Chapter 9 - Analysis of competitive markets Flashcards
Elaborate on what happens in a compatitive market if the government intervenes and sets a price level that is currently beneath the market clearing price
Lower price means that producers will produce less. They will always produce corresponding to the price level, unless if price is less than total average cost.
at the same time, the demand will increase because price has gone down. therefore, demand increase while produciton decrease. Therefore, a price ceiling like this will create excess demand (shortage).
How is a shortage identified graphically?
Consider supply and demand curves that are linear. They intersect in equilibrium point. However, if the governemnt sets a price ceiling, we will get a shortage (recall why). The price is below the equilibrium price, which means that the price line will cut demand curve and supply curve below.
The new price line will cut supply curve at Q_0 and the demand curve at Q_1. The difference between the two points is referred to as the shortage in demand.
Say the government intervenes and sets a price ceiling. Elaborate on how this will impact consumers
Some are worse off, some are better off.
Since the lower price level cause a shortage in demand, there will be more demand than supply. Therefore, some consumers will be rationed out of the market. For these people, the price ceiling is obviously bad.
However, the rest of the consumers are better off because they can now buy the good at a lower price.
Say the government intervenes with a price limit. how does this affect producers?
Some will continue to produce, others will throw in the towel. Total production will go down. In general, every producer loose some, but some more than others.
Say the government intervenes with a price ceiling for some good. Is the loss to producers offset by the gain of consumers?
No. We loose total surplus, which is what we call deadweight loss.
Politically, how is the idea of price ceilings viewed?
It is a great political strategy, as the benefit for consumers are generally good.
Can a price ceiling that is beneath current clearing price result in negative CONSUMER surplus change?
Yes. This is the case if the demand curve is very inelastic, while the supply curve is more elastic. In such a case, a price ceiling has huge impact on the production level, but the consumers are hardly phased at all. The demand would not increase that much, but the quantity supplied would take a large hit. Therefore, the result is that a larger group of consumers will be rationed out of the market. This can cause the change in total consumer surplus to be negative.
What is economic efficiency?
Economic efficiency is referring to maximization of aggregate consumer and producer surplus.
Elaborate on what happens when the government intervenes in a competitive market and sets a price that is above market clearing price.
Firms are takers of price, and in this case, they have to take this new price.
This new price will cause quantity demanded to drop. Since firms cannot sell more than what can be bought, firms will produce at the level where quantity demanded meets some point on the supply curve.
More specifically, the price level intersects at some point on the demand curve (which lies above the supply curve at this point). This intersection point gives a quantity demanded. Then this is the level the firms will produce. Firms would like to prodiuce at a much higher level, but cant.
becasue of the higher price, some consumers will not be buying anymore. At the same time, the lower quantity demanded means that some firms will not produce any more. th result is negative net loss of total surplus.
