ECON191 (Spring 2011)
13 & 15.4.2011 (Tutorial 7)
Chapter 9 The Analysis of Competitive Markets
Minimum prices
 Government policy seeks to raise prices above market-clearing levels
 Examples: Minimum wage law, Regulation of airlines, Agricultural policies
Example 9.3: Airline Regulation
S
Price
Pmin
A
B
P0
C
D
D
Q1





Q3 Q0
Q2
Quantity
Before 1970, the U.S. airline industry was heavily regulated by the Civil Aeronautics
Board. What are the effects of this regulation on surpluses?
At Pmin, airlines supply Q3.
The cost of unsold output: D
Change in PS: A – C –D
Change in CS: –(A+B)
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Price supports and production quota
 Price set by government above free-market level and maintained by government
purchases of excess supply
Example 9.4: Supporting the price of wheat
Price
S
In 1981,
Supply: Qs = 1,800 + 240P
Demand: QD = 3,550 – 266P
Price = $3.46 and Quantity = 2,630
Qg
P0 = $3.70
A
B
P0 = $3.46
C
D + Qg
D
1,800




2,566 2,630 2,688
Quantity
Government raised the price to $3.70 through government purchases of 122 million
bushels (At P = 3.70, QS = 2688, QD = 2566)
Loss in CS: – (A + B) = –$624
Gain in PS: (A + B + C) = $638
Cost to the government: $3.7 × 122 = 451.4
Price
S’
S
In 1985, export demand fell.
Supply: Qs = 1,800 + 240P
Demand: QD = 2,580 – 194P
Price = $1.8 and Quantity = 2,231
QS
P0 = $3.20
P0 = $1.80
D + QS
D
1,800 1,959





2,232 2,425
Quantity
The government wanted to keep the price at $3.20 and at the same time, it imposed a
production quota of 2425 million bushels
2,425 = 2,580 – 194P + QG
QG = -155 + 194P
QG = -155 + 194($3.20) = 466 million bushels
Cost to the government: $3.2 × 466 = 1491
2
Import quotas and tariffs
 Import quota: Limit on the quantity of a good that can be imported
 Tariff: Tax on an imported good
Example 9.5: The sugar quota
Price
(cents/lb.)
DUS
SUS
PUS = 21.5 after quota
D
20
A
16
C
B
11
PW = 8.3 before quota
8
4
1.4



17.4
20.4
Quantity
24.2 (billions of pounds)
The world price of sugar is lower then the price in U.S.
Sugar quotas have protected the sugar industry but driven up prices
Domestic producers and foreign producers have quota rights are better off while
consumers are worse off
 Supply in U.S.: QS = – 8.70 + 1.21P
 Demand in U.S.: QD = 26.53 – 0.29P
 At PW = 8.3, import = 22.8 billion

With a quota of 3 billion, PUS = 21.5




Costs to consumers: A + B + C + D
Gain to producers: A
Gain to foreign producers: D
DWL: B + C
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The impact of a tax or subsidy
 Specific tax: tax of a certain amount of money per unit sold
 Subsidy: payment reducing the buyer’s price below the seller’s price (a negative tax)
Example 9.7: Tax on gasoline
 The goal of a large gasoline tax is to raise government revenue, reduce oil consumption
and reduce US dependence on oil imports
D
Price
($ per
gallon
)
Pb = 1.22
$0.50
Tax
P0 = 1.00
S
B
A
D
C
PS = .72
11
50 60
89 100
150
Quantity (billion
gallons per
year)
 Demand: QD = 150 – 50P
 Supply: QS = 60 + 40P
 Price = $1 and Quantity = 100billion






With a 50 cent tax,
150 – 50Pb = 60 + 40PS
150 – 50(PS+ 0.50) = 60 + 40PS
PS = 0.72
Pb = PS + 0.50 = $1.22
QD = QS = 89 bg/yr




Loss to consumers: A + B (Tax burden: 22cents)
Loss to producers: C + D (Tax burden: 28 cents)
Government revenue: A + D
DWL: B + C
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