Chapter 3
Using Supply and Demand to
Analyze Markets
Copyright © 2020 by Macmillan Learning. All Rights Reserved
MICROECONOMICS Goolsbee | Levitt | Syverson | Third Edition
Introduction (1/1) 3
In this chapter, we put the tools learned in supply and
demand analysis to work to:
measure the total benefits received by consumers and producers.
show how government interventions into markets affect these
benefits.
Copyright © 2020 by Macmillan Learning. All Rights Reserved
Chapter Outline:
3.1 Consumer and Producer Surplus
3.2 Price Regulations
3.3 Quantity Regulations
3.4 Taxes
3.5 Subsidies
3.6 Conclusion
MICROECONOMICS Goolsbee | Levitt | Syverson | Third Edition
Consumer and Producer Surplus
(1/12)
3.1
Before we can analyze the market impact of any policy,
we need a way to measure the benefits consumers
and producers obtain from transacting in markets.
Economists measure these benefits using consumer
Copyright © 2020 by Macmillan Learning. All Rights Reserved
and producer surplus.
Consumer surplus: the difference between the price
consumers would be willing to pay for a good (as
measured by the height of their demand curves) and
the price they actually have to pay.
MICROECONOMICS Goolsbee | Levitt | Syverson | Third Edition
Consumer and Producer Surplus
(2/12)
3.1
Figure 3.1 Consumer Surplus
Copyright © 2020 by Macmillan Learning. All Rights Reserved
The consumer at point E will
not buy any apples because the
market price is too high.
MICROECONOMICS Goolsbee | Levitt | Syverson | Third Edition
Consumer and Producer Surplus
(3/12)
3.1
Producers also benefit from market
exchange.
Producer surplus: the difference
between the price producers actually
Copyright © 2020 by Macmillan Learning. All Rights Reserved
receive for their goods and the cost of
producing them (measured by the height
of the supply curve).
• Producer surplus is not the same as profit,
as we will see in later chapters.
MICROECONOMICS Goolsbee | Levitt | Syverson | Third Edition
Consumer and Producer Surplus
(4/12)
3.1
Figure 3.2 Producer Surplus
The producer at point Z will
not produce any apples
because the market price is
too low.
Copyright © 2020 by Macmillan Learning. All Rights Reserved
MICROECONOMICS Goolsbee | Levitt | Syverson | Third Edition
Consumer and Producer Surplus
(5/12): Question 1
3.1
Ryan would be willing to pay $1 for a lollipop. Sarah would
be willing to pay $0.50. The price of the lollipop is $0.75.
What is Ryan and Sarah’s combined consumer surplus?
A. $0
Copyright © 2020 by Macmillan Learning. All Rights Reserved
B. $0.25
C. $0.50
D. $0.75
MICROECONOMICS Goolsbee | Levitt | Syverson | Third Edition
Consumer and Producer Surplus
(5/12): Question 1 – Correct Answer
3.1
Ryan would be willing to pay $1 for a lollipop. Sarah would
be willing to pay $0.50. The price of the lollipop is $0.75.
What is Ryan and Sarah’s combined consumer surplus?
A. $0
Copyright © 2020 by Macmillan Learning. All Rights Reserved
B. $0.25 (correct answer)
C. $0.50
D. $0.75
MICROECONOMICS Goolsbee | Levitt | Syverson | Third Edition
Consumer and Producer Surplus
(6/12): Question 2
3.1
Tom would be willing to sell his yo-yo for $1.75. Megan
would be willing to sell her yo-yo for $1.50. If the equilibrium
price is $2, what is the combined value of Tom and Megan’s
producer surplus?
A. $0
Copyright © 2020 by Macmillan Learning. All Rights Reserved
B. $0.25
C. $0.50
D. $0.75
MICROECONOMICS Goolsbee | Levitt | Syverson | Third Edition
Consumer and Producer Surplus
(6/12): Question 2 – Correct Answer
3.1
Tom would be willing to sell his yo-yo for $1.75. Megan
would be willing to sell her yo-yo for $1.50. If the equilibrium
price is $2, what is the combined value of Tom and Megan’s
producer surplus?
A. $0
Copyright © 2020 by Macmillan Learning. All Rights Reserved
B. $0.25
C. $0.50
D. $0.75 (correct answer)
MICROECONOMICS Goolsbee | Levitt | Syverson | Third Edition
Consumer and Producer Surplus
(7/12)
3.1
Using consumer and producer surplus, we can
analyze the introduction of new products or the value
of innovation.
A key factor in determining the amount of potential
Copyright © 2020 by Macmillan Learning. All Rights Reserved
consumer surplus in the market is the steepness of the
demand curve.
MICROECONOMICS Goolsbee | Levitt | Syverson | Third Edition
Consumer and Producer Surplus
(8/12)
3.1
Figure 3.3 Consumer Surplus and the Elasticity of Demand
If the demand for glasses is D2,
consumer surplus = B
If the demand for glasses is D1,
consumer surplus = A + B
Copyright © 2020 by Macmillan Learning. All Rights Reserved
All else equal, the steeper the deman
curve, the more the consumer surplu
MICROECONOMICS Goolsbee | Levitt | Syverson | Third Edition
Consumer and Producer Surplus
(9/12)
3.1
The concepts of producer and consumer
surplus can be used to analyze the impact
of any change on either side of the market.
Shifts in the demand or supply curve
Copyright © 2020 by Macmillan Learning. All Rights Reserved
We can show how these shifts affect the
benefits that producers and consumers
receive in a market.
MICROECONOMICS Goolsbee | Levitt | Syverson | Third Edition
Consumer and Producer Surplus
(10/12)
3.1
Figure 3.4 Changes in Surplus from a Supply Shift
Copyright © 2020 by Macmillan Learning. All Rights Reserved
MICROECONOMICS Goolsbee | Levitt | Syverson | Third Edition
Consumer and Producer Surplus
(11/12)
3.1
A decrease in the supply curve increases the equilibrium price
and decreases the equilibrium quantity in the market. This
causes:
consumer surplus to decrease.
Both the increase in price and decrease in quantity decrease CS.
producer surplus to also decrease.
Copyright © 2020 by Macmillan Learning. All Rights Reserved
The increase in price increases PS, but the decrease in quantity
decreases PS. The net effect is negative due to the downward-
sloping demand.
An increase in the supply curve decreases the equilibrium price and
increases the equilibrium quantity in the market. This causes:
consumer surplus to increase.
producer surplus to increase.
MICROECONOMICS Goolsbee | Levitt | Syverson | Third Edition
Consumer and Producer Surplus
(12/12)
3.1
A decrease in the demand curve decreases the equilibrium price
and decreases the equilibrium quantity in the market. This
causes:
producer surplus to decrease.
Both the decrease in price and decrease in quantity decrease PS.
consumer surplus to also decrease.
Copyright © 2020 by Macmillan Learning. All Rights Reserved
The decrease in price increases CS, but the decrease in quantity
decreases CS. The net effect is negative due to the upward
sloping supply.
An increase in the demand curve increases the equilibrium price and
increases the equilibrium quantity in the market. This causes:
producer surplus to increase.
consumer surplus to increase.
MICROECONOMICS Goolsbee | Levitt | Syverson | Third Edition
Price Regulation (1/6) 3.2
Politicians often call for price regulations on products whose prices have risen
sharply.
Price ceiling: the highest price that can be paid legally for a good or service
‒ Binding only when set below the equilibrium price
‒ Nonbinding price ceiling: a price ceiling set above the equilibrium market
price
Copyright © 2020 by Macmillan Learning. All Rights Reserved
What are the effects of price ceilings on markets?
A few important terms:
Transfer: surplus that moves from producers to consumers, or vice versa, as a
result of a regulation
Deadweight loss (DWL): the reduction in total surplus that occurs as a result of
a market inefficiency
MICROECONOMICS Goolsbee | Levitt | Syverson | Third Edition
Price Regulation (2/6) 3.2
Figure 3.6 The Effects of a Price Ceiling
Copyright © 2020 by Macmillan Learning. All Rights Reserved
MICROECONOMICS Goolsbee | Levitt | Syverson | Third Edition
Price Regulation (3/6) 3.2
The supply and demand elasticities determine the relative
sizes of the deadweight loss and the transfer.
If demand and supply are relatively elastic, the deadweight loss is a
larger and the transfer from producer surplus to consumer surplus is
Copyright © 2020 by Macmillan Learning. All Rights Reserved
smaller.
• The more sensitive consumers and producers are to prices,
the greater the change in quantity demanded and supplied.
Alternatively, if demand and supply are relatively inelastic, the
deadweight loss is a smaller and the transfer from producer surplus
to consumer surplus is larger.
MICROECONOMICS Goolsbee | Levitt | Syverson | Third Edition
Price Regulation (4/6) 3.2
3.7 Deadweight Loss and Elasticities
Copyright © 2020 by Macmillan Learning. All Rights Reserved
MICROECONOMICS Goolsbee | Levitt | Syverson | Third Edition
Price Regulation (5/6) 3.2
The other type of price regulation is a price floor.
• Price floor: a regulation that sets the minimum price that can
be legally paid for a good or service (often called a price
support)
Copyright © 2020 by Macmillan Learning. All Rights Reserved
‒ Binding only when set above the equilibrium price
‒ Nonbinding price floor: a price floor set below the equilibrium
market price
What are the effects of price floors on markets?
MICROECONOMICS Goolsbee | Levitt | Syverson | Third Edition
Price Regulation (6/6) 3.2
Figure 3.8 The Effects of a Price Floor
Copyright © 2020 by Macmillan Learning. All Rights Reserved
MICROECONOMICS Goolsbee | Levitt | Syverson | Third Edition
Quantity Regulations (1/2) 3.3
Like price regulations, quantity regulations restrict the
amount of a good or service provided to a market
Quota: a regulation that sets the quantity of a good or
service provided
• Often used to limit imports of certain goods
Copyright © 2020 by Macmillan Learning. All Rights Reserved
‒ Why might a government pursue an import quota?
• Sometimes used to limit exports (e.g., China and rare earths)
What are the effects of quotas on markets?
MICROECONOMICS Goolsbee | Levitt | Syverson | Third Edition
Quantity Regulations (2/2) 3.3
Figure 3.9 The Effects of a Quota
Copyright © 2020 by Macmillan Learning. All Rights Reserved
MICROECONOMICS Goolsbee | Levitt | Syverson | Third Edition
Taxes (1/10) 3.4
Taxes are very prevalent in societies.
Examples:
1. Product markets (e.g., VAT, sales taxes)
2. Labor markets (e.g., income taxes, payroll taxes)
3. Capital markets (e.g., capital gains taxes)
Copyright © 2020 by Macmillan Learning. All Rights Reserved
How do taxes impact markets?
• Some taxes are imposed to correct market failures (see Chapter 16)
• In general, taxes distort market outcomes.
Example: In 2003, Boston’s Mayor Tom Menino proposed a
$0.50 tax on movie tickets.
‒ How should this tax (which was ultimately not adopted by the
legislature) affect the market for movie tickets?
MICROECONOMICS Goolsbee | Levitt | Syverson | Third Edition
Taxes (2/10) 3.4
Figure 3.10 The Effect of a Tax on Boston Movie Tickets
Copyright © 2020 by Macmillan Learning. All Rights Reserved
MICROECONOMICS Goolsbee | Levitt | Syverson | Third Edition
Taxes (3/10) 3.4
Taxes create a deadweight loss.
Why?
Taxes raise prices for consumers and lower the received price to
producers.
• Some consumers who would have purchased at the lower, pre-
Copyright © 2020 by Macmillan Learning. All Rights Reserved
tax price (and gained consumer surplus) do not purchase at
the higher, after-tax price.
• Some firms that were producing (and gaining producer surplus)
at the pre-tax price do not produce at the after-tax price.
The larger the tax, the larger the deadweight loss.
MICROECONOMICS Goolsbee | Levitt | Syverson | Third Edition
Taxes (4/10) 3.4
Figure 3.11 The Effect of a Larger Tax on Boston Movie
Tickets
Copyright © 2020 by Macmillan Learning. All Rights Reserved
MICROECONOMICS Goolsbee | Levitt | Syverson | Third Edition
Taxes (5/10): Question 1 3.4
In Figure 3.11, area _______
represents the consumer
surplus with the smaller tax,
and area ________ represents
the consumer surplus with the
larger tax on Boston movie
tickets.
Copyright © 2020 by Macmillan Learning. All Rights Reserved
A. A + B + C + F; A
B. A + B + C + F; A + B
C. A + B + C; A
D. A + B + C; A + C
MICROECONOMICS Goolsbee | Levitt | Syverson | Third Edition
Taxes (5/10): Question 1 – Correct
Answer 3.4
In Figure 3.11, area _______
represents the consumer
surplus with the smaller tax,
and area ________ represents
the consumer surplus with the
larger tax on Boston movie
tickets.
Copyright © 2020 by Macmillan Learning. All Rights Reserved
A. A + B + C + F; A
B. A + B + C + F; A + B
C. A + B + C; A (correct answer)
D. A + B + C; A + C
MICROECONOMICS Goolsbee | Levitt | Syverson | Third Edition
Taxes (6/10) 3.4
Tax incidence is a term describing who actually bears the burden
of a tax.
In the supply and demand model, it does not matter who is required to
pay the tax (e.g., a sales tax vs. a production tax).
Copyright © 2020 by Macmillan Learning. All Rights Reserved
The total tax incidence will be the same in each case!
MICROECONOMICS Goolsbee | Levitt | Syverson | Third Edition
Taxes (7/10) 3.4
Figure 3.12 Tax Incidence
Copyright © 2020 by Macmillan Learning. All Rights Reserved
MICROECONOMICS Goolsbee | Levitt | Syverson | Third Edition
Taxes (8/10) 3.4
Tax incidence and elasticities
• Elasticities of supply and demand are the major determinants of
incidence.
• In general, when demand is relatively more elastic, consumers will
experience less burden, and vice versa.
Copyright © 2020 by Macmillan Learning. All Rights Reserved
• Alternatively, when supply is relatively more elastic, producers will
experience less burden, and vice versa.
• Rule: The more elastic curve (supply or demand) bares the least
burden (producer or consumer).
MICROECONOMICS Goolsbee | Levitt | Syverson | Third Edition
Taxes (9/10) 3.4
Tax incidence and elasticities
General formula(s) for incidence as a function of elasticities:
ES ED
Copyright © 2020 by Macmillan Learning. All Rights Reserved
Share born by consumer S Share born by producer
E ED ES ED
• Notice, the share born by the consumer relies primarily on the
elasticity of the supplier/producer, and vice versa.
MICROECONOMICS Goolsbee | Levitt | Syverson | Third Edition
Taxes (10/10) 3.4
Figure 3.13 Tax Incidence and Elasticities
Demand More Elastic, Supply More Elastic, Supplier
Consumer Bares Less Burden Bares Less Burden
Copyright © 2020 by Macmillan Learning. All Rights Reserved
MICROECONOMICS Goolsbee | Levitt | Syverson | Third Edition
Subsidies (1/2) 3.5
Subsidy: a payment by the government to a buyer or seller of a good or
service
• Subsidies are simply the opposite of a tax.
• The price the buyer pays is lower than the price the supplier receives.
Pb + subsidy = Ps
Copyright © 2020 by Macmillan Learning. All Rights Reserved
Governments subsidize many products and production processes.
Examples:
• Producer subsidies: ethanol production, research and development
• Consumer subsidies: education, public transportation
MICROECONOMICS Goolsbee | Levitt | Syverson | Third Edition
Subsidies (2/2) 3.5
Figure 3.14 The Impact of a Producer Subsidy
Copyright © 2020 by Macmillan Learning. All Rights Reserved
MICROECONOMICS Goolsbee | Levitt | Syverson | Third Edition
Conclusion (1/1) 3.6
This chapter examined the supply and demand model in more
detail, and analyzed how government policies affect markets.
In the next few chapters, we examine the microeconomic
underpinnings of demand and supply.
Copyright © 2020 by Macmillan Learning. All Rights Reserved
In Chapter 4, we introduce the concept of utility, which provides
context for understanding how consumers make consumption
decisions.
MICROECONOMICS Goolsbee | Levitt | Syverson | Third Edition
