ECON1101 Chapter Notes - Chapter 5: Price Ceiling, Deadweight Loss, Price Floor

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31 May 2018

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Price Ceiling: The Price Ceiling represents a maximum allowable price imposed by

the government.

When Government believes that P is unfairly high (to protect low-income

consumers)

If P of market is less than P of ceiling --> Policy has no effect

The 'winners' of this policy are the consumers with high reservation price (i.e.

high willingness to pay) --> the rick

Solution: if the government wanted to help the low-income households, a

direct lump sum transfer to the poor is more efficient

Deadweight Loss: The Deadweight Loss is the loss in economic surplus due to the

market being prevented from reaching the equilibrium price and quantity where

marginal benefit (MB) equals marginal cost (MC).

Price Floor: The Price Floor represents a minimum allowable price imposed by the

government.

When the government believes that P is unfairly low (to protect producers in

a certain sector)

The 'losers' of this policy are all those harmed by the price floor -->

consumers & producers

Solution: The 'losers' would be willing to pay the 'winners' the exact amount

they gained from the intervention in exchange for cancelling the price

floor --> Pareto Improving Transaction

Taxation

Unlike the price ceiling and the price floor, a tax generates tax revenues

Tax revenues can be used to redistribute wealth within a society

Improves the distribution of income and opportunities across different

population groups

The 'losers' of this policy are the consumers and producers or the consumers

(if D = inelastic or S = perfectly elastic) or producers (if S = inelastic or D =

perfectly elastic)

The 'winner' is the Government --> gets tax revenue to subsidise/reduce

taxes on other markets, provide public goods etc.

Solution: The 'losers' would be willing to pay the 'winner' the exact amount it

gained from the intervention in exchange for cancelling the tax --> Pareto

Improving Transaction

What is the most efficient way of collecting tax revenues? Tax those with the

lowest elasticity.

Why? The more elastic supply & demand are at the initial P, the bigger the

deadweight loss.

Subsidy

Opposite of Tax

Government Cost to assist certain groups of consumers (or producers)

Makes certain goods more affordable for certain groups of consumers

The 'winners' of this policy are the consumers and producers, but it costs

more to the government then it benefits the people.

Solution: If the government wanted to make certain goods more affordable, a

direct lump sum transfer to the poor is more efficient.

Summary: Government Intervention

Perfectly competitive markets converge to an equilibrium where total surplus is

maximised

Any Government intervention that prevents a market from reaching its P is bad for

total surplus

Avoid Government intervention at all cost

Sometimes that is not true: Public Goods!

Chapter 5 - Government Intervention The Cost of

Interfering with Market Forces

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Document Summary

Chapter 5 - government intervention the cost of. Price ceiling: the price ceiling represents a maximum allowable price imposed by the government. When government believes that p is unfairly high (to protect low-income consumers) If p of market is less than p of ceiling --> policy has no effect. The "winners" of this policy are the consumers with high reservation price (i. e. high willingness to pay) --> the rick. Solution: if the government wanted to help the low-income households, a direct lump sum transfer to the poor is more efficient. Deadweight loss: the deadweight loss is the loss in economic surplus due to the market being prevented from reaching the equilibrium price and quantity where marginal benefit (mb) equals marginal cost (mc). Price floor: the price floor represents a minimum allowable price imposed by the government. When the government believes that p is unfairly low (to protect producers in a certain sector)

Related Questions

Under a binding price ceiling, what does the change in consumer surplus represent?
A) The gain in surplus for those buyers who can still purchase the product at the lower price.
B) The loss in surplus for those buyers who previously purchased some units of the good at the higher price, but these units are no longer produced at the lower price.
C) The loss in surplus for those buyers who would like the purchase the excess demand created by the price ceiling policy.
D) Both A and B are correct.
E) Both A and C are correct.

When the market price is held above the competitive level, the deadweight loss is composed of:

A) producer surplus losses associated with units that used to be traded on the market but are no longer exchanged.

B) consumer surplus losses associated with units that used to be traded on the market but are no longer exchanged.
C) producer and consumer surplus losses associated with units that used to be traded on the market but are no longer exchanged.
D) There is no deadweight loss if the government uses a price floor policy to increase the price.

Compared to a tariff, an import quota, which restricts imports to the same amount as the tariff, will leave the country as a whole
A) worse off than a comparable tariff.
B) not as bad off as a comparable tariff.

C) about the same as a comparable tariff.

D) Any of the above can be true.

What is the welfare impact of a subsidy policy?
A) Producer surplus increases, consumer surplus declines, and total welfare declines.
B) Producer and consumer surplus increase, and these gains are larger than the government cost.

C) Producer and consumer surplus increase, and these gains are smaller than the government cost.

D) Producer surplus increases, consumer surplus declines, and total welfare increases due to the subsidy program.

Why is there a deadweight loss associated with subsidy payments?
A) There is no deadweight loss from a subsidy.
B) Quantity supplied is less than the equilibrium amount, so consumers and producers lose surplus value on those units that are no longer produced.
C) Quantity supplied exceeds the equilibrium amount, and consumer willingness to pay for these additional units is smaller than the marginal cost of producing them.
D) The subsidy payment does not distort quantities in the market, but the government cost exceeds consumer willingness to pay for the quantity demanded.

violetmole943

1. Suppose that there is a tax of $1 per unit, and the elasticity of supply is 3 and the elasticity of demand is 2 (in absolute value). How much of the $1 tax is paid by sellers?

		$0.60
		$0.40
		$0.75
		$0.67

2. In Market X, the external benefit of consumption is $5. In Market Y, the external cost of consumption is $10. Efficiency in both markets could be achieved by:

		a tax of $5 in Market X and a subsidy of $10 in Market Y.
		subsidizing both markets.
		taxing Market Y and subsidizing Market X.
		taxing both markets.

3.Economic theory suggests that a natural monopoly should be:

		eliminated whenever it arises.
		regulated to take advantage of economies of scale.
		left alone to operate with excess capacity.
		taken over by the government.

4.When the size of the production is the most efficient:

		total cost is at the minimum.
		average cost is at the minimum.
		marginal cost is at the minimum.
		fixed cost is at the minimum.

5.A firm should exit the industry if which of the following conditions apply?

		TR > TC
		P < AC
		Lifetime expected profit is positive.
		Prices are low now but expected to rise.

6.Figure: Costs

Reference: Ref 11-6

(Figure: Costs) Use the figure. At a price of $20, the firm earns profit of:

		$75.
		$300.
		$225.
		$0, because P = MC at P = $20.

7.When external benefits are present, the market price is ________, however when external costs are present, the market price is ________.

		too low; too high
		equal to the efficient price; too low
		too high; too low
		equal to the efficient price; too high

8.Which of the following statements is TRUE?

I. The EPA's tradeable allowances program for sulfur dioxide establishes property rights to pollute and helps reduce transaction costs by distributing allowances, maintaining databases, and monitoring emissions.

II. One criticism of tradeable allowances is that they prohibit non-businesses and environmental groups from purchasing the allowances.

III. The tradeable allowances for sulfur dioxide have performed poorly because electricity output has increased, causing a rise in sulfur dioxide levels.

		I only
		II and III only
		I, II, and III
		III only

9.Price floors make it illegal to compete for more customers by lowering prices, so firms compete by offering customers:

		various options.
		more quantity.
		more discount.
		higher quality.

10.Figure: Government Price Controls

Reference: Ref 8-3

(Figure: Government Price Controls) Refer to the figure. If the government sets the price ceiling at $31, there will be:

		a shortage of 15 units.
		a surplus of 15 units.
		a supply of 20 units.
		no effect on the market.

11.In which of these instances does price function as a signal in the market?

		Suppliers invest more in exploration when the price of oil increases.
		Consumers complain of price gouging as the price of oil skyrockets.
		Government imposes price controls on the skyrocketing price of oil.
		All of the answers are correct.

12.Ethanol and sugar are both made from sugar cane, and ethanol can be used as substitute fuel for oil. Increasing oil prices cause the demand for ethanol to increase. This will cause the ______ sugar to ______ and its price to ______.

		demand for; decrease; decrease
		supply of; increase; increase
		supply of; decrease; increase
		demand for; increase; increase

13.Why do cotton growers spend billions of dollars to dam rivers and transport water hundreds of miles to grow cotton in California deserts?

		Cotton growers in California don't pay payroll taxes.
		The water used to grow California cotton is highly subsidized by the government.
		Cotton growers in California are mostly operated as nonprofit enterprises.
		The water used to grow California cotton is high in mineral contents, making for a bigger cotton yield.

14.Suppose that the equilibrium price in the market is $10. If the current market price is $7.50:

		the equilibrium price will fall to $7.50.
		competition among buyers will increase the current price.
		the current price will fall below $7.50 as sellers compete for market share.
		There is not enough information provided to answer the question.

15.Which of the following would increase the demand for beef?

		lower pork prices
		higher consumer income
		higher prices of feed grains used to feed beef cattle
		an increase in the price of beef

16.A change in quantity supplied is reflected by a movement along the same supply curve while a change in supply refers to a shift in the entire supply curve.

True

False

17.Table: Production in the United States and Germany

Labor units required to produce:

One Clock

One Sofa

United States		2	5
Germany		3	9

Reference: Ref 2-8

(Table: Production in the United States and Germany) According to the table, the opportunity cost of producing one sofa in the United States is _________, and the opportunity cost of producing one sofa in Germany is _______.

		two clocks; three clocks
		10 clocks; 27 clocks
		0.4 clocks; 0.33 clocks
		2.5 clocks; three clocks

18.Mark values his drum set at $800 and Ella values her guitar at $1,000. Suppose that Mark trades his drum set for Ella's guitar.

		This trade makes Ella worse off by $200.
		This trade makes Mark better off by $200.
		Mark must value Ella's guitar for at least $1,000, and Ella must value Mark's drum set for at least $800.
		This trade creates value by moving the guitar and drum set to people who value them more.