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Policy Implications
OIL AND PRICE CONTROL• Estimated subsidy on LPG, 2011-12 : Rs 25,000  crores•   Government provides subsidy to-   Kerosene...
OIL AND PRICE CONTROL• How does price control effect the society?• Who benefits from this?• Who looses?• When is price con...
Price Controls and           Natural Gas Shortages• QS = 14 + 2PG + 0.25PO  – Quantity supplied in trillion cubic feet (Tc...
Price Controls and          Natural Gas Shortages• Using PO = $8/b and Q DG    G                             QS   gives eq...
Price Controls and                          Natural Gas Shortages             Price            ($/mcf)                   D...
No Regulation• What is the consumer surplus?• What is the producer surplus?• What is the total surplus in the economy?
Price Control• Price control will be effective only if the price  is no higher than the equilibrium price
Price Controls and                  Natural Gas Shortages     Price    ($/mcf)                   D        S               ...
Price Controls and          Natural Gas Shortages• What will be effect of price control of $1 on  the amount traded?• Will...
Price ControlsEffect on Producer Surplus-   Decrease in Producer Surplus-   Value: A+C = (-)$18+1 billion-   Loss due to l...
Price ControlsEffect on Consumer Surplus- Gain due to lower per unit price :- Area A- Loss due to seller selling fewer uni...
Price Control• Net Effect = Change in Producer Surplus +  Change in Consumer Surplus• = (-) [Area A+ B] + Area A – Area C•...
Price Control• Can society ever benefit with a price control?• When will the deadweight loss decrease?• Lower subsidy• Low...
Price Control• Measuring effects of government price  controls on the economy can be estimated by  measuring these two tri...
MARKET FOR HUMAN KIDNEYS
The Market for Human Kidneys• The 1984 National Organ Transplantation Act  prohibits the sale of organs for transplantatio...
The Market for Human Kidneys• We can measure this using the supply and  demand for kidneys from estimated data  – Supply: ...
The Market for Kidneys Price                        S’                                        The loss to suppliers       ...
The Market for Human Kidneys• Recipients:  – Since they do not have to pay for the kidney, they    gain rectangle A ($140 ...
The Market for Human Kidneys• Suppliers:  – Those who supply them are not paid the market    price, estimated at $20,000  ...
The Market for Human Kidneys• Net Effect = Change in Producer Surplus +  Change in Consumer Surplus• = (-) [Area A+ C] + A...
The Market for Human Kidneys•   Arguments in favor of prohibiting the sale of    organs:    1. Imperfect information about...
MINIMUM PRICES
Support Price for Rice farmers• Support price for common rice, 2012: Rs  1,250/kg• Increase from 2011 : Rs 1,080/kg
Minimum Support Price
Minimum Support Price• What is the effect of Minimum Support Price  on the economy?• Who benefits from it and who looses?•...
Minimum Prices• When price is set above the market clearing  price.• Effective minimum price only operates when  minimum p...
Minimum PricesPrice                                     S    If producers produce                                         ...
Minimum Prices• Losses in consumer surplus are  – Increased price leading to decreased quantity    equals area A  – Those ...
Minimum Prices• Net Effect of the price control on the society• DEADWEIGHT LOSS OF B+C• Deadweight loss decreases as- Subs...
Minimum Prices• What if producers expand production to Q2  from the increased price?                      32
Minimum PricesPrice                                     S    If producers produce                                         ...
Minimum Prices• What if producers expand production to Q2  from the increased price?  – Since they only sell Q3, there is ...
Supporting the Price of Wheat• The supply and demand for wheat in 1981 was  – Supply: QS = 1,800 + 240P  – Demand: QD = 3,...
The Wheat Market in 1981  Price               •AB consumer loss                      •ABC producer gain   S               ...
Supporting the Price of Wheat• How much would the government have had  to buy to keep price at $3.70?  – QDTotal = QD + Q ...
Supporting the Price of Wheat• We can quantify the effects on CS  – The change in consumer surplus = (-A -B)     • A = (3....
Supporting the Price of Wheat• Cost to the government:  – $3.70 x 122 million bushels = $451.4 million  – Total cost of pr...
Supporting the Price of Wheat• In 1996, Congress passed the Freedom to  Farm law  – Goal was to reduce the role of governm...
Supporting the Price of Wheat• In 2002, Congress and President Bush  reversed the effects of the 1996 bill by  reinstating...
MINIMUM WAGES
Minimum Wages• Wage is set higher than market clearing wage• Decreased quantity of workers demanded• Those workers hired r...
The Minimum Wage  w           Firms are not allowed to              pay less than wmin. This             results in unempl...
EFFECT OF TAX AND SUBSIDY
The Impact of a Tax or Subsidy• The government wants to impose a $1.00 tax  on movies. It can do it two ways:  – Make the ...
The Impact of a Tax or Subsidy• The burden of a tax (or the benefit of a  subsidy) falls partly on the consumer and  partl...
The Effects of a Specific Tax• For simplicity we will consider a specific tax  on a good  – Tax of a particular amount per...
Incidence of a Specific Tax•   Four conditions that must be satisfied after    the tax is in place:    1. Quantity sold an...
Incidence of a Specific Tax3. QD = QS4. Difference between what consumers pay and    what buyers receive is the tax       ...
Incidence of a Specific Tax          Price                                          S        Pb price                     ...
Incidence of a Specific Tax• In the previous example, the tax was shared  almost equally by consumers and producers• If de...
Impact of Elasticities on Tax Burdens         Burden on Buyer                 Burden on SellerPrice         D             ...
The Impact of a Tax or Subsidy• We can calculate the percentage of a tax  borne by consumers using pass-through  fraction ...
A Tax on Gasoline• The goal of a large gasoline tax is to:  – Raise government revenue  – Reduce oil consumption and reduc...
A Tax on Gasoline• Measuring the Impact of a 50 Cent Gasoline  Tax     • QD = 150 - 50P     • QS = 60 + 40P  – QS = QD at ...
A Tax on Gasoline• With a 50 cent tax:                     QD = QS             150 - 50Pb = 60 + 40PS         150 - 50(PS+...
A Tax on Gasoline• With a 50 cent tax:  –   Q falls by 11%  –   Price to consumers increases by 22 cents per      gallon  ...
The Impact of a 50 Cent Gasoline Tax                            D                     S            Price            ($ per...
The Effects of Subsidy• A subsidy can be analyzed in much the same  way as a tax  – Payment reducing the buyer’s price bel...
Effects of a Subsidy            Price                                             S                                       ...
Effects of a Subsidy• The benefit of the subsidy accrues mostly to  buyers if ED /ES is small• The benefit of the subsidy ...
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Policy implications

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Policy implications

  1. 1. Policy Implications
  2. 2. OIL AND PRICE CONTROL• Estimated subsidy on LPG, 2011-12 : Rs 25,000 crores• Government provides subsidy to- Kerosene: Rs 31/ltr- Diesel : Rs 13.64/ltr- One LPG cylinder (14.6kg): Rs 479• Reduction in subsidy : average Rs 7.5/ltr
  3. 3. OIL AND PRICE CONTROL• How does price control effect the society?• Who benefits from this?• Who looses?• When is price control effective?
  4. 4. Price Controls and Natural Gas Shortages• QS = 14 + 2PG + 0.25PO – Quantity supplied in trillion cubic feet (Tcf)• QD = -5PG + 3.75PO – Quantity demanded (Tcf)• PG = price of natural gas in $/mcf• PO = price of oil in $/b 4
  5. 5. Price Controls and Natural Gas Shortages• Using PO = $8/b and Q DG G QS gives equilibrium values for natural gas – PG = $2/mcf and QG = 20 Tcf• Price ceiling was set at $1/mcf 5
  6. 6. Price Controls and Natural Gas Shortages Price ($/mcf) D S 2.40 B 2.00 C A (Pmax)1.00 0 5 10 15 18 20 25 30 Quantity (Tcf)Chapter 9 6
  7. 7. No Regulation• What is the consumer surplus?• What is the producer surplus?• What is the total surplus in the economy?
  8. 8. Price Control• Price control will be effective only if the price is no higher than the equilibrium price
  9. 9. Price Controls and Natural Gas Shortages Price ($/mcf) D S The gain to consumers is 2.40 rectangle A minus triangle B, and the loss to producers is rectangle A plus triangle C. B 2.00 C A(Pmax)1.00 0 5 10 15 18 20 25 30 Quantity (Tcf) 9
  10. 10. Price Controls and Natural Gas Shortages• What will be effect of price control of $1 on the amount traded?• Will there be shortage or surplus?• How will the producers get effected?
  11. 11. Price ControlsEffect on Producer Surplus- Decrease in Producer Surplus- Value: A+C = (-)$18+1 billion- Loss due to lower per unit price :- Area A- Loss due to seller selling fewer units- Area C
  12. 12. Price ControlsEffect on Consumer Surplus- Gain due to lower per unit price :- Area A- Loss due to seller selling fewer units- Area B- Net Change in consumer surplus:- A-B= $18- 0.4 = $17.6 bn
  13. 13. Price Control• Net Effect = Change in Producer Surplus + Change in Consumer Surplus• = (-) [Area A+ B] + Area A – Area C• Net Loss of Area B + C = $0.4+1 mn• DEADWEIGHT LOSS
  14. 14. Price Control• Can society ever benefit with a price control?• When will the deadweight loss decrease?• Lower subsidy• Lower demand and supply elasticity
  15. 15. Price Control• Measuring effects of government price controls on the economy can be estimated by measuring these two triangles• To measure the effect of government price control one needs information on elasticity of demand and supply 15
  16. 16. MARKET FOR HUMAN KIDNEYS
  17. 17. The Market for Human Kidneys• The 1984 National Organ Transplantation Act prohibits the sale of organs for transplantation• What has been the impact of the Act? 17
  18. 18. The Market for Human Kidneys• We can measure this using the supply and demand for kidneys from estimated data – Supply: QS = 8,000 + 0.2P – Demand: QD = 16,000 - 0.2P• Since the sale of organs is not allowed, the amount available depends on the amount donated – Supply of donated kidneys is limited to 8,000 18
  19. 19. The Market for Kidneys Price S’ The loss to suppliers is seen in areas A & C. S$40,000$30,000 D If kidneys are zero cost, consumer gain would B be A minus B.$20,000 A and D measure the total value of kidneys C when supply is constrained.$10,000 A D 0 4,000 8,000 12,000 Quantity 19
  20. 20. The Market for Human Kidneys• Recipients: – Since they do not have to pay for the kidney, they gain rectangle A ($140 million) since price is $0 – Those who cannot obtain a kidney lose surplus equal to triangle B ($40 million) – Net increase in surplus of recipients of $160 - $40 = $120 million 20
  21. 21. The Market for Human Kidneys• Suppliers: – Those who supply them are not paid the market price, estimated at $20,000 • Loss of surplus equal to area A = $160 million – Some who would donate for the equilibrium price do not donate in the current market • Loss of surplus equal to area C = $40 million – Total SUPPLIER loss of A + C = $200 million 21
  22. 22. The Market for Human Kidneys• Net Effect = Change in Producer Surplus + Change in Consumer Surplus• = (-) [Area A+ C] + Area A – Area B• Net Loss of Area B + C = $80 mn• DEADWEIGHT LOSS
  23. 23. The Market for Human Kidneys• Arguments in favor of prohibiting the sale of organs: 1. Imperfect information about donor’s health and screening 2. Unfair to allocate according to the ability to pay 23
  24. 24. MINIMUM PRICES
  25. 25. Support Price for Rice farmers• Support price for common rice, 2012: Rs 1,250/kg• Increase from 2011 : Rs 1,080/kg
  26. 26. Minimum Support Price
  27. 27. Minimum Support Price• What is the effect of Minimum Support Price on the economy?• Who benefits from it and who looses?• When is Minimum Support Price effective?
  28. 28. Minimum Prices• When price is set above the market clearing price.• Effective minimum price only operates when minimum price support is above the equilibrium price. 28
  29. 29. Minimum PricesPrice S If producers produce Q2, the amount Q2 - Q3 will go unsold. Pmin A D measures total cost of B increased production P0 C not sold. The change in producer D surplus will be A - C - D. Producers may be worse off. D Q3 Q0 Q2 Quantity 29
  30. 30. Minimum Prices• Losses in consumer surplus are – Increased price leading to decreased quantity equals area A – Those priced out of the market lose area B• Producer surplus – Increases from increased price for units sold equal to A – Losses from drop in sales equal to C 30
  31. 31. Minimum Prices• Net Effect of the price control on the society• DEADWEIGHT LOSS OF B+C• Deadweight loss decreases as- Subsidy is smaller- Elasticity of demand and supply is lower
  32. 32. Minimum Prices• What if producers expand production to Q2 from the increased price? 32
  33. 33. Minimum PricesPrice S If producers produce Q2, the amount Q2 - Q3 will go unsold. Pmin A D measures total cost of B increased production P0 C not sold. The change in producer D surplus will be A - C - D. Producers may be worse off. D Q3 Q0 Q2 Quantity 33
  34. 34. Minimum Prices• What if producers expand production to Q2 from the increased price? – Since they only sell Q3, there is no revenue to cover the additional production (Q2-Q3) – Supply curve measures MC of production so total cost of additional production is area under the supply curve for the increased production (Q2-Q3) = area D – Total change in producer surplus = A – C – D 34
  35. 35. Supporting the Price of Wheat• The supply and demand for wheat in 1981 was – Supply: QS = 1,800 + 240P – Demand: QD = 3,550 - 266P – Equilibrium price and quantity was $3.46 and 2,630 million bushels• Government raised the price to $3.70 through government purchases 35
  36. 36. The Wheat Market in 1981 Price •AB consumer loss •ABC producer gain S Qg By buying 122 million bushels,PS = $3.70 the government A C increased the BP0 = $3.46 market-clearing price. D D + Qg 1,800 2,566 2,630 2,688 Quantity 36
  37. 37. Supporting the Price of Wheat• How much would the government have had to buy to keep price at $3.70? – QDTotal = QD + Q g = 3,550 - 266P + Q g – QS = QDT • 1,800 + 240P = 3,550 - 266P + Qg • Qg = 506P - 1,750 • At a price of $3.70, government would buy • Qg = (506)(3.70) - 175 = 122 million bushels 37
  38. 38. Supporting the Price of Wheat• We can quantify the effects on CS – The change in consumer surplus = (-A -B) • A = (3.70 - 3.46)(2,566) = $616 million • B = (1/2)(3.70 - 3.46)(2,630 - 2,566) = $8 million – CS = -$624 million 38
  39. 39. Supporting the Price of Wheat• Cost to the government: – $3.70 x 122 million bushels = $451.4 million – Total cost of program = $624 + 451 = $1,075 million• Gain to producers – A + B + C = $638 million – Government also paid 30 cents/bushel = $806 million 39
  40. 40. Supporting the Price of Wheat• In 1996, Congress passed the Freedom to Farm law – Goal was to reduce the role of government and make agriculture more market-oriented – Eliminated production quotas, gradually reduced government purchases and subsidies through 2003 44
  41. 41. Supporting the Price of Wheat• In 2002, Congress and President Bush reversed the effects of the 1996 bill by reinstating subsidies for most crops – Calls for “fixed direct payments” – New bill would cost taxpayers almost $1.1 billion in annual payments to wheat producers alone – 2002 farm bill expected to cost taxpayers $190 billion over 10 years • Estimated $83 billion over existing programs 45
  42. 42. MINIMUM WAGES
  43. 43. Minimum Wages• Wage is set higher than market clearing wage• Decreased quantity of workers demanded• Those workers hired receive higher wages• Unemployment results, since not everyone who wants to work at the new wage can 47
  44. 44. The Minimum Wage w Firms are not allowed to pay less than wmin. This results in unemployment. Swmin A is gain to workers A who find jobs at B higher wage. w0 C The deadweight loss is given by triangles B and C. Unemployment D L1 L0 L2 L 48
  45. 45. EFFECT OF TAX AND SUBSIDY
  46. 46. The Impact of a Tax or Subsidy• The government wants to impose a $1.00 tax on movies. It can do it two ways: – Make the producers pay $1.00 for each movie ticket they sell – Make consumers pay $1.00 when they buy each movie• In which option are consumers paying more? 50
  47. 47. The Impact of a Tax or Subsidy• The burden of a tax (or the benefit of a subsidy) falls partly on the consumer and partly on the producer• How the burden is split between the parties depends on the relative elasticities of demand and supply 51
  48. 48. The Effects of a Specific Tax• For simplicity we will consider a specific tax on a good – Tax of a particular amount per unit sold• For our example, consider a specific tax of $t per cigarette sold 52
  49. 49. Incidence of a Specific Tax• Four conditions that must be satisfied after the tax is in place: 1. Quantity sold and buyer’s price, Pb, must be on the demand curve • Buyers only concerned with what they must pay 2. Quantity sold and seller’s price, PS, must be on the supply curve • Sellers only concerned with what they receive 53
  50. 50. Incidence of a Specific Tax3. QD = QS4. Difference between what consumers pay and what buyers receive is the tax 54
  51. 51. Incidence of a Specific Tax Price S Pb price •Buyers lose A + B buyers pay A •Sellers lose D + CTax = B$1.00 P0 •Government gains A + C D D in tax revenue. PS price producers •The deadweight get loss is B + C. D Q1 Q0 Quantity 55
  52. 52. Incidence of a Specific Tax• In the previous example, the tax was shared almost equally by consumers and producers• If demand is relatively inelastic, however, burden of tax will fall mostly on buyers – Cigarettes• If supply is relatively inelastic, the burden of tax will fall mostly on sellers 56
  53. 53. Impact of Elasticities on Tax Burdens Burden on Buyer Burden on SellerPrice D Price S Pb S t Pb P0 P0 PS t D PS Q1 Q0 Quantity Q1 Q0 Quantity
  54. 54. The Impact of a Tax or Subsidy• We can calculate the percentage of a tax borne by consumers using pass-through fraction – ES/(ES - Ed) – Tells fraction of tax “passed through” to consumers through higher prices – For example, when demand is perfectly inelastic (Ed = 0), the pass-through fraction is 1 – consumers bear 100% of tax 58
  55. 55. A Tax on Gasoline• The goal of a large gasoline tax is to: – Raise government revenue – Reduce oil consumption and reduce US dependence on oil imports• We will consider a gas tax in the market during mid-1990’s 59
  56. 56. A Tax on Gasoline• Measuring the Impact of a 50 Cent Gasoline Tax • QD = 150 - 50P • QS = 60 + 40P – QS = QD at $1 and 100 billion gallons per year (bg/yr) 60
  57. 57. A Tax on Gasoline• With a 50 cent tax: QD = QS 150 - 50Pb = 60 + 40PS 150 - 50(PS+ 0.50) = 60 + 40PS PS = .72 Pb = PS + 0.50 = $1.22 QD = QS = 89 bg/yrChapter 9 61
  58. 58. A Tax on Gasoline• With a 50 cent tax: – Q falls by 11% – Price to consumers increases by 22 cents per gallon – Producers receive about 28 cents per gallon less – Government revenue would be significant at $44.5 billion per year 62
  59. 59. The Impact of a 50 Cent Gasoline Tax D S Price ($ per gallon) Consumer Loss = A + B B Producer Loss = C + D Pb = 1.22 A The buyer pays 22 cents of the$0.50 P0 = 1.00 tax, andTax C the producer pays 28 cents. D PS = .72 Government revenue = A + D = 0.50(89) = $44.5 billion. 11 Quantity (billion 50 60 89 100 150 gallons per year)Chapter 9 63
  60. 60. The Effects of Subsidy• A subsidy can be analyzed in much the same way as a tax – Payment reducing the buyer’s price below the seller’s price• It can be treated as a negative tax• The seller’s price exceeds the buyer’s price• Quantity increases 64
  61. 61. Effects of a Subsidy Price S Like a tax, the benefit PS of a subsidy is split between buyers andSubsidy P0 sellers, depending upon the elasticities of Pb supply and demand. D Q0 Q1 QuantityChapter 9 65
  62. 62. Effects of a Subsidy• The benefit of the subsidy accrues mostly to buyers if ED /ES is small• The benefit of the subsidy accrues mostly to sellers if ED /ES is large 66

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