Varian9e LecturePPTs Ch16

Chapter 16
Equilibrium
Market Equilibrium
● A market is in equilibrium when total
quantity demanded by buyers equals
total quantity supplied by sellers.
Market Equilibrium
Market
p
demand
q=D(p)
D(p)
Market Equilibrium
p Marke
t
q=S(p)
supply
S(p)
Market Equilibrium
Market Marke
p
demand t
q=S(p)
supply
q=D(p)
D(p), S(p)
Market Equilibrium
Market Marke
p
demand t
q=S(p)
supply
p*
q=D(p)
q* D(p), S(p)
Market Equilibrium
Market Marke
p
demand t
q=S(p)
supply
D(p*) = S(p*); the
market
p* is in equilibrium.
q=D(p)
q* D(p), S(p)
Market Equilibrium
Market Marke
p
demand t
q=S(p)
supply
D(p’) < S(p’); an excess
p’ of quantity supplied over
p* quantity demanded.
q=D(p)
D(p’) S(p’) D(p), S(p)

Market Equilibrium
Market Marke
p
demand t
q=S(p)
supply
D(p’) < S(p’); an excess
p’ of quantity supplied over
p* quantity demanded.
q=D(p)
D(p’) S(p’) D(p), S(p)

Market price must fall towards
p*.
Market Equilibrium
Market Marke
p
demand t
q=S(p)
supply
D(p”) > S(p”); an
excess
p* of quantity demanded
p” over quantity supplied.
q=D(p)
S(p” D(p”) D(p), S(p)

)
Market Equilibrium
Market Marke
p
demand t
q=S(p)
supply
D(p”) > S(p”); an
excess
p* of quantity demanded
p” over quantity supplied.
q=D(p)
S(p” D(p”) D(p), S(p)

) price must rise towards
Market
p*.
Market Equilibrium
● An example of calculating a market
equilibrium when the market demand
and supply curves are linear.
Market Equilibrium
Market Marke
p
demand t
S(p) = c+dp
supply
p*
D(p) = a-bp
q* D(p), S(p)
Market Equilibrium
Market Marke
p
demand t
S(p) = c+dp
supply
What are the

p* values
of p* and q*?
D(p) = a-bp
q* D(p), S(p)
Market Equilibrium
At the equilibrium price p*, D(p*) =

S(p*).
Market Equilibrium

S(p*).
That is,
Market Equilibrium

S(p*).
That is,
which
gives
Market Equilibrium

S(p*).
That is,
which
gives
an
d
Market Equilibrium
Market Marke
p
demand t
S(p) = c+dp
supply
D(p) = a-bp
D(p), S(p)
Market Equilibrium
● Can we calculate the market
equilibrium using the inverse market
demand and supply curves?
Market Equilibrium
● Can we calculate the market
equilibrium using the inverse market
demand and supply curves?
● Yes, it is the same calculation.
Market Equilibrium
the equation of the inverse

market
demand curve. And
the equation of the inverse

market
supply curve.
Market Equilibrium
Market
D-1(q),
inverse Market inverse
S-1(q)
demand supply
S-1(q) = (-c+q)/d
p*
D-1(q) = (a-q)/b
q* q
Market Equilibrium
D-1(q), Market
S-1(q) demand Market inverse
supply
S-1(q) = (-c+q)/d
At equilibrium,
p* D-1(q*) = S-1(q*).
D-1(q) = (a-q)/b
q* q
Market Equilibrium
an
d
At the equilibrium quantity q*, D-1(p*) = S-1(p*).
Market Equilibrium
an
d
That is,
Market Equilibrium
an
d
That is,
which
gives
Market Equilibrium
an
d
That is,
which
gives
an
d
Market Equilibrium
D-1(q), Market Marke
S-1(q) demand t
S-1(q) = (-c+q)/d
supply
D-1(q) = (a-q)/b
q
Market Equilibrium
● Two special cases:
– quantity supplied is fixed,
independent of the market price,
and
– quantity supplied is extremely
sensitive to the market price.
Market Equilibrium
p Market quantity supplied is
fixed, independent of price.
q* q
Market Equilibrium
fixed, independent of price.
S(p) = c+dp, so d=0
and S(p) ≡ c.
q* = c q
Market Equilibrium
Market Market quantity supplied is
p
demand fixed, independent of price.
S(p) = c+dp, so d=0
and S(p) ≡ c.
D-1(q) = (a-q)/b
q* = c q
Market Equilibrium
p
S(p) = c+dp, so d=0
and S(p) ≡ c.
p*
D-1(q) = (a-q)/b
q* = c q
Market Equilibrium
p
S(p) = c+dp, so d=0
and S(p) ≡ c.
p* = p* = D-1(q*); that is,
(a- p* = (a-c)/b.
c)/b D-1(q) = (a-q)/b
q* = c q
Market Equilibrium
p
S(p) = c+dp, so d=0
and S(p) ≡ c.
p* = p* = D-1(q*); that is,
(a- p* = (a-c)/b.
c)/b D-1(q) = (a-q)/b
q* = c q
Market Equilibrium
p
S(p) = c+dp, so d=0
and S(p) ≡ c.
p* = p* = D-1(q*); that is,
(a- p* = (a-c)/b.
c)/b D-1(q) = (a-q)/b
q* = c q
with d = 0
give
Market Equilibrium
● Two special cases are
– when quantity supplied is fixed,
independent of the market price,
✓ and
– when quantity supplied is
extremely sensitive to the market
price.
Market Equilibrium
extremely sensitive to
price.
q
Market Equilibrium
extremely sensitive to
price.S-1(q) = p*.
p*
q
Market Equilibrium
p
demand extremely sensitive to
price.S-1(q) = p*.
p*
D-1(q) = (a-q)/b
q
Market Equilibrium
p
price.S-1(q) = p*.
p*
D-1(q) = (a-q)/b
q* q
Market Equilibrium
p
price.S-1(q) = p*.
p* = D-1(q*) = (a-q*)/b so
p* q* = a-bp*
D-1(q) = (a-q)/b
q* = q
a-bp*
Quantity Taxes
● A quantity tax levied at a rate of $t is
a tax of $t paid on each unit traded.
● If the tax is levied on sellers then it is
an excise tax.
● If the tax is levied on buyers then it is
a sales tax.
Quantity Taxes
● What is the effect of a quantity tax on
a market’s equilibrium?
● How are prices affected?
● How is the quantity traded affected?
● Who pays the tax?
● How are gains-to-trade altered?
Quantity Taxes
● A tax rate t makes the price paid by
buyers, pb, higher by t from the price
received by sellers, ps.
Quantity Taxes
● Even with a tax the market must
clear.
● I.e. quantity demanded by buyers at
price pb must equal quantity supplied
by sellers at price ps.
Quantity Taxes
an
d
describe the market’s equilibrium.
Notice these conditions apply no
matter if the tax is levied on sellers or
on
buyers.
Quantity Taxes
an
d
describe the market’s equilibrium.
Notice that these two conditions apply
no
matter if the tax is levied on sellers or on
buyers.
Hence, a sales tax rate $t has the
same effect as an excise tax rate
$t.
Quantity Taxes & Market Equilibrium
Market Marke
p
demand t
supply
No tax
p
*
q D(p), S(p)
*
Market Marke
p
demand t
supply An excise tax
raises the market
$ supply curve by
p t $t
*
q D(p), S(p)
*
Market Marke
p
demand t
raises the market
pb $ supply curve by $t,
p t raises the buyers’
* price and lowers the
quantity traded.
qt q D(p), S(p)
*
Market Marke
p
demand t
raises the market
pb $ supply curve by $t,
p t raises the buyers’
p
*s price and lowers the
quantity traded.
qt q D(p), S(p)
*
And sellers receive only p = p - t.
s b
Market Marke
p
demand t
supply
No tax
p
*
q D(p), S(p)
*
Market Marke
p
demand t
supply An sales tax
lowers
the market demand
p curve by $t
*
$
t
q D(p), S(p)
*
Market Marke
p
demand t
supply An sales tax lowers
the market demand
curve by $t, lowers
p the sellers’ price and
p
*s reduces the quantity
$ traded.
t
qt q D(p), S(p)
*
Market Marke
p
demand t
supply An sales tax lowers
the market demand
pb curve by $t, lowers
p the sellers’ price and
p
*s reduces the quantity
$ traded.
t
qt q D(p), S(p)
*
And buyers pay pb = ps + t.
Market Marke
p
demand t
supply A sales tax levied at
rate $t has the same
pb $ effects on the
p t market’s equilibrium
p
*s as does an excise
$ tax
t levied at rate $t.
qt q D(p), S(p)
*
Quantity Taxes & Market
Equilibrium
● Who pays the tax of $t per unit
traded?
● The division of the $t between
buyers and sellers is the incidence of
the tax.
Market Marke
p
demand t
supply
pb
p
p
*s
qt q D(p), S(p)
*
Market Marke
p
demand t
Tax paid bysupply
buyers
pb
p
p
*s
qt q D(p), S(p)
*
Market Marke
p
demand t
supply
pb
p
p Tax paid by
*s sellers
qt q D(p), S(p)
*
Market Marke
p
demand t
Tax paid bysupply
buyers
pb
p
p Tax paid by
*s sellers
qt q D(p), S(p)
*
Quantity Taxes & Market
Equilibrium
● E.g. suppose the market demand and
supply curves are linear.
an
d
an
d
With the tax, the market equilibrium
satisfies
an s
d
an o
d
an
d
With the tax, the market equilibrium
satisfies
an s
d
an o
d
Substituting for pb gives
an giv
d e
The quantity traded at equilibrium

is
As t → 0, ps and pb →
the
equilibrium price if →
there is no tax (t = 0) and qt
the quantity traded at equilibrium
when there is no tax.
As t increases, ps falls,
pb rises,
and qt falls.
The tax paid per unit by the buyer

is
The tax paid per unit by the buyer

is
The tax paid per unit by the seller

is
The total tax paid (by buyers and

sellers
combined) is
Tax Incidence and Own-Price
Elasticities
● The incidence of a quantity tax
depends upon the own-price
elasticities of demand and supply.
Elasticities
Market Marke
p
demand t
supply
pb $
p t
p
*s
qt q D(p), S(p)
*
Elasticities
Market Marke
p
demand t
supply Change to buyers’
pb $ price is pb - p*.
p t
Change to
p
*s quantity
demanded is Δq.
qt q D(p), S(p)
*
Δ
q
Elasticities
Around p = p* the own-price
elasticity
of demand is approximately
Elasticities
elasticity
of demand is approximately
Elasticities
Market Marke
p
demand t
supply
pb $
p t
p
*s
qt q D(p), S(p)
*
Elasticities
Market Marke
p
demand t
supply Change to sellers’
pb $ price is ps - p*.
p t
Change to
p
*s quantity
demanded is Δq.
qt q D(p), S(p)
*
Δ
q
Elasticities
elasticity
of supply is approximately
Elasticities
elasticity
of supply is approximately
Elasticities
Market Marke
p
demand t
Tax paid bysupply
buyers
pb
p
p Tax paid by
*s sellers
qt q D(p), S(p)
*
Elasticities
Market Marke
p
demand t
Tax paid bysupply
buyers
pb
p
p Tax paid by
*s sellers
qt q D(p), S(p)
*
Tax incidence =
Elasticities
Tax incidence =
Elasticities
Tax incidence =
S
o
Elasticities
Tax incidence is
The fraction of a $t quantity tax paid

by buyers rises as supply becomes
more
own-price elastic or as demand
becomes
less own-price elastic.
Elasticities
Market Marke
p
demand t
supply As market demand
$ becomes less own-
pb price elastic, tax
p t
incidence shifts
p
*s more
to the buyers.
qt q D(p), S(p)
*
Elasticities
Market Marke
p
demand t
$ becomes less own-
p t
incidence shifts
p
*s more
to the buyers.
qt q D(p), S(p)
*
Elasticities
Market Marke
p
demand t
$ becomes less own-
ps= p* t
incidence shifts
more
to the buyers.
qt = q* D(p), S(p)
Elasticities
Market Marke
p
demand t
$ becomes less own-
ps= p* t
incidence shifts
more
to the buyers.
qt = q* D(p), S(p)
When εD = 0, buyers pay the entire tax, even
though it is levied on the sellers.
Elasticities
Tax incidence is
Similarly, the fraction of a $t quantity

tax paid by sellers rises as supply
becomes less own-price elastic or as
demand becomes more own-price
elastic.
Deadweight Loss and Own-Price
Elasticities
● A quantity tax imposed on a
competitive market reduces the
quantity traded and so reduces
gains-to-trade (i.e. the sum of
Consumers’ and Producers’
Surpluses).
● The lost total surplus is the tax’s
deadweight loss, or excess burden.
Elasticities
Market Marke
p
demand t
supply
No tax
p
*
q D(p), S(p)
*
Elasticities
Market Marke
p
demand t
supply
No tax
C
p S
*
q D(p), S(p)
*
Elasticities
Market Marke
p
demand t
supply
No tax
p
* PS
q D(p), S(p)
*
Elasticities
Market Marke
p
demand t
supply
No tax
C
p S
* PS
q D(p), S(p)
*
Elasticities
Market Marke
p
demand t
supply
No tax
C
p S
* PS
q D(p), S(p)
*
Elasticities
Market Marke
p
demand t
supply
The tax
pb C $ reduces
p S t both CS and PS
p
* s PS
qt q D(p), S(p)
*
Elasticities
Market Marke
p
demand t
supply
The tax reduces
pb C $ both CS and PS,
p S Tax t transfers
p
* s PS surplus
to government
qt q D(p), S(p)
*
Elasticities
Market Marke
p
demand t
supply
The tax reduces
p S Tax t transfers
p
* s PS surplus
to government
qt q D(p), S(p)
*
Elasticities
Market Marke
p
demand t
supply
The tax reduces
p S Tax t transfers
p
* s PS surplus
to government
qt q D(p), S(p)
*
Elasticities
Market Marke
p
demand t
supply
The tax reduces
p S Tax t transfers surplus
p
* s PS to government,
and lowers total
qt q D(p), S(p)
* surplus.
Elasticities
Market Marke
p
demand t
supply
pb C $
p S Tax t
p
* s PS Deadweight
loss
qt q D(p), S(p)
*
Elasticities
Market Marke
p
demand t
supply
pb $
p t
p
*s Deadweight
loss
qt q D(p), S(p)
*
Elasticities
Market Marke
p
demand t
supply
Deadweight loss
pb $ falls
p t as market demand
p
*s becomes less own-
price elastic.
qt q D(p), S(p)
*
Elasticities
Market Marke
p
demand t
supply
Deadweight loss
pb $ falls
p t as market demand
p
*s becomes less own-
price elastic.
qt q D(p), S(p)
*
Elasticities
Market Marke
p
demand t
supply
Deadweight loss
pb $ falls
ps= p* t as market demand
becomes less own-
price elastic.
qt = q* D(p), S(p)
When εD = 0, the tax causes no deadweight
loss.
Elasticities
● Deadweight loss due to a quantity
tax rises as either market demand or
market supply becomes more own-
price elastic.
● If either εD = 0 or εS = 0 then the
deadweight loss is zero.

Varian9e LecturePPTs Ch16

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Chapter 16

D(p’) S(p’) D(p), S(p)

D(p’) S(p’) D(p), S(p)

S(p” D(p”) D(p), S(p)

S(p” D(p”) D(p), S(p)

What are the

At the equilibrium price p, D(p) =

At the equilibrium price p, D(p) =

At the equilibrium price p, D(p) =

At the equilibrium price p, D(p) =

the equation of the inverse

the equation of the inverse

The quantity traded at equilibrium

The tax paid per unit by the buyer

The tax paid per unit by the buyer

The tax paid per unit by the seller

The total tax paid (by buyers and

The fraction of a $t quantity tax paid

Similarly, the fraction of a $t quantity

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