Session 3

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Agenda
 Solve 2 linear equations (2 unknowns) and illustrate the
solution graphically
 Solve 3 linear equations (3 unknowns)
 Equilibrium price and quantity in the goods market
 Equilibrium in labour market
 Price controls
 Tax, subsidies and their distribution
 Break-even analysis
 Consumer and producer surplus
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Solving 2 linear equations + Graph
 Example:
1) 2X+3Y = 12.5
2) -X + 2Y = 6
 Solution:
1) 2X + 3Y = 12.5
2) x 2  -2X + 4Y = 12
7Y = 24.5
Y=24.5/7=3.5
Subtitute Y=3.5 in equation 2)  -X + 2(3.5) = 6
X=7–6=1
 X = 1 and Y = 3.5
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 y-axis
7
6

4
(1,3.5)
3

2 (2.5,2.5)
1

-4 -3 -2 -1 0 1 2 3 4 5 x-axis

2 equations with 2 unknows may have:

• A unique solution.
• No solution (y=1+x and y-x=2)
• Infinitely many solutions (y=2-x and 2y+2x=4)
• Same/coincide/identical lines 4
Three simultaneous equations with 3 unknowns
Solve these simultaneous equations
2x  y  z  4 ... (1)
x yz3 ... (2)
2x  2 y  z  12 ... (3)
Hints:
• Select 2 equations and eliminate 1 unknown
• Select another 2 equations and eliminate previous unknown
• Study Work example 3.6

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Equilibrium price and quantity in the
goods market
(Pe, Qe)

120

100
Given:
80
Qd = 200-2Pd
Qs = -20+2Ps
Price 60
Demand Curve
Calculate Pe & Qe
40 Supply Curve

20

0
0 50 100 150 200 250
Quantity

• When price above Pe  excess supply

• When price below Pe  excess demand  shortage

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Equilibrium in labour market
(We, Le)

12
Terbalik
10

8 Given:
Wage 6 Wd = 9-0.6Ld
Labour Demand
4 Labour Supply
Ws = 2+0.4Ls
2
Calculate We & Le
0
0 10 20 30
Labour

• When wage above We  excess supply  unemployment

• When wage below We  excess demand  Labor shortage

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Price controls
 Price ceilings
 The price is not allowed to go above the maximum or “ceiling” price
 Imposed by the government to protect consumers because the Pe is
considered too high
 Leads “black market”  worked example 3.9 page 115
 Price floors
 The price is not allowed to go below the minimum or “floor” price
 Imposed by the government to protect producers because the Pe or We is
considered too low
 Minimum wage laws  worked example 3.10 page 116

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Taxes, Subsidies, and their Distribution
 Fixed Tax per unit of output
 The supply curve will shift to the left.
 Consumer will pay the new Pe (higher than Pe) and Producer receives the
new Pe minus tax (lower than Pe).
  worked example 3.12 page 121
 Subsidies
 The supply curve will shift to the right.
 Consumer will pay the new Pe (lower than Pe) and Producer receives the
new Pe plus subsidy (higher than Pe).
  worked example 3.13 page 123
 Distribution of taxes/subsidies (for linear function)
 % tax/subsidies paid/received by Consumer: |md|/(|md|+|ms|)
 % tax/subsidies paid/received by Producer |ms|/(|md|+|ms|)

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Effects of fixed tax per unit of output
Qd = 200-2Pd
120

100
Qs = -20+2Ps
80

Price 60
Demand Curve
40 Supply Curve

20

0
0 50 100 150 200 250
Quantity

• Tax $6/unit
• Because of tax, the producer will get less money/motivation to
produce  supply function will shift to ......
Qs = -20+2(Ps-6)

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 Effects of fixed tax per unit of output
Qs = -32+2Ps

Qs = -20+2Ps

Consumer P=58
55
Producer P=52

Qd = 200-2Pd

0 50 90 100 150 200

Quantity
• Tax $6/unit
• Because of tax, the producer will get less money/motivation to
produce  supply function will shift to ...... 11
Break-even Analysis
 Break – Even Point:
Total Revenue = Total Cost
 Example :
The total revenue and cost function are given as follows :
TR = 3Q
TC = 10 + 2Q
Calculate the break-even point and make the graph.

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 Break-even Analysis
TC TR TR = 3 Q
45
40
Break-even point
35 TC = 10 + 2 Q
TC = TR = 30
25

20
15
At break-even, Q = 10
10

5
0 Q
0

10

12

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Problem Example

A firm receives $2.5 per unit for a particular

good. The fixed costs incurred are $44 while
each unit production cost $1.4.
a. Write down the equation for total revenue and
total cost
b. Calculate the break even point algebraically
c. If government imposes a tax of $0.70 per unit,
recalculate the break-even point.
d. Show the graphical solutions for part (b) and
(c).
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Consumer Surplus
Consumer Surplus: The difference between the amount that the
consumer are willing to pay and the amount that the consumer
actually pays
Example:
Calculate the consumer surplus
(CS) when the price = $55 per unit

When P = $55, Q = 90 unit

CS = Area of triangle
= 0.5 (55)(90)

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Producer Surplus
Producer Surplus: The difference between the revenue that the
producer receives and the revenue that the producer was willing
to accept
Example:
Calculate the producer surplus
(PS) when the price = $55 /unit

When P = $55, Q = 90 unit

PS = Area of triangle
= 0.5 (45)(90)

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Consumer & Producer Surplus at Market
Equilibrium (W.E. 3.15)
The demand and supply function of a good are given as:
Demand function: P = 60 – 0.6Q
Supply function: P = 20 + 0.2Q

Calculate the values of consumer and producer surplus at the

equilibrium! What is the total surplus?

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Answer (W.E. 3.15)

Pe = 50 units
Qe = $30

CS = (0.5) (50) (30) = 750

PS = (0.5) (50) (10) = 250

Total surplus = CS + PS
= 750 + 250
= 1000

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