Agricultural Price SupportSupply RestrictionsZero QuotaNon-Zero QuotaImport TariffTax and Subsidy1 10 9 8 7 S 6 P2 5P P1 A B D 4 3 E D 2 1 0 Q2 Q1 Q3 0 1 2 3 4 5 6 7 8 9 10 Q 1 Agricultural Price Support 14.01 Principles of Microeconomics, Fall 2007 Chia-Hui Chen October 24, 2007 Lecture 17 Supply Restrictions, Tax, and Subsidy Outline 1. Chap 9: Agricultural Price Support 2. Chap 9: Supply Restrictions 3. Chap 9: Tax and Subsidy 1 Agricultural Price Support In this case, government sets prices higher than the free marke t level, and buys excess supply (see Fig ure 1). The buyer’s price is s hown on the y-axis in the following graphs. The original consumer surplus equals the area between the Figure 1: Agricultural Pr ic e Support. demand curve and the line of price P1; after the price support, it equals the area between the demand curve and the line of price P2, thus ΔCS = −(A + B). The original producer surplus equals the area between the supply curve and the line of pric e P1; after the price support, it eq uals the area between the supply Cite as: Chia-Hui Chen, course materials for 14.01 Principles of Microeconomics, Fall 2007. MIT OpenCourseWare (http://ocw.mit.edu), Massachusetts Institute of Technology. Downloaded on [DD Month YYYY].10 9 8 7S P61 P A BP50 CP42 3D 2 1 0 Q1 Q0 0 2 4 6 8 10 Q 2 Supply Restrictions 2 curve and the line of price P2, thus ΔP S = A + B + D. Government buys quantity Q3 − Q2 at price P2; the cost equals the area of the rectangular ΔG = −(B + D + E). The deadweight loss to the society is DW L = −(B + E). 2 Supply Restrictions Government r e stricts quantity supplied to b e less than Q1 (see Figure 2). The Figure 2: Supply Restriction. original cons umer surplus eq uals the area between the demand curve and the line of price P0; after the supply restriction, it equals the area between the demand curve and the line of price P1, thus ΔCS = −(A + B). The original producer surplus equals the area between the supply curve and the line of price P0; after the supply restriction, it equals the area of the trapezoid, with the supply cur ve, the line of price P1, the line of quantity Q1, and the price axis as its sides, thus ΔP S = A − C. Cite as: Chia-Hui Chen, course materials for 14.01 Principles of Microeconomics, Fall 2007. MIT OpenCourseWare (http://ocw.mit.edu), Massachusetts Institute of Technology. Downloaded on [DD Month YYYY].10 9 8 7 SD 6 P5 P0 4 PW A B C 3 DD 2 1 0 QS Q0 QD 0 1 2 3 4 5 6 7 8 9 10 Q 2.1 Zero Quota 3 Thus, the deadweight loss is DW L = −(B + C). Example g overnment measures include import quota a nd tariff, which benefit domestic producers but hurt consumers. 2.1 Zero Quota SD is the domestic supply, and DD is the domestic demand. If no import is allowed, the domestic price is P0. Without restriction on import, the domestic price would be the same as the world price PW , which is lower than PD (see Figure 3). Without import quota restriction, consumer surplus equals the area Figure 3: Zero Quota. between the domestic demand curve and the line of price PW ; if the quota is zero, it equals the area b e tween the domestic demand curve and the line of price P0, thus ΔCS = −(A + B + C). Without quota restriction, producer surplus equals the area between the domes-tic supply curve and the line of price PW ; if the quota is zero , it equals the area between the domestic supply curve and the line of price P0, thus ΔP S = A. The deadweight loss is DW L = B + C. 2.2 Non-Zero Quota Given the same SD, DD, and PW , now suppose the government sets non-zero quota k. The domestic price P1 is where the difference between do mestic demand Cite as: Chia-Hui Chen, course materials for 14.01 Principles of Microeconomics, Fall 2007. MIT OpenCourseWare (http://ocw.mit.edu), Massachusetts Institute of Technology. Downloaded on [DD Month YYYY].2.3 Import Tariff 4P5 4 P1 3 PW A B C D DD 2 10 9 8 7 SD 6 1 Q Q Q Q0 S S1 D1 D 0 2 4 6 8 10 Q Cite as: Chia-Hui Chen, course materials for 14.01 Principles of Microeconomics, Fall 2007. MIT OpenCourseWare (http://ocw.mit.edu), Massachusetts Institute of Technology. Downloaded on [DD Month YYYY]. Figure 4: Non-Zero Quota. (QD1) and domestic supply (QS1) is k (see Figure 4). Likewise, the change o f consumer surplus ΔCS = −(A + B + C + D); and the change of domestic producer surplus ΔP SD = A. The net domestic loss equals −(ΔCS + ΔP S) = B + C + D. The foreign producer surplus increases by excess profits, which equal the area of rectangular C ΔP SF = C. The total deadweight loss is DW L = B + D. The domestic loss is Domestic Loss = B + C + D. 2.3 Import Tariff Government imposes a tariff P1 − PW on each unit imported (see Figure 5). The change of co ns umer surplus and domestic producer surplus are5 3 Tax and Subsidy P 10 9 8 7 SD 6 5 P 41 A B C D 3 PW DD 2 1 Q Q Q Q 0 S S1 D1 D 0 2 4 6 8 10 Q Cite as: Chia-Hui Chen, course materials for 14.01 Principles of Microeconomics, Fall 2007. MIT OpenCourseWare (http://ocw.mit.edu), Massachusetts Institute of Technology. Downloaded on [DD Month YYYY]. Figure 5: Import Tariff. ΔCS = −(A + B + C + D) and ΔP SD = A, respectively. Foreign producers gain nothing, that is to say ΔP SF = 0, because C becomes the revenue of government ΔG = C. The deadweight loss is DW L = B + D, which equals to the domestic loss. 3 Tax and Subsidy Assume that government imposes a $ 1 tax on each cigarette unit. Given the market price P , if the tax is paid by • producers, then buyers pay P and producers get P − 1; • consumers, then buyers pay P + 1 and producers get P .6 3 Tax and Subsidy Therefore, the price paid by buyers and the price received by producers always have a difference of 1 (see Figure 6). Let PB be the buyer’s price and PS be the seller’s price. PD − PS = 1. In figure 6, we put buyer’s price on the y axis. Therefo re, with the tax, the ′supply curve moves from S to S . The equilibrium