Applying The Competitive Model

Perloff 9; WB 12 and 13.
We re-evaluate price floors, price ceilings and per-unit taxes, using welfare analysis, which allows us to measure, in a more sophisticated way, the impact these policies have on consumers and suppliers.

We consider four scenarios relevant to perfect competition

  1. equilibrium
  2. after a price ceiling
  3. after a price floor
  4. after a per-unit tax (on consumers or suppliers)

Welfare analysis can also be used in other (non-competitive) situations: monopoly, oligopoly and pricing.

Producer surplus

Producer surplus (PS) is how much producers get out of trading, measured in dollars. It is the sum across all units sold of the price the firm gets paid for that unit minus its marginal cost (which is the firm's minimum “willingness-to-get-paid”). It is not equal to the total profit unless there are no fixed costs.

Consumer surplus

Consumer surplus (CS) is how much consumers get out of trading, measured in dollars. It is the sum across all units sold of the buyer's willingness-to-pay (WTP) minus the price paid.

It is convenient to calculate the CS using the inverse Demand function, which gives the willingness-to-pay of the Qth consumer.

Government revenue

Government revenue (G) is how much the government extracts from trading, measured in dollars. It is tax times the quantity exchanged/traded. It is only relevant to scenario #4.

Welfare

Welfare (W) = PS + CS + G. It is always highest in the competitive equilibrium.

Deadweight loss

The deadweight loss (DWL) is the loss in welfare, compared to the competitive equilibrium. It is easy to see that the DWL is minimized, and the Welfare maximized, when the quantity is set where P = MC. This efficient outcome is achieved under perfect competition, but also under optimal discriminatory pricing by non-competitive firms.

  • Compute CS, PS and W in the competitive equilibrium.
  • Compute CS, PS, W and DWL for a price ceiling.
  • Compute CS, PS, W and DWL for a price floor.
  • Compute CS, PS, G, W and DWL for a per-unit tax.
  • Compute DWL for a minimum quota.
  • Compute CS, PS, G, W and DWL for a per-unit subsidy.
  • (Perloff, ch9 q9, 10) If the government wants to reduce the quantity traded to Q2, what total subsidy must it pay to suppliers?

More resources

More information

Comments

Unless otherwise stated, the content of this page is licensed under Creative Commons Attribution-ShareAlike 3.0 License