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Ch16
- 2. Market Equilibrium A market is in equilibrium when total quantity demanded by buyers equals total quantity supplied by sellers.
- 7. Market Equilibrium Market p demand Market supply q=S(p) D(p*) = S(p*); the market is in equilibrium. p* q=D(p) q* D(p), S(p)
- 8. Market Equilibrium Market p demand Market supply q=S(p) D(p’) < S(p’); an excess of quantity supplied over quantity demanded. q=D(p) p’ p* D(p’) S(p’) D(p), S(p)
- 9. Market Equilibrium Market p demand Market supply q=S(p) D(p’) < S(p’); an excess of quantity supplied over quantity demanded. q=D(p) p’ p* D(p’) S(p’) D(p), S(p) Market price must fall towards p*.
- 10. Market Equilibrium Market p demand Market supply q=S(p) D(p”) > S(p”); an excess of quantity demanded over quantity supplied. q=D(p) p* p” S(p”) D(p”) D(p), S(p)
- 11. Market Equilibrium Market p demand Market supply q=S(p) D(p”) > S(p”); an excess of quantity demanded over quantity supplied. q=D(p) p* p” S(p”) D(p”) D(p), S(p) Market price must rise towards p*.
- 12. Market Equilibrium An example of calculating a market equilibrium when the market demand and supply curves are linear. D(p ) = a − bp S(p ) = c + dp
- 13. Market Equilibrium Market p demand Market supply S(p) = c+dp p* D(p) = a-bp q* D(p), S(p)
- 14. Market Equilibrium Market p demand Market supply S(p) = c+dp What are the values of p* and q*? p* D(p) = a-bp q* D(p), S(p)
- 15. Market Equilibrium D(p ) = a − bp S(p ) = c + dp At the equilibrium price p*, D(p*) = S(p*).
- 16. Market Equilibrium D(p ) = a − bp S(p ) = c + dp At the equilibrium price p*, D(p*) = S(p*). That is, a − bp* = c + dp*
- 17. Market Equilibrium D(p ) = a − bp S(p ) = c + dp At the equilibrium price p*, D(p*) = S(p*). That is, a − bp* = c + dp* which gives a−c p = b+d *
- 18. Market Equilibrium D(p ) = a − bp S(p ) = c + dp At the equilibrium price p*, D(p*) = S(p*). That is, a − bp* = c + dp* which gives a−c p = b+d * ad + bc and q = D(p ) = S(p ) = . b+d * * *
- 19. Market Equilibrium Market p demand * p = a−c b+d Market supply S(p) = c+dp D(p) = a-bp ad + bc q = b +d * D(p), S(p)
- 20. Market Equilibrium Can we calculate the market equilibrium using the inverse market demand and supply curves?
- 21. Market Equilibrium Can we calculate the market equilibrium using the inverse market demand and supply curves? Yes, it is the same calculation.
- 22. Market Equilibrium a−q −1 q = D(p ) = a − bp ⇔ p = = D ( q), b the equation of the inverse market demand curve. And −c+q q = S(p ) = c + dp ⇔ p = = S−1 ( q), d the equation of the inverse market supply curve.
- 23. Market Equilibrium D-1(q), S-1(q) Market inverse demand Market inverse supply S-1(q) = (-c+q)/d p* D-1(q) = (a-q)/b q* q
- 24. Market Equilibrium D-1(q), Market S-1(q) demand Market inverse supply S-1(q) = (-c+q)/d At equilibrium, D-1(q*) = S-1(q*). p* D-1(q) = (a-q)/b q* q
- 25. Market Equilibrium p=D −1 a−q −c+q −1 ( q) = . and p = S ( q) = d b At the equilibrium quantity q*, D-1(p*) = S-1(p*).
- 26. Market Equilibrium p=D −1 a−q −c+q −1 ( q) = . and p = S ( q) = d b At the equilibrium quantity q*, D-1(p*) = S-1(p*). That is, a − q* − c + q* = b d
- 27. Market Equilibrium p=D −1 a−q −c+q −1 ( q) = . and p = S ( q) = d b At the equilibrium quantity q*, D-1(p*) = S-1(p*). That is, a − q* − c + q* = b d * ad + bc which gives q = b+d
- 28. Market Equilibrium p=D −1 a−q −c+q −1 ( q) = . and p = S ( q) = d b At the equilibrium quantity q*, D-1(p*) = S-1(p*). That is, a − q* − c + q* = b d * ad + bc which gives q = b+d * and p = D −1 * (q ) = S −1 a−c (q ) = . b+d *
- 29. Market Equilibrium D-1(q), Market S-1(q) demand * p = a−c b+d Market supply S-1(q) = (-c+q)/d D-1(q) = (a-q)/b ad + bc q = b +d * q
- 30. Market Equilibrium Two special cases: quantity supplied is fixed, independent of the market price, and quantity supplied is extremely sensitive to the market price.
- 31. Market Equilibrium Market quantity supplied is fixed, independent of price. p q* q
- 32. Market Equilibrium Market quantity supplied is fixed, independent of price. S(p) = c+dp, so d=0 and S(p) ≡ c. p q* = c q
- 33. Market Equilibrium Market p demand Market quantity supplied is fixed, independent of price. S(p) = c+dp, so d=0 and S(p) ≡ c. D-1(q) = (a-q)/b q* = c q
- 34. Market Equilibrium Market p demand Market quantity supplied is fixed, independent of price. S(p) = c+dp, so d=0 and S(p) ≡ c. p* D-1(q) = (a-q)/b q* = c q
- 35. Market Equilibrium Market p demand p* = (a-c)/b Market quantity supplied is fixed, independent of price. S(p) = c+dp, so d=0 and S(p) ≡ c. p* = D-1(q*); that is, p* = (a-c)/b. D-1(q) = (a-q)/b q* = c q
- 36. Market Equilibrium Market p demand p* = (a-c)/b Market quantity supplied is fixed, independent of price. S(p) = c+dp, so d=0 and S(p) ≡ c. p* = D-1(q*); that is, p* = (a-c)/b. D-1(q) = (a-q)/b a − c q* = c p = b+d * ad + bc q = b+d * q
- 37. Market Equilibrium Market p demand p* = (a-c)/b Market quantity supplied is fixed, independent of price. S(p) = c+dp, so d=0 and S(p) ≡ c. p* = D-1(q*); that is, p* = (a-c)/b. D-1(q) = (a-q)/b q a − c q* = c p = b+d * ad + bc with d = 0 give q = b+d * a−c p = b * q* = c.
- 38. Market Equilibrium Two special cases are when quantity supplied is fixed, independent of the market price, and when quantity supplied is extremely sensitive to the market price.
- 39. Market Equilibrium p Market quantity supplied is extremely sensitive to price. q
- 40. Market Equilibrium p Market quantity supplied is extremely sensitive to price. S-1(q) = p*. p* q
- 41. Market Equilibrium Market p demand Market quantity supplied is extremely sensitive to price. S-1(q) = p*. p* D-1(q) = (a-q)/b q
- 42. Market Equilibrium Market p demand Market quantity supplied is extremely sensitive to price. S-1(q) = p*. p* D-1(q) = (a-q)/b q* q
- 43. Market Equilibrium Market p demand Market quantity supplied is extremely sensitive to price. S-1(q) = p*. p* = D-1(q*) = (a-q*)/b so q* = a-bp* p* D-1(q) = (a-q)/b q* = a-bp* q
- 44. Quantity Taxes A quantity tax levied at a rate of $t is a tax of $t paid on each unit traded. If the tax is levied on sellers then it is an excise tax. If the tax is levied on buyers then it is a sales tax.
- 45. Quantity Taxes What is the effect of a quantity tax on a market’s equilibrium? How are prices affected? How is the quantity traded affected? Who pays the tax? How are gains-to-trade altered?
- 46. Quantity Taxes A tax rate t makes the price paid by buyers, pb, higher by t from the price received by sellers, ps. pb − ps = t
- 47. Quantity Taxes Even with a tax the market must clear. I.e. quantity demanded by buyers at price pb must equal quantity supplied by sellers at price ps. D(pb ) = S( ps )
- 48. Quantity Taxes D(pb ) = S( ps ) pb − ps = t and describe the market’s equilibrium. Notice these conditions apply no matter if the tax is levied on sellers or on buyers.
- 49. Quantity Taxes D(pb ) = S( ps ) pb − ps = t and describe the market’s equilibrium. Notice that these two conditions apply no matter if the tax is levied on sellers or on buyers. Hence, a sales tax rate $t has the same effect as an excise tax rate $t.
- 50. Quantity Taxes & Market Equilibrium Market p demand Market supply No tax p* q* D(p), S(p)
- 51. Quantity Taxes & Market Equilibrium Market p demand Market supply $t p* q* An excise tax raises the market supply curve by $t D(p), S(p)
- 52. Quantity Taxes & Market Equilibrium Market p demand Market supply $t pb p* qt q* An excise tax raises the market supply curve by $t, raises the buyers’ price and lowers the quantity traded. D(p), S(p)
- 53. Quantity Taxes & Market Equilibrium Market p demand Market supply $t pb p* ps qt q* An excise tax raises the market supply curve by $t, raises the buyers’ price and lowers the quantity traded. D(p), S(p) And sellers receive only ps = pb - t.
- 54. Quantity Taxes & Market Equilibrium Market p demand Market supply No tax p* q* D(p), S(p)
- 55. Quantity Taxes & Market Equilibrium Market p demand Market supply p* An sales tax lowers the market demand curve by $t $t q* D(p), S(p)
- 56. Quantity Taxes & Market Equilibrium Market p demand p* ps Market supply $t qt q* An sales tax lowers the market demand curve by $t, lowers the sellers’ price and reduces the quantity traded. D(p), S(p)
- 57. Quantity Taxes & Market Equilibrium Market p demand pb p* ps Market supply $t qt q* An sales tax lowers the market demand curve by $t, lowers the sellers’ price and reduces the quantity traded. D(p), S(p) And buyers pay pb = ps + t.
- 58. Quantity Taxes & Market Equilibrium Market p demand Market supply $t pb p* ps $t qt q* A sales tax levied at rate $t has the same effects on the market’s equilibrium as does an excise tax levied at rate $t. D(p), S(p)
- 59. Quantity Taxes & Market Equilibrium Who pays the tax of $t per unit traded? The division of the $t between buyers and sellers is the incidence of the tax.
- 60. Quantity Taxes & Market Equilibrium Market p demand Market supply pb p* ps qt q* D(p), S(p)
- 61. Quantity Taxes & Market Equilibrium Market Market p demand supply Tax paid by buyers pb p* ps qt q* D(p), S(p)
- 62. Quantity Taxes & Market Equilibrium Market p demand pb p* ps Market supply Tax paid by sellers qt q* D(p), S(p)
- 63. Quantity Taxes & Market Equilibrium Market Market p demand supply Tax paid by buyers pb p* ps Tax paid by sellers qt q* D(p), S(p)
- 64. Quantity Taxes & Market Equilibrium E.g. suppose the market demand and supply curves are linear. D(pb ) = a − bpb S( ps ) = c + dps
- 65. Quantity Taxes & Market Equilibrium D(pb ) = a − bpb and S(ps ) = c + dps .
- 66. Quantity Taxes & Market Equilibrium D(pb ) = a − bpb and S(ps ) = c + dps . With the tax, the market equilibrium satisfies pb = ps + t and D(pb ) = S(ps ) so pb = ps + t and a − bpb = c + dps .
- 67. Quantity Taxes & Market Equilibrium D(pb ) = a − bpb and S(ps ) = c + dps . With the tax, the market equilibrium satisfies pb = ps + t and D(pb ) = S(ps ) so pb = ps + t and a − bpb = c + dps . Substituting for pb gives a − c − bt a − b( ps + t ) = c + dps ⇒ps = . b +d
- 68. Quantity Taxes & Market Equilibrium a − c − bt ps = b +d and pb = ps + t give a − c + dt pb = b +d The quantity traded at equilibrium is qt = D( pb ) = S( ps ) ad + bc − bdt = a + bpb = . b +d
- 69. Quantity Taxes & Market Equilibrium a − c − bt ps = b +d a − c + dt pb = b +d ad + bc − bdt q = b +d t a −c = p *, the As t → 0, ps and pb → b +d equilibrium price if ad + bc , there is no tax (t = 0) and qt → b +d the quantity traded at equilibrium when there is no tax.
- 70. Quantity Taxes & Market Equilibrium a − c − bt ps = b +d a − c + dt pb = b +d As t increases, ad + bc − bdt q = b +d t ps falls, pb rises, and qt falls.
- 71. Quantity Taxes & Market Equilibrium a − c − bt ps = b +d a − c + dt pb = b +d ad + bc − bdt q = b +d t The tax paid per unit by the buyer is a − c + dt a − c dt pb − p = − = . b +d b +d b +d *
- 72. Quantity Taxes & Market Equilibrium a − c − bt ps = b +d a − c + dt pb = b +d ad + bc − bdt q = b +d t The tax paid per unit by the buyer is a − c + dt a − c dt pb − p = − = . b +d b +d b +d * The tax paid per unit by the seller is a − c a − c − bt bt p − ps = − = . b +d b +d b +d *
- 73. Quantity Taxes & Market Equilibrium a − c − bt ps = b +d a − c + dt pb = b +d ad + bc − bdt q = b +d t The total tax paid (by buyers and sellers combined) is ad + bc − bdt T = tq = t . b +d t
- 74. Tax Incidence and Own-Price Elasticities The incidence of a quantity tax depends upon the own-price elasticities of demand and supply.
- 75. Tax Incidence and Own-Price Elasticities Market p demand Market supply $t pb p* ps qt q* D(p), S(p)
- 76. Tax Incidence and Own-Price Elasticities Market p demand Market supply $t pb p* ps qt q* ∆q Change to buyers’ price is pb - p*. Change to quantity demanded is ∆q. D(p), S(p)
- 77. Tax Incidence and Own-Price Elasticities Around p = p* the own-price elasticity of demand is approximately ∆q * q εD ≈ * pb − p * p
- 78. Tax Incidence and Own-Price Elasticities Around p = p* the own-price elasticity of demand is approximately ∆q * q εD ≈ pb − p* p* ⇒ pb − p* ≈ ∆q × p* ε D × q* .
- 79. Tax Incidence and Own-Price Elasticities Market p demand Market supply $t pb p* ps qt q* D(p), S(p)
- 80. Tax Incidence and Own-Price Elasticities Market p demand Market supply $t pb p* ps qt q* ∆q Change to sellers’ price is ps - p*. Change to quantity demanded is ∆q. D(p), S(p)
- 81. Tax Incidence and Own-Price Elasticities Around p = p* the own-price elasticity of supply is approximately ∆q * q εS ≈ * ps − p * p
- 82. Tax Incidence and Own-Price Elasticities Around p = p* the own-price elasticity of supply is approximately ∆q * q εS ≈ * ps − p * p ⇒ ps − p* ≈ ∆q × p* * ε S× q .
- 83. Tax Incidence and Own-Price Elasticities Market Market p demand supply Tax paid by buyers pb p* ps Tax paid by sellers qt q* D(p), S(p)
- 84. Tax Incidence and Own-Price Elasticities Market Market p demand supply Tax paid by buyers pb p* ps Tax paid by sellers qt q* Tax incidence = D(p), S(p) * pb − p * p − ps .
- 85. Tax Incidence and Own-Price Elasticities * Tax incidence = * pb − p ≈ * ∆q × p * εD × q . pb − p * p − ps . * ps − p ≈ * ∆q × p * ε S× q .
- 86. Tax Incidence and Own-Price Elasticities * Tax incidence = * pb − p ≈ So * ∆q × p * εD × q * pb − p * p − ps . pb − p * p − ps . * ps − p ≈ εS ≈ − . εD * ∆q × p * ε S× q .
- 87. Tax Incidence and Own-Price Elasticities * Tax incidence is pb − p * p − ps εS ≈ − . εD The fraction of a $t quantity tax paid by buyers rises as supply becomes more own-price elastic or as demand becomes less own-price elastic.
- 88. Tax Incidence and Own-Price Elasticities Market p demand Market supply $t pb p* ps qt q* As market demand becomes less ownprice elastic, tax incidence shifts more to the buyers. D(p), S(p)
- 89. Tax Incidence and Own-Price Elasticities Market p demand Market supply $t pb p* ps qt q* As market demand becomes less ownprice elastic, tax incidence shifts more to the buyers. D(p), S(p)
- 90. Tax Incidence and Own-Price Elasticities Market p demand pb ps= p* Market supply $t qt = q* As market demand becomes less ownprice elastic, tax incidence shifts more to the buyers. D(p), S(p)
- 91. Tax Incidence and Own-Price Elasticities Market p demand pb ps= p* Market supply $t As market demand becomes less ownprice elastic, tax incidence shifts more to the buyers. D(p), S(p) qt = q* When ε D = 0, buyers pay the entire tax, even though it is levied on the sellers.
- 92. Tax Incidence and Own-Price Elasticities * Tax incidence is pb − p * p − ps εS ≈ − . εD Similarly, the fraction of a $t quantity tax paid by sellers rises as supply becomes less own-price elastic or as demand becomes more own-price elastic.
- 93. Deadweight Loss and Own-Price Elasticities A quantity tax imposed on a competitive market reduces the quantity traded and so reduces gains-to-trade (i.e. the sum of Consumers’ and Producers’ Surpluses). The lost total surplus is the tax’s deadweight loss, or excess burden.
- 94. Deadweight Loss and Own-Price Elasticities Market p demand Market supply No tax p* q* D(p), S(p)
- 95. Deadweight Loss and Own-Price Elasticities Market p demand p* Market supply No tax CS q* D(p), S(p)
- 96. Deadweight Loss and Own-Price Elasticities Market p demand Market supply No tax p* PS q* D(p), S(p)
- 97. Deadweight Loss and Own-Price Elasticities Market p demand p* Market supply No tax CS PS q* D(p), S(p)
- 98. Deadweight Loss and Own-Price Elasticities Market p demand p* Market supply No tax CS PS q* D(p), S(p)
- 99. Deadweight Loss and Own-Price Elasticities Market p demand Market supply $t pb CS p* ps PS qt q* The tax reduces both CS and PS D(p), S(p)
- 100. Deadweight Loss and Own-Price Elasticities Market p demand Market supply $t pb CS p* Tax ps PS qt q* The tax reduces both CS and PS, transfers surplus to government D(p), S(p)
- 101. Deadweight Loss and Own-Price Elasticities Market p demand Market supply $t pb CS p* Tax ps PS qt q* The tax reduces both CS and PS, transfers surplus to government D(p), S(p)
- 102. Deadweight Loss and Own-Price Elasticities Market p demand Market supply $t pb CS p* Tax ps PS qt q* The tax reduces both CS and PS, transfers surplus to government D(p), S(p)
- 103. Deadweight Loss and Own-Price Elasticities Market p demand Market supply $t pb CS p* Tax ps PS qt q* The tax reduces both CS and PS, transfers surplus to government, and lowers total surplus. D(p), S(p)
- 104. Deadweight Loss and Own-Price Elasticities Market p demand Market supply $t pb CS p* Tax ps PS Deadweight loss qt q* D(p), S(p)
- 105. Deadweight Loss and Own-Price Elasticities Market p demand Market supply $t pb p* ps Deadweight loss qt q* D(p), S(p)
- 106. Deadweight Loss and Own-Price Elasticities Market p demand Market supply $t pb p* ps qt q* Deadweight loss falls as market demand becomes less ownprice elastic. D(p), S(p)
- 107. Deadweight Loss and Own-Price Elasticities Market p demand Market supply $t pb p* ps qt q* Deadweight loss falls as market demand becomes less ownprice elastic. D(p), S(p)
- 108. Deadweight Loss and Own-Price Elasticities Market p demand pb ps= p* Market supply $t Deadweight loss falls as market demand becomes less ownprice elastic. D(p), S(p) qt = q* When ε D = 0, the tax causes no deadweight loss.
- 109. Deadweight Loss and Own-Price Elasticities Deadweight loss due to a quantity tax rises as either market demand or market supply becomes more ownprice elastic. If either ε D = 0 or ε S = 0 then the deadweight loss is zero.