Using Supply and Demand to Analyze Markets

Mir Ahasan Kabir, Ph.D.

Department of Economics
University of Toronto
[Link]@[Link]

September 18, 2024

Mir Ahasan Kabir, Ph.D. (UofT) Chapter 3 September 18, 2024 1 / 41

Overview

1 Consumer and Producer Surplus

2 Price Regulations

3 Quantity Regulations

4 Taxes

5 Subsidies

6 Conclusion

Mir Ahasan Kabir, Ph.D. (UofT) Chapter 3 September 18, 2024 2 / 41

 Consumer and Producer Surplus

Consumer and Producer Surplus

Consumer Surplus: The difference between what consumers are

willing to pay and what they actually pay.
Producer Surplus: The difference between what producers receive
and their minimum acceptable price.
Both concepts help assess market efficiency and welfare.

Mir Ahasan Kabir, Ph.D. (UofT) Chapter 3 September 18, 2024 3 / 41

 Consumer and Producer Surplus

Consumer and Producer Surplus

Consumer surplus is the area above the price and below the demand
curve.
Mir Ahasan Kabir, Ph.D. (UofT) Chapter 3 September 18, 2024 4 / 41
 Consumer and Producer Surplus

Consumer and Producer Surplus

Producer surplus is the area below the price and above the supply
curve.
Mir Ahasan Kabir, Ph.D. (UofT) Chapter 3 September 18, 2024 5 / 41
 Consumer and Producer Surplus

Consumer and Producer Surplus

Consumer Surplus:
Z Q∗
CS = (Pd (Q) − P ∗ ) dQ
0

where Pd (Q) is the demand function and P ∗ is the equilibrium price.

Producer Surplus:
Z Q∗
PS = (P ∗ − Ps (Q)) dQ
0

where Ps (Q) is the supply function and Q ∗ is the equilibrium quantity.

Mir Ahasan Kabir, Ph.D. (UofT) Chapter 3 September 18, 2024 6 / 41

 Consumer and Producer Surplus

Consumer and Producer Surplus

Question 1: Ryan would be willing to pay $1 for a lollipop. Sarah would

be willing to pay $0.50. The price of the lollipop is $0.75. What is Ryan
and Sarah’s combined consumer surplus?
A $0
B $0.25
C $0.50
D $0.75

Mir Ahasan Kabir, Ph.D. (UofT) Chapter 3 September 18, 2024 7 / 41

 Consumer and Producer Surplus

Consumer and Producer Surplus

Question 1: Ryan would be willing to pay $1 for a lollipop. Sarah would

be willing to pay $0.50. The price of the lollipop is $0.75. What is Ryan
and Sarah’s combined consumer surplus?
A $0
B $0.25
C $0.50
D $0.75

Mir Ahasan Kabir, Ph.D. (UofT) Chapter 3 September 18, 2024 8 / 41

 Consumer and Producer Surplus

Consumer and Producer Surplus

Question 2: Tom would be willing to sell his yo-yo for $1.75. Megan
would be willing to sell her yo-yo for $1.50. If the equilibrium price is $2,
what is the combined value of Tom and Megan’s producer surplus?
A $0
B $0.25
C $0.50
D $0.75

Mir Ahasan Kabir, Ph.D. (UofT) Chapter 3 September 18, 2024 9 / 41

 Consumer and Producer Surplus

Consumer and Producer Surplus

Question 2: Ryan would be willing to pay $1 for a lollipop. Sarah would

be willing to pay $0.50. The price of the lollipop is $0.75. What is Ryan
and Sarah’s combined consumer surplus?
A $0
B $0.25
C $0.50
D $0.75

Mir Ahasan Kabir, Ph.D. (UofT) Chapter 3 September 18, 2024 10 / 41

 Consumer and Producer Surplus

Consumer and Producer Surplus

A key factor in determining the amount of potential consumer surplus in the

market is the steepness of the demand curve.

If the demand for glasses is D2,

consumer surplus = B
If the demand for glasses is D1,
consumer surplus = A + B
All else equal, the steeper the
demand curve, the more the
consumer surplus.

Figure 3.3 Consumer Surplus and the

Elasticity of Demand

Mir Ahasan Kabir, Ph.D. (UofT) Chapter 3 September 18, 2024 11 / 41

 Consumer and Producer Surplus

Consumer and Producer Surplus

We can show how these shifts affect the benefits that producers and consumers
receive in a market.

If the demand for glasses is D2,

consumer surplus = B
If the demand for glasses is D1,
consumer surplus = A + B
All else equal, the steeper the
demand curve, the more the
consumer surplus.
Figure 3.4 Changes in Surplus from a
Supply Shift

Mir Ahasan Kabir, Ph.D. (UofT) Chapter 3 September 18, 2024 12 / 41

 Consumer and Producer Surplus

Consumer and Producer Surplus

A decrease in the supply curve increases the equilibrium price and

decreases the equilibrium quantity in the market. This causes:
consumer surplus to decrease.
Both the increase in price and decrease in quantity decrease CS.
producer surplus to also decrease.
The increase in price increases PS, but the decrease in quantity
decreases PS. The net effect is negative due to the downward-sloping
demand.
An increase in the supply curve decreases the equilibrium price and
increases the equilibrium quantity in the market. This causes:
consumer surplus to increase.
producer surplus to increase.

Mir Ahasan Kabir, Ph.D. (UofT) Chapter 3 September 18, 2024 13 / 41

 Consumer and Producer Surplus

Consumer and Producer Surplus

A decrease in the demand curve decreases the equilibrium price and

decreases the equilibrium quantity in the market. This causes:
producer surplus to decrease.
Both the decrease in price and decrease in quantity decrease PS.
consumer surplus to also decrease.
The decrease in price increases CS, but the decrease in quantity
decreases CS. The net effect is negative due to the upward sloping
supply.
An increase in the demand curve increases the equilibrium price and
increases the equilibrium quantity in the market. This causes:
producer surplus to increase.
consumer surplus to increase.

Mir Ahasan Kabir, Ph.D. (UofT) Chapter 3 September 18, 2024 14 / 41

 Price Regulations

Price Regulations

Price Ceiling: Maximum legal price sellers can charge.

Price Floor: Minimum legal price buyers must pay.
Both can cause deadweight loss and inefficiencies.

Mir Ahasan Kabir, Ph.D. (UofT) Chapter 3 September 18, 2024 15 / 41

 Price Regulations

Price Regulations

Figure 3.6 The Effects of a Price Ceiling

Consumer surplus increases, but producer surplus decreases.
Deadweight loss is created due to inefficiency.
Mir Ahasan Kabir, Ph.D. (UofT) Chapter 3 September 18, 2024 16 / 41
 Price Regulations

Price Regulations

Z Q∗
DWL = (Pd (Q) − Ps (Q)) dQ
Qceiling

where Qceiling is the quantity supplied at the price ceiling.

The area of the deadweight loss represents lost welfare due to the
price ceiling.

Mir Ahasan Kabir, Ph.D. (UofT) Chapter 3 September 18, 2024 17 / 41

 Price Regulations

Price Regulations

The supply and demand elasticities determine the relative sizes of the
deadweight loss and the transfer.

If demand and supply are relatively elastic, the deadweight loss is a larger
and the transfer from producer surplus to consumer surplus is smaller.
The more sensitive consumers and producers are to prices, the greater
the change in quantity demanded and supplied.

Alternatively, if demand and supply are relatively inelastic, the deadweight

loss is a smaller and the transfer from producer surplus to consumer
surplus is larger.

Mir Ahasan Kabir, Ph.D. (UofT) Chapter 3 September 18, 2024 18 / 41

 Price Regulations

Price Regulations

3.7 Deadweight Loss and Elasticities

Mir Ahasan Kabir, Ph.D. (UofT) Chapter 3 September 18, 2024 19 / 41

 Price Regulations

Price Regulations

The other type of price regulation is a price floor.

Price floor: a regulation that sets the minimum price that can be legally
paid for a good or service (often called a price support)
Binding only when set above the equilibrium price
Nonbinding price floor: a price floor set below the equilibrium market
price

What are the effects of price floors on markets?

Mir Ahasan Kabir, Ph.D. (UofT) Chapter 3 September 18, 2024 20 / 41

 Price Regulations

Price Regulations

Figure 3.8 The Effects of a Price Floor

Mir Ahasan Kabir, Ph.D. (UofT) Chapter 3 September 18, 2024 21 / 41

 Quantity Regulations

Quantity Regulations

Like price regulations, quantity regulations restrict the amount of a good

or service provided to a market.
Examples: Quotas, pollution limits.

Quota: a regulation that sets the quantity of a good or service provided.

Often used to limit imports of certain goods
Why might a government pursue an import quota?
Sometimes used to limit exports (e.g., China and rare earths)
Often leads to a rise in prices and deadweight loss.

What are the effects of quotas on markets?

Mir Ahasan Kabir, Ph.D. (UofT) Chapter 3 September 18, 2024 22 / 41

 Quantity Regulations

Quantity Regulations

Figure 3.9 The

Effects of a Quota

Mir Ahasan Kabir, Ph.D. (UofT) Chapter 3 September 18, 2024 23 / 41

 Quantity Regulations

Quantity Regulations

Z Q∗
DWL = (Pd (Q) − Ps (Q)) dQ
Qquota

Here Qquota is the quantity allowed by the quota.

Both consumer and producer surplus are reduced, creating inefficiency.

Mir Ahasan Kabir, Ph.D. (UofT) Chapter 3 September 18, 2024 24 / 41

 Taxes

Taxes
Taxes impose an additional cost on the buyers or sellers and are very
prevalent in societies.
Causes a shift in supply or demand and creates deadweight loss.

Examples:
1 Product markets (e.g., VAT, sales taxes)
2 Labor markets (e.g., income taxes, payroll taxes)
3 Capital markets (e.g., capital gains taxes)

How do taxes impact markets?

Some taxes are imposed to correct market failures (see Chapter 16)
In general, taxes distort market outcomes.
Example: In 2003, Boston’s Mayor Tom Menino proposed a $0.50
tax on movie tickets.
How should this tax (which was ultimately not adopted by the
legislature) affect the market for movie tickets?
Mir Ahasan Kabir, Ph.D. (UofT) Chapter 3 September 18, 2024 25 / 41
 Taxes

Tax Incidence: Graphical Analysis

Figure 3.10 The Effect of a Tax on Boston Movie Tickets

The burden of the tax is shared between consumers and producers

depending on the elasticities.
Mir Ahasan Kabir, Ph.D. (UofT) Chapter 3 September 18, 2024 26 / 41
 Taxes

Tax Incidence
Taxes raise prices for consumers and lower the received price to producers.

Pb = Ps + t

where Pb is the price paid by buyers, Ps is the price received by sellers,

and t is the tax per unit.

The tax creates deadweight loss as well as a redistribution of surplus.

Some consumers who would have purchased at the lower, pre-tax
price (and gained consumer surplus) do not purchase at the higher,
after-tax price.
Some firms that were producing (and gaining producer surplus) at the
pre-tax price do not produce at the after-tax price.

The larger the tax, the larger the deadweight loss.

Mir Ahasan Kabir, Ph.D. (UofT) Chapter 3 September 18, 2024 27 / 41
 Taxes

Tax Incidence

Question 3: In Figure 3.11, area represents the consumer surplus with

the smaller tax, and area represents the consumer surplus with the larger
tax on Boston movie tickets.

A A + B + C + F; A
B A + B + C + F; A + B
C A + B + C; A
D A + B + C; A + C

Figure 3.11 The Effect of a Larger

Tax on Boston Movie Tickets

Mir Ahasan Kabir, Ph.D. (UofT) Chapter 3 September 18, 2024 28 / 41

 Taxes

Tax Incidence

Question 3: In Figure 3.11, area represents the consumer surplus with

the smaller tax, and area represents the consumer surplus with the larger
tax on Boston movie tickets.

A A + B + C + F; A
B A + B + C + F; A + B
C A + B + C; A
D A + B + C; A + C

Figure 3.11 The Effect of a Larger

Tax on Boston Movie Tickets

Mir Ahasan Kabir, Ph.D. (UofT) Chapter 3 September 18, 2024 29 / 41

 Taxes

Tax Incidence
Tax incidence is a term describing who actually bears the burden of a tax.
In the supply and demand model, it does not matter who is required to
pay the tax (e.g., a sales tax vs. a production tax).
The total tax incidence will be the same in each case!

Figure 3.12 Tax Incidence

Mir Ahasan Kabir, Ph.D. (UofT) Chapter 3 September 18, 2024 30 / 41

 Taxes

Tax Incidence

Tax incidence and elasticities

Elasticities of supply and demand are the major determinants of

incidence.
In general, when demand is relatively more elastic, consumers will
experience less burden, and vice versa.
Alternatively, when supply is relatively more elastic, producers will
experience less burden, and vice versa.

Rule: The more elastic curve (supply or demand) bares the least
burden (producer or consumer).

Mir Ahasan Kabir, Ph.D. (UofT) Chapter 3 September 18, 2024 31 / 41

 Taxes

Tax Incidence

Tax incidence and elasticities

General formula(s) for incidence as a function of elasticities:

ES
Share born by consumer = (E S +|E D |)

|E D |
Share born by producer = (E S +|E D |)

Notice, the share born by the consumer relies primarily on the elasticity of
the supplier producer, and vice versa.

Mir Ahasan Kabir, Ph.D. (UofT) Chapter 3 September 18, 2024 32 / 41

 Taxes

Tax Incidence

Figure 3.13 Tax Incidence and Elasticities

Mir Ahasan Kabir, Ph.D. (UofT) Chapter 3 September 18, 2024 33 / 41

 Taxes

Tax Incidence

Question 4: Suppose South Norfolk implements per-pound pricing for

trash services. The supply and demand curves are

Q S = 1, 500P − 150 Q D = 225 − 375P

Price is measured in $ per pound of trash, and quantity is measured in

hundreds of thousands of pounds of trash. Determine the equilibrium
price and quantity.
A Price equals $5.00 and quantity equals 7,350.
B Price equals $5.00 and quantity equals 1,650.
C Price equals $0.04 and quantity equals 210.
D Price equals $0.20 and quantity equals 150.

Mir Ahasan Kabir, Ph.D. (UofT) Chapter 3 September 18, 2024 34 / 41

 Taxes

Tax Incidence

Question 4: Suppose South Norfolk implements per-pound pricing for

trash services. The supply and demand curves are

Q S = 1, 500P − 150 Q D = 225 − 375P

Price is measured in $ per pound of trash, and quantity is measured in

hundreds of thousands of pounds of trash. Determine the equilibrium
price and quantity.
A Price equals $5.00 and quantity equals 7,350.
B Price equals $5.00 and quantity equals 1,650.
C Price equals $0.04 and quantity equals 210.
D Price equals $0.20 and quantity equals 150.

Mir Ahasan Kabir, Ph.D. (UofT) Chapter 3 September 18, 2024 35 / 41

 Taxes

Tax Incidence

Question 5: Now suppose South Norfolk imposes a tax of 5 cents per

pound of trash collected to pay for the litter that is created when trash is
thrown out of car windows:

Q S = 1, 500P − 150 Q D = 225 − 375P

Determine the new equilibrium price and quantity after the tax is
imposed.
A Price equals $0.24 and quantity equals 210.
B Price equals $0.16 and quantity equals 90.
C Price equals $0.19 and quantity equals 135.
D Price equals $0.15 and quantity equals 75.

Mir Ahasan Kabir, Ph.D. (UofT) Chapter 3 September 18, 2024 36 / 41

 Taxes

Tax Incidence

Question 5: Now suppose South Norfolk imposes a tax of 5 cents per

pound of trash collected to pay for the litter that is created when trash is
thrown out of car windows:

Q S = 1, 500P − 150 Q D = 225 − 375P

Determine the new equilibrium price and quantity after the tax is
imposed.
A Price equals $0.24 and quantity equals 210.
B Price equals $0.16 and quantity equals 90.
C Price equals $0.19 and quantity equals 135.
D Price equals $0.15 and quantity equals 75.

Mir Ahasan Kabir, Ph.D. (UofT) Chapter 3 September 18, 2024 37 / 41

 Subsidies

Subsidies

Subsidies a payment by the government to a buyer or seller of a

good or service and lower the cost for either producers or consumers,
increasing the quantity exchanged.
Subsidies are simply the opposite of a tax. Causes a shift in supply or
demand and creates deadweight loss, lead to inefficiency due to
overproduction.
The price the buyer pays is lower than the price the supplier receives.

Pb + subsidy = Ps

Governments subsidize many products and production processes.

Examples:

Producer subsidies: ethanol production, research and development

Consumer subsidies: education, public transportation
Mir Ahasan Kabir, Ph.D. (UofT) Chapter 3 September 18, 2024 38 / 41
 Subsidies

Subsidies: Graphical Analysis

Figure 3.14 The Impact of a Producer Subsidy

Producer and consumer surplus increase, but at a cost of government

expenditure.
Deadweight loss occurs due to overproduction.
Mir Ahasan Kabir, Ph.D. (UofT) Chapter 3 September 18, 2024 39 / 41
 Conclusion

Conclusion

This chapter examined the supply and demand model in more detail, and
analyzed how government policies affect markets.
We explored how market regulations such as price ceilings, floors,
taxes, and subsidies affect surplus and efficiency.
Each regulation creates deadweight loss and shifts in
consumer/producer surplus.
Understanding these concepts is crucial for evaluating government
interventions in markets.
In the next few chapters, we examine the microeconomic underpinnings of
demand and supply.

In Chapter 4, we introduce the concept of utility, which provides context

for understanding how consumers make consumption decisions.

Mir Ahasan Kabir, Ph.D. (UofT) Chapter 3 September 18, 2024 40 / 41

 Conclusion

Questions ???
Comments !!!
Suggestions ...

Mir Ahasan Kabir, Ph.D. (UofT) Chapter 3 September 18, 2024 41 / 41