11/2/22

SUPPLY, DEMAND AND

GOVERNMENT POLICIES
CONSUMER SURPLUS
PRODUCER SURPLUS

2. Government intervention
• 2 types of government intervention:

Direct:
Price ceiling– Price floor
Indirect:
Taxes– Subsidies

à NW (Net Welfare) or DWL

(Deadweight Loss) ???

1. Consumer Surplus – Producer Surplus

• Consumer Surplus
• The amount a buyer is willing P
to pay for a good minus the
amount the buyer actually pays
S
for it
• Willingness to pay
• The maximum amount that a CS
PE E
buyer will pay for a good PS
• Producer Surplus
The amount a seller is paid D
for a good minus the seller’s Q
cost of providing it QE

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Consumer Surplus
• The amount that buyers are willing to pay for a good
minus the amount they actually pay for it

• Measures the benefit that buyers receive from a good as

the buyers themselves perceive it.

• Consumer surplus is a good measure of economic well-

being if policymakers want to satisfy the preferences of
buyers.

Consumer Surplus

• The area below the demand

curve and above the price
measures the consumer
surplus in a market

Producer Surplus

Producer Surplus
• The amount a seller is P
paid for a good minus S
the seller’s cost of
providing it
CS
Cost PE E
PS
• The value of everything
a seller must give up to D
produce a good Q
QE

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Producer Surplus

• The area below the price and

above the supply curve measures
the producer surplus in a
market.

Producer Surplus

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Market Efficiency

• Consumer surplus = Value to

buyers – Amount paid by buyers
• Producer surplus = Amount
received by sellers – Cost to
sellers.

• Total surplus = (Value to buyers –

Amount paid by buyers) +
(Amount received by sellers – Cost
to sellers)

• Total surplus = Value to buyers

– Cost to sellers.

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2. Government Intervenes
P
S

Price ceiling Pmax

Maximum price
a b
PE E benefits buyers
c d receive
Pmax The sellers have
e to follow
Shortage
D
Q
QS QE QD

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2. Government Intervenes
• Price Ceiling (maximum price)
▫ A legal maximum on the price at which a good can be sold
▫ Outcomes: a shortage of the good arises
▫ Price Ceilings Affect Market Outcomes
▫ Consumer surplus: ∆CS = c – b
▫ Producer surplus: ∆PS = – c – d

à Deadweight loss :
∆DWL = ∆CS + ∆PS = – b – d

• Ex: Rent-control laws set a maximum rent that landlords may

charge tenants.

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2. Government Intervenes
• Price ceiling
▫ Ceiling price cases: Necessities for daily life such as food, fuel, ...
when the war happens or governments want to control inflation.
▫ Products and services for public needs such as electricity, water,
communications, public transport,
▫ Provide public services at low cost and to regulate

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2. Government Intervenes
P
S
Price floor
Surplus Pmin
a
Pmin
b c d •A legal
PE j minimum on
e f E the price at
which a good
can be sold
g h i D
Q
QD QE QS

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2. Government Intervenes
• Price floor
▫ Outcomes: a surplus of the good arises
▫ Price Floor Affect Market Outcomes:
– In the case the manufacture produces the quantity QD
– Consumer surplus: ∆CS = – b – c
– Producer surplus: ∆PS = b – f
à DWL = – c – f
– In the case the manufacture produces the quantity QS
– Unsold: (QS – QD): ∆DWL = – c – f – h – i – j
– Sold: (QS – QD): ∆DWL = – c – f – h – i – j

– Ex: The minimum wage. Minimum-wage laws dictate the lowest

price for labor that any employer may pay.

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Taxes
• Governments use
taxes to raise
revenue for
public projects,
such as roads,
schools, and
national defense.

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Questions
• When the government levies a tax on a good, who
actually bears the burden of the tax?
• The people buying the good? The people selling the
good?
• If buyers and sellers share the tax burden, what
determines how the burden is divided? Can the
government simply legislate the division of the
burden, or is the division determined by more
fundamental market forces?

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How Taxes on Sellers Affect Market Outcomes

• (1) We decide whether the law affects the supply curve

or the demand curve.
• (2) We decide which way the curve shifts.
• (3) We examine how the shift affects the equilibrium
price and quantity.

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2. Government Intervenes
P S’
E with tax
Price the buyers S Tax
pay after tax
levied ($/unit)
E1
PD = P1 t A tax levied
PS=PD =P0 a b on sellers
E0 E without tax
c d
PS

Price the sellers

receive after tax D
levied Q
Q1 Q0

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2. Government Intervenes
P
Price the buyer
pay after tax S Tax
levied ($/unit)

PD A tax levied
PS=PD =P0 a b on buyers
E0 E without tax
c d t
PS = P1
E1
Price the seller E with tax
receive after tax D’ D
levied Q
Q1 Q0

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2. Government Intervenes
• Taxes
▫ Quantity decrease: Q0 à Q1
▫ Price increase: P0 à P1
▫ The price of Demand increase: P0 à PD = P1
▫ The price of Surply decrease: P0 à PS
▫ Market outcomes:
– Consumers: ∆CS = – a – b
– Producers: ∆PS = – c – d
– Government: ∆G = a + c
à ∆DWL = – b – d

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• To sum up:
• Taxes discourage market activity. When a good is
taxed, the quantity of the good sold is smaller in
the new equilibrium.
• Buyers and sellers share the burden of taxes. In the
new equilibrium, buyers pay more for the good,
and sellers receive less.

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How the Burden of a Tax Is Divided

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How the Burden of a Tax Is Divided

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2. Government Intervenes
• Taxes
• The tax burden does not depend on tax imposes on the buyers
or sellers, but on the shape (elasticity) of the supply curve and
the demand curve.
• If the elasticity of demand is less than the elasticity of supply,
the buyers suffer a greater tax burden than the sellers.
• If the elasticity of supply is less than the elasticity of demand,
the sellers suffer a greater tax burden than the buyers
• The the loss of social welfare depends on the elasticity of the supply
or the demand.
• With the same demand curve, the less elasticity of supply leads to
the loss of welfare will be smaller than the case of elastic supply.
• With the same supply curve, the less elasticity of demand lead to
the loss of welfare will be smaller than the case of elastic demand

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2. Government Intervene
P S
Price sellers E without subsidy
receive after
subsidizing S’

PS E0 Subsidy
a b
PS=PD =P0 e s ($/unit)
c d
PD =P1 E1 E with subsidy

Price buyer pay

after subsidizing

D
Q
Q0 Q1

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2. Government Intervene
• Subsidy
▫ Quantity increase: Q0 à Q1
▫ Price decrease: P0 à P1
▫ Price of demand decrease: P0 à PD = P1
▫ Price of supply increase: P0 à PS
▫ Outcomes:
– Consumer surplus: ∆CS = c + d
– Producer surplus: ∆PS = a + b
– Government: ∆G = – a – b – c – d – e
à ∆DWL = – e

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