Willingness-to-pay: the maximum amount that a buyer will pay for a good.
Consumer Surplus = Value to buyers – Amount buyer pays and
Producer Surplus = Amount sellers receive – Cost to sellers
Since amount buyer pays = amount sellers receive
Total Surplus = Consumer Surplus + Producer Surplus or
Total Surplus = Value to buyers – Cost to sellers
Total Surplus is maximized at equilibrium.
Chapter 10 – Externalities
Sometimes there are benefits and costs that arise in the market that go uncompensated.
These are called externalities.
A positive externality is a benefit that is enjoyed by society, but society doesn’t pay to receive it.
A negative externality is a cost suffered by society, and the instigator isn’t made to pay for the damage they do.
Negative externalities lead markets to produce more than is socially desirable. Positive externalities lead markets to produce less than is socially desirable. Negative Externality
The government can internalize an externality by imposing a tax on the producer to get them to produce less – to produce the socially desirable quantity.
This tax is known as a Pigovian Tax, levied on each unit of output sold
The Coarse Theorem
This is a proposition that if private parties can bargain without cost over the allocation of resources, they can solve the externalities problem on their own.
However, property rights have to be well defined for bargaining to work.
A property right is the exclusive authority to determine how a resource is used, whether that resource is owned by government or by individuals.
Private property rights have two other attributes in addition to determining the use of a resource:
One is the exclusive right to the services of the resource.
Second, a private property right includes the right to delegate, rent, or sell any portion of the rights by exchange or gift at whatever price the owner determines (provided someone is willing to pay that price).
Chapter 6 & 8 – Supply, Demand & Government Policies
A price ceiling is a legal maximum on the price at which a good can be sold.
The price ceiling is not binding (not effective) if it is set above equilibrium price.
The price ceiling is binding (effective) if set below equilibrium price, leading to a shortage.
In eqm., Qd = Qs 1700 – 2P = 2P – 900 4P = 2600 P = 650
Qd = 1700 – 2(650) = 400 = Qs = Q*
What if the province imposes a rent ceiling of $500?
If P = 500 Qd = 1700 – 2(500) = 700 Qs = 2(500) – 900 = 100
Shortage = Qd – Qs = 600
A price floor is a legal minimum on the price at which a good can be sold.
The price floor is not binding if set below the equilibrium price.
The price floor is binding if set above the equilibrium price, leading to a surplus.
Excess supply = Qs – Qd
A quota is a quantity control.
An upper limit on the quantity of a good that can be sold.
The government usually issues quota licences that give producers the right to produce a specified amount of a good.
The quota is set at 9 million litres per week.
At Q = 9 million, consumers are willing to pay $1.80 per litre (this is the demand price).
But, at that Q, producers would normally be happy to receive $ .60 per litre.
The difference between these 2 prices is the quota rent: quota owners receive an additional $1.20 per litre per week.
This is also the value of the quota.
A tax on Consumers
Example: the government imposes a tax of $ .50 per bottle on consumers of beer.
Now there’s a new eqm at P = $2.80 and Q = 90. But, the consumers must pay the $ .50 tax. They end up paying a price PC = $3.30, while the firm (the bar) receives PF = $2.80. The government receives