Transcript Policy Analysis - Economics

Policy Analysis
Outline
• Welfare Analysis
– Consumer surplus
– Producer surplus
• Welfare consequences of minimum wage
• Wage subsidy as alternative to minimum
wage
• Tortillas as a Cautionary Tale
Economic Efficiency
• A situation is economically inefficient if there is
some way to change it so that so that someone
gains while no one else loses.
• A change is a Pareto improvement if at least one
person gains and no one loses
• A change is economically efficient if the winners
could compensate the losers by enough to make
the change a Pareto improvement.
Assessing Benefits
•
•
•
•
•
Consumer Sovereignty
“Willingness to Pay” = Consumer Benefit
Consumer Surplus
“Willingness to Sell” =Opportunity Cost
Producer Surplus
Consumer Surplus -- Difference
between Willingness to Pay and Price
Paid by Buyer
Price
r1
r2
r3
r4
P0
Demand
1
2
3 4
5
Quantity
Consumer Surplus Is Triangle Below Demand,
Above Market Price.
Price
Consumer
Surplus
P0
Demand
5
Quantity
Total Expenditure
Producer Surplus- Difference Between
Opportunity Cost and Selling Price
Price
t5
t4
t3
t2
t1
P0=t5
1
2
3
4
5
Quantity
Producer Surplus
Price
Supply
P0=t5
Producer Surplus
Quantity
Consumer and Producer Surplus - Market
Equilibrium
Price
Consumer Surplus
Supply
P0
Producer Surplus
Q0
Demand
Quantity
Impact of Price Floor on Efficiency
A -- New CS
A+B+E -- Old CS
B+C+D -- New PS
C+F+D -- Old PS
Supply
A
Price Floor
B
E
F
C
Market clearing price
D
Demand
Q1
Q0
E+F is deadweight loss associated with the price floor.
Impact of Price Ceiling on Efficiency
Demand
A+B+C -- New CS
A+B+E -- Old CS
D -- New PS
C+D+F -- Old PS
Supply
A
B
C
D
E
F
Market Clearing Price
Price Ceiling
E+F is the Deadweight Loss Associated with Price Ceiling
SUMMARY
• Market Equilibrium is Efficient. No
Deadweight Loss.
• Price controls create a deadweight loss
• Also, there are costs associated with
rationing mechanisms, black markets etc.
Impact of $12 Minimum Wage
$2 Wage Subsidy
Comparison
• If demand is elastic,
minimum wage
reduces employment
• Benefits accrue to
workers who stay
employed
• Costs borne by
employers and
consumers
• Wage subsidy
increases employment
• Benefits shared by
employers and
workers
• Subsidy funded from
general government
revenues
Subsidy Benefits Employers and Workers
Impact of Subsidy on Efficiency
Price
Sellers
receive
A+B+F+E = CS after Subsidy
A+B = CS before Subsidy
B+C+F+G = PS after Subsidy
F+G= PS before Subsidy
B+C+D+E+F = Subsidy
D=Deadweight Loss from Subsidy
A
B
Price
buyers
pay
F
C
Pre Subsidy Price
D
E
G
Pre Subsidy Q
Post
Subsidy
Q
Tortillas
On New Year’s Day 1999, Mexico ended price
controls on tortillas. The price stood at 3 pesos
per kilo (31 cents for 2.2 pound stack). Some
shops immediately raised their prices by 50%. In
1998, the government phased out subsidies to the
tortilla industry that helped keep prices down.
The tortilla subsidy was replaced with programs
such as one that gives the 1.2 million poorest
Mexicans free tortillas each day.
Source: Smith, James, Los Angeles Times, Jan 7, 1999
Questions
• What does the price increase suggest about
the elasticity of demand for tortillas?
• How does the impact of a subsidy to
consumers differ from the impact of a
subsidy to producers?
• What are the advantages of price controls
as compared with subsidies?
P
Elasticity of Demand for
Tortillas?
Supply
PA
Price ceiling
PB
Demand B
Demand A
Kilos of tortillas
Subsidy to Producers
Subsidy to Consumers
Another Approach
If All Consumers Received Subsidy:
• If all consumers receive the subsidy, output
is same
• Price producers receive is same in two cases
• Price consumers pay is same in two cases
Disadvantages of Subsidies
• Control of subsidies by local bureaucrats
created opportunties to exploit subsidies for
political ends. Price controls anonymous.
• Consumers not eligible for subsidies, but
still relatively poor will pay a higher price
for tortillas.
Key Concepts
• Impact of price controls and of subsidies
depends on elasticity of demand (and
supply).
• Price floors lead to surpluses. Price ceilings
to shortages.
• Price controls lead to a deadweight loss.