UofA ECON 101 Winter 2023 (Week 6) - 2

ECON 101 Introduction to Microeconomics
WEEK 6 (Winter 2023)

Feb 07, 2023
Ashutosh Sarker, Ph.D.

Department of Economics
University of Alberta
Week 6 - Reading
▪ Chapter 6:
Supply, Demand,
and Government
Policies
▪ Chapter 7:
Consumers,
Producers, and the
Efficiency of Markets
2
Recap
▪ Price elasticity of demand/supply - responsiveness of the
demand/supply to a change in its price
▪ Inelastic demand curve: total revenue rises as price rises.
▪ Elastic demand curve: total revenue falls as price rises
▪ Income elasticity of demand: positive for a “normal good”
or negative for an “inferior good”
▪ Price elasticity of demand and supply will vary from the
short run to the long run: both producers and consumers
can adjust to the circumstances
3
Week 6 – Learning Objectives
▪ To analyze the market impacts of price ceilings and
price floors
▪ To explain the concepts of consumer surplus and
producer surplus and use them to evaluate the
efficiency of markets
▪ To analyze the impact of government taxation policy
on social welfare
4
Looking For The Answers To These Questions:
Chapter 6: Supply, Demand and Government
Policies
▪ What are price ceilings and price floors?
What are some examples of each?
▪ How do price ceilings and price floors affect
market outcomes?
▪ How do taxes affect market outcomes?
How do the effects depend on whether
the tax is imposed on buyers or sellers?
▪ What is the incidence of a tax?
What determines the incidence? 5
Chapter 6: Supply, Demand, and
Government Policies
Government Policies That Alter the Market Outcome
Government policies can alter market outcomes,
using:
1. Controls on Prices
Price controls are used when policymakers believe
the market price is unfair to buyers or sellers
2. Taxes
Government can make buyers or sellers pay a
specific amount on each unit
7
1. Controls on Prices, Part 1
1. Price Controls:
▪Price controls are used when policymakers
believe the market price is unfair to buyers or
sellers
▪Price controls can be
•a price ceiling
a legal maximum on the price at which a
good can be sold (e.g., rent control laws)
•a price floor
a legal minimum on the price at which a
good can be sold (e.g., minimum wage laws)
8
Price Ceiling
A legal maximum on the price at which a good can be sold
9
How price ceilings affect market outcomes
1
Price ceiling is a legal maximum on the price at which a good can be sold
11
A Market with a Price Ceiling
A price ceiling above the equilibrium
(a) A Price Ceiling That Is Not Binding
price is not binding—has no effect on
the market outcome.
The government imposes a price

ceiling of $4
Because the price ceiling is above
the equilibrium price of $3, the price
ceiling has no effect, and the market
can reach the equilibrium of supply
and demand.
In this equilibrium, quantity supplied
and quantity demanded both equal
100 cones.
1
A Market with a Price Ceiling
The government imposes a price
(b) A Price Ceiling That Is Binding ceiling of $2
Because the price ceiling is below
the equilibrium price of $3, the
market price equals $2.
At this price, 125 cones are
demanded and only 75 are
supplied, so there is a shortage of
50 cones.
A binding price
ceiling creates
13
Effects of price ceilings:
A binding price ceiling creates
• shortages because QD > QS.
➢Example: petrol shortage of the 1970s
• non-price rationing
➢Examples: long lines, discrimination by sellers
Note: Non-price rationing (first-come, first-served) is the use

of a method other than price controls that limits output.
14
Example 1:
Price Control: Gasoline Shortage
15
• 1973, OPEC raised the price of
crude oil
– Reduced the supply of gasoline
– Long lines at gas stations
• What was responsible for the long
gas lines?
– OPEC
• Shortage of gasoline
– U.S. government regulations Source: Internet
• Price ceiling on gasoline
16
• Price ceiling on gasoline
– Before OPEC raised the price of crude oil
• Equilibrium price was below the price ceiling
• No effect on the market
– When the price of crude oil rose
• Decrease in the supply of gasoline
• Equilibrium price was above the price ceiling
• Binding price ceiling: Severe shortage
• Laws regulating the price of gasoline
were repealed 17
Lines at the Gas Pump FIGURE 6.2
18
Example 2:
Price Control: Rent Control
19
• Rent controls are ceilings placed on the
rents that landlords may charge their
tenants.
• The goal of rent control policy is to help
the poor by making housing more
affordable.
• One economist called rent control “the
best way to destroy a city, other than
bombing.”
20
Rent Control in the Short Run and the Long Run
• Economists often criticize rent control, arguing that it is a highly

inefficient way to help the poor raise their standard of living.
• One economist has called rent control “the best way to destroy
a city, other than bombing.”
21
(a) Rent Control in the Short Run
(supply and demand are inelastic)
▪ Panel (a) shows the
short-run effects of rent
control
• Because the supply
and demand for
apartments are
relatively inelastic,
the price ceiling
imposed by a rent-
control law causes
only a small shortage
of housing.
22
(b) Rent Control in the Long Run
(supply and demand are elastic) ▪ Panel (b) shows the
long-run effects of
rent control
• Because the
supply and
demand for
apartments are
more elastic, rent
control causes a
large shortage.
23
Rent control in the short run and the long run, Part 1
• Price ceiling: rent control
– Local government places a ceiling on
rents
– Goal: to help the poor
• Making housing more affordable
– Critique
• Highly inefficient way to help the poor raise
their standard of living
24
• Adverse effects in the short run
– Supply and demand for housing are inelastic in the short run
– Small shortage
– Reduced rents
• Adverse effects in the long run
– Supply and demand are more elastic
– Landlords
• Are not building new apartments
• Are failing to maintain existing ones
– People
• Find their own apartments
• Induce more people to move into a city
– Large shortage of housing
25
• Adverse effects in the long run
– Rationing mechanisms
• Long waiting lists
• Preference to tenants without children
• Discriminate on the basis of race
• Bribes to building superintendents
• People respond to incentives
– Free markets
• Landlords – clean and safe buildings
• Higher prices 26
• People respond to incentives
– Rent control
• Shortages and waiting lists
• Landlords lose their incentive to respond to
tenants’ concerns
• Tenants get lower rents and lower-quality
housing
• Policymakers – additional regulations
– Difficult and costly to enforce
27
PRICE FLOOR
Price floor is a legal minimum on the price at which a good

can be sold
28
How price floors affect market outcomes
29
(A) A Price Floor That Is Not Binding
▪ The government imposes a price floor

of $2
• Because this is below the
equilibrium price of $3, the price
floor has no effect.
• The market price adjusts to
balance supply and demand.
• At the equilibrium, quantity
supplied and quantity demanded
both equal 100 cones.
30
(B) A Price Floor That Is Binding
▪ The government imposes a price floor of
$4
• Because this is above the
equilibrium price of $3.
• Therefore, the market price equals
$4.
• Because 120 cones are supplied at
this price and only 80 are
demanded, there is a surplus of 40
cones.
31
• If minimum wage is above equilibrium
• Unemployment
• Higher income for workers who
have jobs
• Lower income for workers who
cannot find jobs
• Impact of the minimum wage on
highly skilled and experienced
workers
• No effect: their equilibrium wages
are well above the minimum
• Minimum wage: not binding
32
• Impact of the minimum wage on teenage
labor
• Least skilled and least experienced
• Low equilibrium wages
• Willing to accept a lower wage in
exchange for on-the-job training
33
Evaluating price controls
▪ Markets are usually a good way to organize economic
activity
• Economists usually oppose price ceilings and price
floors
▪ Governments can sometimes improve market outcomes
• Want to use price controls
• Because of unfair market outcome
• Aimed at helping the poor
• Often hurt those they are trying to help
• Other ways of helping those in need
• Rent subsidies
• Wage subsidies
34
2. Taxes, Part 1
How taxes affect market outcomes
TAX AND MARKET OUTCOME
35
2. Taxes, Part 2
Taxes and market outcomes
36
2. Taxes, Part 3
Equivalence of a tax on buyers or a tax on sellers
▪ Buyers and sellers share the tax burden

▪ Whether a tax is placed on buyers or sellers,
the impact is the same
37
2. Taxes, Part 4
A Tax on Buyers
38
2. Taxes, Part 5
A Tax on Sellers
39
2. Taxes, Part 6
Elasticity and tax incidence
▪Tax incidence is how the burden of
a tax is shared among buyers and
sellers.
▪Who bears the burden of tax more
heavily?
40
2. Taxes, Part 7
How the Burden of a Tax Is Divided (a)
41
2. Taxes, Part 8
How the Burden of a Tax Is Divided (b)
42
2. Taxes, Part 9
Elasticity and tax incidence
So, how is the burden of the tax divided?
The burden of a tax falls more

heavily on the side of the
market that is less elastic.
43
Summary, Part 1
• A price ceiling is a legal maximum on the price
of a good. An example is rent control. If the
price ceiling is below the equilibrium price, it is
binding and causes a shortage.
• A price floor is a legal minimum on the price of
a good. An example is the minimum wage. If
the price floor is above the equilibrium price, it
is binding and causes a surplus. The labor
surplus caused by the minimum wage is
unemployment.
44
Summary, Part 2
• A tax on a good places a wedge between the

price buyers pay and the price sellers receive,
and causes the equilibrium quantity to fall,
whether the tax is imposed on buyers or sellers.
• The incidence of a tax is the division of the
burden of the tax between buyers and sellers,
and does not depend on whether the tax is
imposed on buyers or sellers.
• The incidence of the tax depends on the price
elasticities of supply and demand.
45
Chapter 7: Consumers, Producers,
and the Efficiency of Markets
Week 6 – Learning Objectives
Chapter 7: Consumers, Producers, and the Efficiency of
Markets
• To explain the concepts of consumer surplus and
producer surplus and use them to evaluate the efficiency
of markets
47
Looking For The Answers To These Questions:
Chapter 7: Consumers, Producers, and the
Efficiency of Markets
▪ What is consumer surplus? How is it related to
the demand curve?
▪ What is producer surplus? How is it related to
the supply curve?
▪ Do markets produce a desirable allocation of
resources? Or could the market outcome be
improved upon?
48
Welfare Economics
• Welfare economics
– The study of how the allocation of
resources affects economic well-being
• Benefits that buyers and sellers receive from
engaging in market transactions
• How society can make these benefits as large
as possible
• In any market, the equilibrium of supply and
demand maximizes the total benefits received
by all buyers and sellers combined
49
Consumer Surplus - 1
• Willingness to pay, WTP
– Maximum amount the buyer will pay for
that good
– How much the buyer values the good
• Consumer surplus, CS = WTP – P
– Amount a buyer is willing to pay minus the
amount the buyer actually pays
– Benefits buyers receive from participating
in a market.
© 2021 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a 50
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
EXAMPLE 1A: Willingness to pay
You work at the local store that sells refurbished
iPads. The store is running a sale on the refurbished
iPad mini 3. Each of your roommates wants to buy
an iPad mini 3. Their willingness to pay is given in
the table below.
Name WTP
Q: If the sale price is $200, who
will buy an iPad, and what is the
Alexis $250 quantity demanded?
Cameron 175 A: Alexis & Fatima will buy an iPad
Fatima 300 mini. Cameron & Jamir will not.
• Hence, Qd = 2 when P = $200
Jamir 125
© 2021 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
51
EXAMPLE 1B: WTP and the demand curve
Derive the
demand P (price
who buys Qd
schedule: of iPad)
$301 & up nobody 0
Name WTP
251 – 300 Fatima 1
Alexis $250
176 – 250 Alexis, Fatima 2
Cameron 175
Cameron, Alexis,
Fatima 300 126 – 175 3
Fatima
Jamir 125 Jamir, Cameron,
0 – 125 4
Alexis, Fatima
52
EXAMPLE 1C: The demand curve – 1
P
$350
P Qd
$300
$250 $301 & up 0
$200 251 – 300 1

$150 176 – 250 2
$100
126 – 175 3
$50
0 – 125 4
$0
0 1 2 3 4 Q
53
About the staircase shape…
P This D curve looks like
$350 a staircase with 4
$300 steps – one per buyer.
$250 If there were a huge #
of buyers, as in a
$200
competitive market,
$150 there would be a huge
$100 # of very tiny steps,
and it would look more
$50 like a smooth curve.
$0
0 1 2 3 4 Q
54
EXAMPLE 1C: The demand curve – 2
P Fatima’s At any Q, the height of
$350 WTP the D curve is the
$300 Alexis’ WTP WTP of the marginal
$250 buyer, the buyer who
$200 would leave the
$150 Cameron’s market if P were any
WTP
$100 higher.
Jamir’s
$50 WTP
$0
Q
0 1 2 3 4
55
EXAMPLE 1D: Calculating consumer surplus
CS = WTP - P
Name WTP Suppose P = $260.

Alexis $250 • Fatima’s CS = $300 – 260
Cameron 175
= $40.
Fatima 300
• The others get no CS
because they do not buy
Jamir 125
an iPad mini at this price.
• Total CS = $40.
56
EXAMPLE 1E: CS and the demand curve
P
Fatima’s P = $260
$350 WTP
$300 Fatima’s CS =
$250 $300 – 260 = $40
$200 Total CS = $40
$150
$100
$50
$0
0 1 2 3 4 Q
57
EXAMPLE 1E: A lower price increases CS
P
Fatima’s Suppose P = $220
$350 WTP
$300 Fatima’s CS =
$250 $300 – 220 = $80
$200 Alexis’ CS = $250 –
Alexis’
$150 WTP 220 = $30
$100 Total CS = $110
$50
$0
0 1 2 3 4 Q
58
Consumer Surplus – 2
• Total consumer surplus
– The area below the demand curve and
above the price
• The height of the demand curve = the value
buyers place on the good (WTP)
• Each buyer’s CS = WTP – P
• The sum of the consumer surplus of all
buyers in the market
EXAMPLE 2A: Total consumer surplus
CS is the area P The demand for T-shirts

between P and the $ 60 P = $30, Qd = 15
D curve, from 0 to Q.
50
Recall: area of h
a triangle equals 40
½ x base x height 30
Height =
20
$60 – 30 = $30.
So, 10
D
CS = ½ x 15 x $30 0 Q
= $225. 0 5 10 15 20 25 30
60
EXAMPLE 2B: A higher price reduces CS
P If P rises to $40,
60 CS = ½ x 10 x $20
1. Fall in CS due
= $100.
to buyers leaving 50
the market Two reasons for
40
the fall in CS.
30
2. Fall in CS due 20
to remaining 10
buyers paying the D
higher P 0 Q
0 5 10 15 20 25 30
61
Producer Surplus – 1
• Cost
– Value of everything a seller must give up
to produce a good
• Including opportunity cost
• Willingness to sell, WTS
– The lowest price accepted by a seller for
one unit of a good or service
• The cost is a measure of willingness to sell:
produce and sell the good/service only if the
price > cost
• Producer surplus, PS = P - cost
– Amount a seller is paid for a good minus
the seller’s cost of providing it
– Price received minus willingness to sell
– Measures the benefit sellers receive from
participating in a market
EXAMPLE 3A: Cost and willingness to sell
You are the owner of 3 properties with identical lawns that need
mowing. There are 3 lawn-mowing business in town that you
can hire. The table below shows their willingness to sell:
Q: Derive the supply schedule from the cost data.
64
EXAMPLE 3B: The supply curve – 1
P
$40 P Qs
$0 – 9 0
$30
10 – 19 1
$20
20 – 34 2
$10 35 & up 3
$0
Q
0 1 2 3
65
EXAMPLE 3B: The supply curve – 2
P At each Q, the
$40 height of the S
Chris’ curve is the cost of
cost the marginal
$30
seller, the seller
Jada’s who would leave
$20 cost
the market if the
price were any
$10 Jin’s cost
lower.
$0 Q
0 1 2 3
66
EXAMPLE 3C: Producer surplus & the S curve
P PS = P – cost
$40 Suppose P = $25.
Chris’
cost Jin’s PS = 25 – 10
$30
= $15
Jada’s
$20 cost Jada’s PS = 25 –
20 = $5
$10 Jin’s cost
Chris’ PS = $0
$0 Total PS = $20
0 1 2 3 Q
67
• Producer surplus, PS = P - cost
– The area below the price and above the
supply curve
• The height of the supply curve measures
sellers’ costs
• Each seller’s PS = P – cost
• Total area is the sum of the producer surplus
of all sellers
EXAMPLE 4A: Total producer surplus
PS is the area The supply of T-shirts
P
between P and the
S curve, from 0 to 60
Q. 50 S
The height of this 40
triangle is $40 – 15 30
= $25. h
20
So,
10
PS = ½ x b x h
= ½ x 25 x $25 0 Q
= $312.50 0 5 10 15 20 25 30
69
EXAMPLE 4B: A lower price reduces PS
If P falls to $30, 1. Fall in PS
P
PS = ½ x 15 x $15 60 due to sellers
= $112.50 leaving market
50 S
Two reasons for the
40
fall in PS.
30
2. Fall in PS due to 20
remaining sellers 10
getting lower P
0 Q
0 5 10 15 20 25 30
70
Market Efficiency – 1
• Total surplus = CS + PS
– Consumer surplus = Value to buyers –
Amount paid by buyers
• Buyers’ gains from participating in the market
– Producer surplus = Amount received by
sellers – Cost to sellers
• Sellers’ gains from participating in the market
Total surplus = Value to buyers – Cost to sellers
EXAMPLE 5: Evaluating the market equilibrium
Market equilibrium: P
P = $30 60
Q = 15
50 S
Total surplus
40 CS
= CS + PS
30
PS
20
Is the market
equilibrium 10
D
efficient? 0 Q
0 5 10 15 20 25 30
72
Summary, Part 1
• Consumer surplus: buyers’ willingness to pay for a
good minus the amount they actually pay
– Measures the benefit buyers get from
– Area below the D curve and above P
• Producer surplus: amount sellers receive for their
goods minus their costs of production
– Measures the benefit sellers get from
– Area below P and above the S curve
73
Summary, Part 2
• An allocation of resources that maximizes total
surplus is said to be efficient
– Policymakers are concerned with the efficiency,
as well as the equality, of economic outcomes.
• Equilibrium of S and D maximizes total surplus
– The invisible hand of the marketplace leads
buyers and sellers to allocate resources
efficiently.
• Markets do not allocate resources efficiently in the
presence of market failures (market power or
externalities)
74
Next Week
Chapter 8 Application: The Costs of

Taxation
Chapter 9 Application: International Trade
75
Please review the discussion
questions well so you can follow
the answers better when we
discuss them.
76
Thank you
77

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ECON 101 Introduction to Microeconomics

WEEK 6 (Winter 2023)

Ashutosh Sarker, Ph.D.

A legal maximum on the price at which a good can be sold

The government imposes a price

Note: Non-price rationing (first-come, first-served) is the use

• Price ceiling on gasoline

• Economists often criticize rent control, arguing that it is a highly

Price floor is a legal minimum on the price at which a good

▪ The government imposes a price floor

TAX AND MARKET OUTCOME

Taxes and market outcomes

▪ Buyers and sellers share the tax burden

How the Burden of a Tax Is Divided (a)

How the Burden of a Tax Is Divided (b)

So, how is the burden of the tax divided?

The burden of a tax falls more

• A tax on a good places a wedge between the

$200 251 – 300 1

Name WTP Suppose P = $260.

CS is the area P The demand for T-shirts

Chapter 8 Application: The Costs of

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