21.1 Consumer Surplus and Producer Surplus

• Willingness to pay is the maximum amount a consumer is willing to pay for a product.

• Consumer surplus is the amount a consumer is willing to pay for a product minus the price the consumer actually pays.

• Willingness to accept is the maximum amount a producer is willing to accept as payment for a product; equal to the marginal cost of production.

• Producer surplus is the price a producer receives for a product minus the marginal cost production.

21.2 Market Equilibrium and Efficiency

• Total surplus is the sum of consumer surplus and producer surplus.

• Price ceiling is a maximum price set by the government.

• The maximum price reduces the total surplus of the market because it prevents some mutually beneficial transactions.

• Price floor is a maximum price set by the government.

• Under a maximum price, the first two consumers gain at the expense of the first two producers, whereas under the maximum price, the first two producers gain at the expense of the first two consumers.

  • Like the maximum price, the minimum price prevents mutually beneficial transactions for the third, fourth, and fifth laws.

• The market equilibrium maximizes the total surplus of the market because it guarantees that all mutually beneficial transactions will happen.

21.3 Controlling Prices - Maximum and Minimum Prices

• Some examples of goods that have been subject to maximum prices or may be subject to maximum prices in the near future:

  • Rental housing where during World War II, the federal government instituted a national system of rent controls. Although only New York City continued rent control after the war, during the 1970s rent control spread to dozens of cities.

  • Gasoline where in response to sharp increases in the price of gasoline in the 1970s, the national government set a maximum price on gasoline.

  • Medical goods and services where some proposals to control medical costs include price controls for prescription drugs.

• In all three cases, a maximum price will cause excess demand and reduce the total surplus of the market.

• Deadweight loss is the decrease in the total surplus of the market that results from a policy such as rent control.

• Three effects associated with rent control add to its efficiency:

  • Search cost where at the artificially low maximum price p, the number of the people seeking apartments exceeds the number of apartments available. Consumers will spend more time searching for apartments, so an additional cost of rent control is the opportunity cost of the extra time spent searching for apartments.

  • Cheating because rent control outlaws mutually beneficial transactions, many people violate the spirit and the letter of the law by cheating. In some rent control cities, consumers pay extra money to property owners to outbid other consumers. These extra payments are often distinguished as “nonrefundable security deposits” or as “key money” -thousands of dollars to get the keys to an application.

  • Decrease in quality of housing is given to lower payoff from providing apartments for rent, property owners will have less incentive to spend money on repair and maintenance, so the quality of apartments will decrease. In other words, Lowe rents are offset in art by lower housing quality.

21.4 Controlling Quantities - Licensing and Import Restrictions

• The government issues licenses to limit the number of establishments that could be considered a nuisance to some citizens and they protect consumers from low quality product ps and poor service.

• The losers from licensing programs are consumers. The winners are the people who receive a free medallion and the right to charge an artificially high price for taxi service.

• A way to control quantity is to limit the imports of a particular good.

• An import restriction increases the market price and decreases the total surplus of the market.

• If the United States banned sugar imports, foreign suppliers would disappear from the market, so the total supply of the sugar would consist of only the domestic supply.

  • The import ban would decrease the total surplus in the sugar market.

  • The import ban would cause domestic producers to gain at the expense of domestic consumers because consumers would lose more than domestic producers would gain, the import ban would cause a net loss for people in the United States.

21.5 Who Really Pays Taxes?

• The housing firm will charge more for apartments and pay less for its inputs, so the tax will actually be paid by consumers and input suppliers.

• A unit tax increases the cost of production, so we need a higher price to get firms to produce any given quantity.

  • The supply curve shifts upward by the amount of the tax.

• The shift of the supply curve increases the equilibrium price of apartments.

• The apartment tax affect the people who supply inputs such as land and labor to the housing industry.

  • The tax decreases the output of the industry, so the industry needs smaller quantities of inputs used to produce apartments.

  • The resulting excess supply of inputs will decrease land and labor prices, decreasing the cost of producing apartments.

• If the demand for tax goods is inelastic we need a large price hike to eliminate the excess demand caused by the tax.

  • Therefore, consumers will be hit by large increases in price, and so they will pay the bulk of the tax.

• Deadweight loss from taxation is the difference between the total burden of a tax amount of revenue collected by the government.

• Excess burden of a tax is another name for deadweight loss.