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![Harburger’s Approach
The ABH dead weight triangle is approximated by the
following equation (equation 4.1 in the text):
))((
2
1
MCCM QQPPDWL
By algebraic manipulation it can be shown that:
**
2
1 2
QPdDWL [1]](https://image.slidesharecdn.com/deadweightloss-160220182149/85/Dead-weight-loss-33-320.jpg)
![To estimate industry-level price elasticities (),
Cowling and Mueller took advantage of the fact
that the firm’s profit maximizing price (P*)
satisfies the following condition:
MCP
P
*
* [2]
Recall that d is the price-cost margin . Thus we can
say:
MCP
P
d
*
*1
[3]
Thus by equation [2], we can say:
d
1 Thus if you can
estimate d, you
can estimate ](https://image.slidesharecdn.com/deadweightloss-160220182149/85/Dead-weight-loss-37-320.jpg)
![Thus substitute 1/d for in equation [1] and you
get:
**
2
1
**
1
2
1 2
QdPQPd
d
DWL
[4]
Substituting (P*- MC)/P* for d in equation [4] gives us:
*
2
1
*)*(
2
1
**
*
2
1
QMCPQP
P
MCP
DWL [5]
Thus, Cowling and Mueller showed that DWL for an
industry was equal to ½ of the economic profits () of
firms in the industry.](https://image.slidesharecdn.com/deadweightloss-160220182149/85/Dead-weight-loss-38-320.jpg)
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Dead weight loss
- 1. Dead weight lossand Tax Presented by- ☺ Pooja goyal 13189 ☺ Pooja sharma 13190 ☺ Priyanka meena 13210 ☺ Pia singh 13186
- 2. Dead weight lossoccurs when government imposes tax on commodity, and both producer and consumer loose part of their surplus, the loss suffers by both producer and consumer is dead weight loss.
- 3.
- 4. Tax Wedge Atax places a wedge between the price buyers pay and the price sellers receive. Because of this tax wedge, the quantity sold falls below the level that would be sold without a tax. The size of the market for that good shrinks.
- 5. Tax Revenue Copyright ©2004 South-Western Tax revenue (T × Q) Size of tax (T) Quantity sold (Q) Quantity0 Price Demand Supply Quantity without tax Quantity with tax Price buyers pay Price sellers receive
- 6. How a TaxEffects Welfare Copyright © 2004 South-Western A F B D C E Quantity0 Price Demand Supply =PB Q2 =PS Price buyers pay Price sellers receive =P1 Q1 Price without tax
- 7. Determinants of Deadweight Loss What determines whether the deadweight loss from a tax is large or small? The magnitude of the deadweight loss depends on how much the quantity supplied and quantity demanded respond to changes in the price. That, in turn, depends on the price elasticities of supply and demand.
- 8. Determinants of 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.
- 9. Tax Distortions andElasticities Copyright © 2004 South-Western (a) Inelastic Supply Price 0 Quantity Demand Supply Size of tax When supply is relatively inelastic, the deadweight loss of a tax is small.
- 10. Tax Distortions andElasticities Copyright © 2004 South-Western (b) Elastic Supply Price 0 Quantity Demand SupplySize of tax When supply is relatively elastic, the deadweight loss of a tax is large.
- 11. Tax Distortions andElasticities Copyright © 2004 South-Western Demand Supply (c) Inelastic Demand Price 0 Quantity Size of tax When demand is relatively inelastic, the deadweight loss of a tax is small.
- 12. Tax Distortions andElasticities Copyright © 2004 South-Western (d) Elastic Demand Price 0 Quantity Size of tax Demand Supply When demand is relatively elastic, the deadweight loss of a tax is large.
- 13. Extreme cases Ifdemand were perfectly inelastic (a vertical demand curve), the quantity demanded is unchanged by the imposition of the tax. As a result, the tax imposes no deadweight loss.
- 14. Similarly, ifsupply were perfectly inelastic (a vertical supply curve), the quantity supplied is unchanged by the tax and there is also no deadweight loss.
- 15. Deadweight Loss andTax Rate With each increase in the tax rate, the deadweight loss of the tax rises even more rapidly than the size of the tax.
- 16. Tax Revenue andTax Rate For the small tax, tax revenue is small. As the size of the tax rises, tax revenue grows. But as the size of the tax continues to rise, tax revenue falls because the higher tax reduces the size of the market.
- 17. Deadweight Loss andTax Revenue from Three Taxes of Different Sizes Copyright © 2004 South-Western Tax revenue Demand Supply Quantity0 Price Q1 (a) Small Tax Deadweight loss PB Q2 PS
- 18. Deadweight Loss andTax Revenue from Three Taxes of Different Sizes Copyright © 2004 South-Western Tax revenue Quantity0 Price (b) Medium Tax PB Q2 PS Supply Demand Q1 Deadweight loss
- 19. Deadweight Loss andTax Revenue from Three Taxes of Different Sizes Copyright © 2004 South-Western Taxrevenue Demand Supply Quantity0 Price Q1 (c) Large Tax PB Q2 PS Deadweight loss
- 20. How Deadweight Lossand Tax Revenue Vary with the Size of a Tax Copyright © 2004 South-Western Deadweight Loss 0 Tax Size
- 21. How Deadweight Lossand Tax Revenue Vary with the Size of a Tax – Laffer curve Copyright © 2004 South-Western Tax Revenue 0 Tax Size
- 22. Laffer Curve TheLaffer curve depicts the relationship between tax rates and tax revenue. Supply-side economics : refers to the views of Reagan and Laffer who proposed that a tax cut would induce more people to work and thereby have the potential to increase tax revenues.
- 23.
- 24. The Deadweight Loss In monopoly, firm sets its price above marginal cost, it places a wedge between the consumer’s willingness to pay and the producer’s cost. ◦ This wedge causes the quantity sold to fall short of the social optimum.
- 25. The Inefficiency ofMonopoly Quantity0 Price Deadweight loss Demand Marginal revenue Marginal cost Efficient quantity Monopoly price Monopoly quantity
- 26. The Deadweight Loss The deadweight loss caused by a monopoly is similar to the deadweight loss caused by a tax. The difference between the two cases is that the government gets the revenue from a tax, whereas a private firm gets the monopoly profit. For reducing deadweight loss, in monopoly, price discrimination is use.
- 27. PRICE DISCRIMINATION Pricediscrimination is the business practice of selling the same good at different prices to different customers, even though the costs for producing for the two customers are the same.
- 28. PRICE DISCRIMINATION Pricediscrimination is not possible when a good is sold in a competitive market since there are many firms all selling at the market price. In order to price discriminate, the firm must have some market power. Perfect Price Discrimination ◦ Perfect price discrimination refers to the situation when the monopolist knows exactly the willingness to pay of each customer and can charge each customer a different price.
- 29. PRICE DISCRIMINATION Twoimportant effects of price discrimination: ◦ It can increase the monopolist’s profits. ◦ It can reduce deadweight loss.
- 30. Welfare with andwithout Price Discrimination Copyright © 2004 South-Western Profit (a) Monopolist with Single Price Price 0 Quantity Deadweight loss DemandMarginal revenue Consumer surplus Quantity sold Monopoly price Marginal cost
- 31. Welfare with andwithout Price Discrimination Profit (b) Monopolist with Perfect Price Discrimination Price 0 Quantity Demand Marginal cost Quantity sold
- 32. Estimating Dead WeightLoss Due to Imperfectly Competitive Market Structures Economists are naturally interested in estimating the size of dead weight losses (DWLs) resulting from allocative inefficiency. Estimating DWL is difficult because the investigator will not normally know the true value of marginal cost. Hence, DWL must be estimated indirectly.
- 33. Harburger’s Approach The ABHdead weight triangle is approximated by the following equation (equation 4.1 in the text): ))(( 2 1 MCCM QQPPDWL By algebraic manipulation it can be shown that: ** 2 1 2 QPdDWL [1]
- 34. Explanation of equation is price elasticity of demand d is the price cost margin, that is: P MCP d P* is the monopoly price Q* is the monopoly output •To estimate d, Harburger measured the difference between rate of return for the industry and the average rate of return for all industries. •Harburger assumed that, for all industries, = 1
- 35. Harburger’s estimates Based ondata for U.S. industries in the 1920s, Harburger estimated the DWL due to monopoly to be equal to 1/10 of 1 percent of GNP. Hence, the welfare loss due to pricing above marginal cost is very small and would hardly justify the allocation of substantial resources for antitrust enforcement.
- 36. Cowling and Mueller’sApproach above reveals that estimates of DWL are sensitive to assumptions made about elasticity of demand ( )Cowling and Mueller made adjustments to the methodology used by Harburger and , using a sample of 734 U.S. firms for 1963-66, reached radically different conclusions as regards the magnitude of welfare losses. •Cowling and Mueller changed a key assumption of Harburger; namely, that for all industries, = 1.
- 37. To estimate industry-levelprice elasticities (), Cowling and Mueller took advantage of the fact that the firm’s profit maximizing price (P*) satisfies the following condition: MCP P * * [2] Recall that d is the price-cost margin . Thus we can say: MCP P d * *1 [3] Thus by equation [2], we can say: d 1 Thus if you can estimate d, you can estimate
- 38. Thus substitute 1/dfor in equation [1] and you get: ** 2 1 ** 1 2 1 2 QdPQPd d DWL [4] Substituting (P*- MC)/P* for d in equation [4] gives us: * 2 1 *)*( 2 1 ** * 2 1 QMCPQP P MCP DWL [5] Thus, Cowling and Mueller showed that DWL for an industry was equal to ½ of the economic profits () of firms in the industry.
- 39.
- 40. Price Quantity 0 P* Q* MC D MR * 2 1 *)*( 2 1 ** * 2 1 QMCPQP P MCP DWL •DWLis given by the black –shaded triangle. • is given by the green- shaded rectangle Measuring Dead Weight Loss
- 41. Cowling and Mueller’s results Assumingthat 12 percent is a "normal" rate of return on capital, Cowling and Mueller produced 2 estimates of DWL in the U.S. economy: • The low estimate, which does not include advertising expenditures as a component of the dead weight loss, was 4 percent of GNP (about $403 billion in 2001). • The high estimate, which reckoned advertising expenditures as "wasted resources," was 13 percent of GNP (about $1.394 trillion in 2001).
Editor's Notes
- #26 The Inefficiency of Monopoly The monopolist produces less than the socially efficient quantity of output.