and
Deadweight Loss?
20
Tax Distortions and Elasticities
(a) Inelastic Supply
Price
0
Quantity
21
Tax Distortions and Elasticities
(b) Elastic Supply
Price
0
Quantity
22
Tax Distortions and Elasticities
(c) Inelastic Demand
Price
0
Quantity
23
Tax Distortions and Elasticities
(d) Elastic Demand
Price
0
Quantity
24
DETERMINANTS OF THE DEADWEIGHT LOSS

• The greater the elasticities of demand and
  supply
• the larger will be the decline in equilibrium
  quantity and,
• the greater the deadweight loss of a tax.

Policy makers should be careful before imposing
Taxes on Products !!
25
Is there any relationship between DEADWEIGHT LOSS
and TAX REVENUE as Taxes very?
26
Revenue and Tax Size
27
How Deadweight Loss and Tax Revenue Vary with the
Size of a Tax
(a) Deadweight Loss
Deadweight
Loss
0
Tax Size
28
How Deadweight Loss and Tax Revenue Vary with the
Size of a Tax
(b) Revenue (the Laffer curve)
Tax
Revenue
0
Tax Size
29
Numerical Problems

• Consider the previous market with Demand curve q
  16 - 10p and Supply curve q -8 20p. (Here q
  is in millions of kg. and p is in dollars per
  kg.). Imagine that the government imposes a 0.60
  per-unit tax on the prices that buyers pay.
• 1. Calculate the Change in Consumer surplus,
  Change in Producer surplus and Government
  Revenue.
• Calculate the deadweight loss due to imposition
  of tax in this market.
• (Hint To find the Consumer surplus and Producer
  surplus, find the Prices when Quantity demanded
  and Quantity Supplied is zero)

30
Numerical Problems

• Consider the previous market with Demand curve q
  16 - 10p and Supply curve q -8 20p. (Here q
  is in millions of kg. and p is in dollars per
  kg.). Imagine that the government imposes a 0.60
  per-unit tax on the prices that buyers pay.
• Change in Consumer surplus 2.4
• Change in Producer surplus 1.2
• Government Revenue 2.4 million
• 2. Deadweight loss 1.2 million

31
Application International TradeA. Free
Trade Determinants of Imports and ExportsB.
Restricted Trade1. Impact of Tariff2. Impact of
QuotaC. Arguments for Imposing Restrictions
32
The Equilibrium without International Trade
Price
of Steel
0
Quantity
of Steel
33
Assume that the country is opened to FREE TRADE

• 3 Primary Impacts
• Domestic Consumers can buy from world markets
• Domestic producers face competitions from the
  international producers
• Eventually domestic price equals the world price

34
Case 1 World Price Higher than Domestic
Equilibrium Price
Price
Does Free Trade benefit exporting countries?
of Steel
0
Quantity
of Steel
35
How Free Trade Affects Welfare in an Exporting
Country
Price
of Steel
0
Quantity
of Steel
36
Welfare Matrix
Before Trade
After Trade
Net ?
Consumer Surplus
AB
Producer Surplus
Total Surplus
37
How Free Trade Affects Welfare in an Exporting
Country
Price
of Steel
0
Quantity
of Steel
38
Welfare Matrix
Before Trade
After Trade
Net ?
Consumer Surplus
AB
A
- B
Producer Surplus
Total Surplus
39
How Free Trade Affects Welfare in an Exporting
Country
Price
of Steel
0
Quantity
of Steel
40
Welfare Matrix
Before Trade
After Trade
Net ?
Consumer Surplus
AB
A
- B
Producer Surplus
C
Total Surplus
41
How Free Trade Affects Welfare in an Exporting
Country
Price
of Steel
0
Quantity
of Steel
42
Welfare Matrix
Before Trade
After Trade
Net ?
Consumer Surplus
AB
A
- B
Producer Surplus
C
BCD
(BD)
Total Surplus
43
Welfare Matrix
Before Trade
After Trade
Net ?
Consumer Surplus
AB
A
- B
Producer Surplus
C
BCD
(BD)
Total Surplus
D
ABC
ABCD
Gains from trade for Exporting Country
44
Overall Impact of the Trade?
45
Trade creates winners and losers
46
Winners and Losers in Exporting Country
Before Trade
After Trade
Net ?

• B

Consumer Surplus
AB
A
Producer Surplus
C
BCD
(BD)
Total Surplus
D
ABC
ABCD
Consumers lose
47
Winners and Losers in Exporting Country
Before Trade
After Trade
Net ?
Consumer Surplus
AB
A

• B

Producer Surplus
(BD)
C
BCD
Total Surplus
D
ABC
ABCD
Producers Gain
48
Winners and Losers in Exporting Country
Before Trade
After Trade
Net ?
Consumer Surplus

• B

AB
A
Producer Surplus
C
BCD
(BD)
Total Surplus
D
ABC
ABCD
Country as whole benefit
49
Case 2 World Price lower than domestic
equilibrium price
Price
Does Free Trade benefit importing countries?
of Steel
Quantity
0
of Steel
50
How Free Trade Affects Welfare in an Importing
Country
Price
of Steel
0
Quantity
of Steel
51
Figure 5 How Free Trade Affects Welfare in an
Importing Country
Price
of Steel
0
Quantity
of Steel
52
How Free Trade Affects Welfare in an Importing
Country
53
Trade creates winners and losers for importing
countries1. Consumers gain2. Producers lose3.
Country as a whole benefit
54
The Effects of a Tariff

• A tariff is a tax on goods produced abroad and
  sold domestically.
• Tariffs raise the price of imported goods above
  the world price by the amount of the tariff.

55
The Effects of a Tariff
Price
of Steel
Tariff
0
Quantity
of Steel
56
Welfare before Tariff
Price
of Steel
0
Quantity
of Steel
57
Welfare Effects of a Tariff
Price
of Steel
Tariff
0
Quantity
of Steel
58
The Effects of an Import Quota

• An import quota is a limit on the quantity of a
  good that can be produced abroad and sold
  domestically.

59
The Effects of an Import Quota
Price
of Steel
Quota
0
Quantity
of Steel
60
The Effects of an Import Quota

• Because the quota raises the domestic price above
  the world price, domestic buyers of the good are
  worse off, and domestic sellers of the good are
  better off.
• License holders are better off because they make
  a profit from buying at the world price and
  selling at the higher domestic price.

61
The Effects of an Import Quota
Price
of Steel
Quota
E"
0
Quantity
of Steel
62
The Effects of an Import Quota
63
The Effects of an Import Quota

• With a quota, total surplus in the market
  decreases by an amount referred to as a
  deadweight loss.
• The quota can potentially cause an even larger
  deadweight loss, if a mechanism such as lobbying
  is employed to allocate the import licenses.

64
The Lessons for Trade Policy

• Both tariffs and import quotas . . .
• raise domestic prices.
• reduce the welfare of domestic consumers.
• increase the welfare of domestic producers.
• cause deadweight losses.

65
The Lessons for Trade Policy

• Other Benefits of International Trade
• Increased variety of goods
• Lower costs through economies of scale
• Increased competition
• Enhanced flow of ideas

66
THE ARGUMENTS FOR RESTRICTING TRADE

• Jobs
• National Security
• Infant Industry
• Unfair Competition
• Protection-as-a-Bargaining Chip

67
CASE STUDY Trade Agreements and the World Trade
Organization

• Unilateral when a country removes its trade
  restrictions on its own.
• Multilateral a country reduces its trade
  restrictions while other countries do the same.

68
CASE STUDY Trade Agreements and the World Trade
Organization

• NAFTA
• The North American Free Trade Agreement (NAFTA)
  is an example of a multilateral trade agreement.
• In 1993, NAFTA lowered the trade barriers among
  the United States, Mexico, and Canada.

69
CASE STUDY Trade Agreements and the World Trade
Organization

• GATT/WTO
• The General Agreement on Tariffs and Trade (GATT)
  refers to a continuing series of negotiations
  among many of the worlds countries with a goal
  of promoting free trade.
• GATT/WTO has successfully reduced the average
  tariff among member countries from about 40
  percent after WWII to about 5 percent today.

70
Thank you