Lecture 10 · Week 12 · Besanko & Braeutigam ch. 10 · about 45 min

Competitive Markets: Applications

Using the competitive model to evaluate policy: why the free-market equilibrium maximises total surplus, and the deadweight loss created by price ceilings, price floors and excise taxes.

By the end you can

Compute total surplus and explain why competitive equilibrium maximises it
Compute the shortage and deadweight loss from a binding price ceiling
Compute the surplus and deadweight loss from a binding price floor
Compute tax incidence and deadweight loss from a per-unit excise tax

Total surplus and efficiency

Total surplusKey formulaFormula sheet →

TS = CS + PS

$CS$: consumer surplus
$PS$: producer surplus

Use it when you need the overall measure of a market's economic benefit, to compare the free-market outcome against a policy intervention.

Throughout this lesson: $Q^d = 200 - 2P$ , $Q^s = -40 + 4P$ , giving equilibrium $P_e = 40$ , $Q_e = 120$ (check: $200-80=120$ and $-40+160=120$ ).

Price ceilings

A price ceiling is a legal maximum price. It only matters (binds) if set below the equilibrium price.

Price floors

A price floor is a legal minimum price. It only binds if set above equilibrium.

Excise taxes and tax incidence

A per-unit excise tax $t$ drives a wedge between the price buyers pay ( $P_b$ ) and the price sellers receive ( $P_s = P_b - t$ ).

Tax wedgeKey formulaFormula sheet →

P_b - P_s = t

$P_b$: price paid by buyers
$P_s$: price received by sellers
$t$: the per-unit tax

Use it when a tax is imposed and you need to find the new equilibrium quantity and the prices on each side of the market.

Tax revenue and deadweight lossKey formulasFormula sheet →

\text{Tax revenue} = t \times Q_{\text{tax}} \qquad DWL = \tfrac{1}{2}(Q_e - Q_{\text{tax}})\,t

$Q_{\text{tax}}$: the after-tax equilibrium quantity

Use it when you need the government's revenue from the tax, or the efficiency cost, once the after-tax quantity and prices are known.

Exam practice

Summary and review

Total surplus $TS = CS+PS$ is maximised at the competitive equilibrium.
Binding price ceiling (below $P_e$ ): shortage, quantity traded falls to $Q^s(P_c)$ , deadweight loss triangle appears.
Binding price floor (above $P_e$ ): surplus (unsold quantity), quantity traded falls to $Q^d(P_f)$ , deadweight loss triangle appears.
Excise tax creates a wedge $P_b - P_s = t$ ; tax revenue $= t \times Q_{\text{tax}}$ ; $DWL = \tfrac12(Q_e-Q_{\text{tax}})t$ .
Tax incidence depends on relative elasticity, not on which side is legally taxed: the less elastic side bears more of the burden.