MicroEconomics theory and application 12th by browning an zupan chapter 10

Prepared by Dr. Della Lee Sue, Marist College

MICROECONOMICS: Theory & Applications
Chapter 10: Using the Competitive Model
By Edgar K. Browning & Mark A. Zupan
John Wiley & Sons, Inc.
12th Edition, Copyright 2015

Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.


Learning Objectives


Show how changes in market conditions or government policies affect
the welfare of consumers, producers, and market participants as a
whole.



Analyze the effects of an excise tax on a specific good on the welfare of
consumers, producers, and market participants as a whole.



Detail how regulation of the U.S. airline industry affected fares, airline
company profits, and service quality.
(continued)

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Learning Objectives

(continued)



Explain how the entry restrictions imposed by most major U.S. cities on
taxis affect fares and the profits earned by licensed taxi owners.



Understand the effects of international trade on consumer and producer
surplus and why a net gain results to a country from either imports or
exports.



Explore how government-specified maximum quantities, or quotas, on
sugar imports affect consumers, domestic producers, and the net
welfare of the United States as well as other countries that produce
sugar.

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Show how changes in market conditions or government policies affect the
welfare of consumers, producers, and market participants as a whole.

10.1 THE EVALUATION OF GAINS AND
LOSSES

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The Evaluation of Gains and Losses


Consumer surplus – a measure of the net gain to a consumer or group
of consumers from purchasing a good arising from cost being below the
maximum that consumers are willing to pay



Producer surplus – gains to producers from the sale of output to
consumers, arising from price exceeding the minimum necessary to
compensate the seller.

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Producer Surplus

Who gets the producer surplus?
Suppliers

of inputs to the industry if the supply curve is upward-sloping

Owners

of inputs with horizontal supply curves to the industry receive no
producer surplus.
There

is no aggregate producer surplus for a constant-cost competitive
industry in long-run equilibrium.

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Figure 10.1 - Producer Surplus

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Consumer Surplus, Producer Surplus,
and Efficient Output




Total surplus – 2 approaches:


the sum of producer and consumer surplus



the sum of total surplus associated with each unit of output, added
over all units of output

Efficiency in output – the condition in which output is expanded to the
point where marginal benefit equals marginal cost

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Figure 10.2 - Competition Maximizes
Total Surplus

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The Deadweight Loss of a Price Ceiling


Deadweight loss – also called welfare cost, a measure of the aggregate
loss in well-being of participants in a market resulting from an
inefficient output level



Comparison of changes in consumer surplus and producer surplus
indicate who gains and who loses

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Figure 10.3 - A Price Ceiling Reduces
Total Surplus

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Analyze the effects of an excise tax on a specific good on the welfare of
consumers, producers, and market participants as a whole.

10.2 EXCISE TAXATION

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Excise Taxation
Excise tax – a tax levied on a specific good


Per unit tax: does not depend on the market price



Ad valorem tax: an excise tax that is levied as a certain percentage
of the market price

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Figure 10.4 - Effects of a Per-Unit
Excise Tax

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The Consequences of an Excise Tax


Short-Run Effects
 Firms reduce output.
 Market price rises.



Long-Run Effects
 Even when the tax is levied on and collected from firms, consumers
bear a cost as a result of the higher price.
 After the long-run adjustment to the tax, firms make zero economic
profits.

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Who Bears the Burden of the Tax?
When an excise tax is imposed on a good, elasticity determines how
much output falls and how much the price to consumers rises.


For a given demand curve and tax per unit, the more inelastic the supply
curve:
 the smaller is the tax burden on consumers
 the larger is the tax burden on producers
 the smaller is the output reduction



For a given supply curve and tax per unit, the more inelastic the demand
curve:
 the greater is the tax burden on consumers
 the smaller is the tax burden on producers
 the smaller is the reduction in output

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Figure 10.5 - How Elasticities Affect the
Tax Burden

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When the Consumer Bears the Entire
Burden of the Tax




Situations of extreme elasticity:


If the demand is perfectly inelastic, the demand curve is vertical.



If the supply curve is perfectly elastic, the supply curve is
horizontal, which is the constant-cost case.

In both cases,


the price to consumers rises by the amount of the tax.

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The Deadweight Loss of Excise
Taxation


Any deviation from the competitive level of output is inefficient and
results in a decrease in consumer surplus and producer surplus (total
loss)



Tax revenue: gain to the government



Excess burden –deadweight loss produced by a tax



Total loss = tax revenue + excess burden

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Figure 10.6 - The Deadweight Loss of
an Excise Tax

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Figure 10.7 – Supply Elasticity and the
Deadweight Loss of Rent Control

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Detail how regulation of the U.S. airline industry affected fares, airline
company profits, and service quality.

10.3 AIRLINE REGULATION AND

DEREGULATION

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Airline Regulation and Deregulation





1938-1978: period of regulation in the airline industry by the Civil
Aeronautics Board (CAB)
Factors that were regulated:
 Fares
 Routes between 2 cities
 Entry of new firms into the industry
Support for deregulation:
 Fares were set above the market equilibrium fare.
 Accounting profits for the airline industry were below the national
average for all industries over the 20 years prior to deregulation in
1978.

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What Happened to the Profits?
[in the airline industry]


Profitable routes covered the loss from unprofitable routes that airlines
were required to operate.



Airline employee unions bargained for higher wages when fares were
above competitive levels.



Nonprice competition increased costs.

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Figure 10.8 - Airline Regulation by the
CAB

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