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14 © 2010 W. W. Norton & Company, Inc. Consumer’s Surplus 14 © 2010 W. W. Norton & Company, Inc. Consumer’s Surplus

Monetary Measures of Gains-to. Trade u You can buy as much gasoline as you Monetary Measures of Gains-to. Trade u You can buy as much gasoline as you wish at $1 per gallon once you enter the gasoline market. u Q: What is the most you would pay to enter the market? © 2010 W. W. Norton & Company, Inc. 2

Monetary Measures of Gains-to. Trade u A: You would pay up to the dollar Monetary Measures of Gains-to. Trade u A: You would pay up to the dollar value of the gains-to-trade you would enjoy once in the market. u How can such gains-to-trade be measured? © 2010 W. W. Norton & Company, Inc. 3

Monetary Measures of Gains-to. Trade u Three such measures are: – Consumer’s Surplus – Monetary Measures of Gains-to. Trade u Three such measures are: – Consumer’s Surplus – Equivalent Variation, and – Compensating Variation. u Only in one special circumstance do these three measures coincide. © 2010 W. W. Norton & Company, Inc. 4

$ Equivalent Utility Gains u Suppose gasoline can be bought only in lumps of $ Equivalent Utility Gains u Suppose gasoline can be bought only in lumps of one gallon. u Use r 1 to denote the most a single consumer would pay for a 1 st gallon -- call this her reservation price for the 1 st gallon. u r 1 is the dollar equivalent of the marginal utility of the 1 st gallon. © 2010 W. W. Norton & Company, Inc. 5

$ Equivalent Utility Gains u Now that she has one gallon, use r 2 $ Equivalent Utility Gains u Now that she has one gallon, use r 2 to denote the most she would pay for a 2 nd gallon -- this is her reservation price for the 2 nd gallon. u r 2 is the dollar equivalent of the marginal utility of the 2 nd gallon. © 2010 W. W. Norton & Company, Inc. 6

$ Equivalent Utility Gains u Generally, if she already has n-1 gallons of gasoline $ Equivalent Utility Gains u Generally, if she already has n-1 gallons of gasoline then rn denotes the most she will pay for an nth gallon. u rn is the dollar equivalent of the marginal utility of the nth gallon. © 2010 W. W. Norton & Company, Inc. 7

$ Equivalent Utility Gains u r 1 + … + rn will therefore be $ Equivalent Utility Gains u r 1 + … + rn will therefore be the dollar equivalent of the total change to utility from acquiring n gallons of gasoline at a price of $0. u So r 1 + … + rn - p. Gn will be the dollar equivalent of the total change to utility from acquiring n gallons of gasoline at a price of $p. G each. © 2010 W. W. Norton & Company, Inc. 8

$ Equivalent Utility Gains u. A plot of r 1, r 2, … , $ Equivalent Utility Gains u. A plot of r 1, r 2, … , rn, … against n is a reservation-price curve. This is not quite the same as the consumer’s demand curve for gasoline. © 2010 W. W. Norton & Company, Inc. 9

$ Equivalent Utility Gains r 1 r 2 r 3 r 4 r 5 $ Equivalent Utility Gains r 1 r 2 r 3 r 4 r 5 r 6 1 2 © 2010 W. W. Norton & Company, Inc. 3 4 5 6 10

$ Equivalent Utility Gains u What is the monetary value of our consumer’s gain-to-trading $ Equivalent Utility Gains u What is the monetary value of our consumer’s gain-to-trading in the gasoline market at a price of $p. G? © 2010 W. W. Norton & Company, Inc. 11

$ Equivalent Utility Gains u The dollar equivalent net utility gain for the 1 $ Equivalent Utility Gains u The dollar equivalent net utility gain for the 1 st gallon is $(r 1 - p. G) u and is $(r 2 - p. G) for the 2 nd gallon, u and so on, so the dollar value of the gain-to-trade is $(r 1 - p. G) + $(r 2 - p. G) + … for as long as rn - p. G > 0. © 2010 W. W. Norton & Company, Inc. 12

$ Equivalent Utility Gains r 1 r 2 r 3 r 4 r 5 $ Equivalent Utility Gains r 1 r 2 r 3 r 4 r 5 r 6 p. G 1 2 © 2010 W. W. Norton & Company, Inc. 3 4 5 6 13

$ Equivalent Utility Gains r 1 r 2 r 3 r 4 r 5 $ Equivalent Utility Gains r 1 r 2 r 3 r 4 r 5 r 6 p. G 1 2 © 2010 W. W. Norton & Company, Inc. 3 4 5 6 14

$ Equivalent Utility Gains r 1 r 2 r 3 r 4 r 5 $ Equivalent Utility Gains r 1 r 2 r 3 r 4 r 5 r 6 $ value of net utility gains-to-trade p. G 1 2 © 2010 W. W. Norton & Company, Inc. 3 4 5 6 15

$ Equivalent Utility Gains u Now suppose that gasoline is sold in half-gallon units. $ Equivalent Utility Gains u Now suppose that gasoline is sold in half-gallon units. u r 1, r 2, … , rn, … denote the consumer’s reservation prices for successive half-gallons of gasoline. u Our consumer’s new reservation price curve is © 2010 W. W. Norton & Company, Inc. 16

$ Equivalent Utility Gains r 1 r 3 r 5 r 7 r 9 $ Equivalent Utility Gains r 1 r 3 r 5 r 7 r 9 r 11 1 2 3 4 5 6 7 8 9 10 11 © 2010 W. W. Norton & Company, Inc. 17

$ Equivalent Utility Gains r 1 r 3 r 5 r 7 r 9 $ Equivalent Utility Gains r 1 r 3 r 5 r 7 r 9 r 11 p. G 1 2 3 4 5 6 7 8 9 10 11 © 2010 W. W. Norton & Company, Inc. 18

$ Equivalent Utility Gains r 1 r 3 r 5 r 7 r 9 $ Equivalent Utility Gains r 1 r 3 r 5 r 7 r 9 r 11 $ value of net utility gains-to-trade p. G 1 2 3 4 5 6 7 8 9 10 11 © 2010 W. W. Norton & Company, Inc. 19

$ Equivalent Utility Gains u And if gasoline is available in onequarter gallon units. $ Equivalent Utility Gains u And if gasoline is available in onequarter gallon units. . . © 2010 W. W. Norton & Company, Inc. 20

$ Equivalent Utility Gains 1 2 3 4 5 6 7 8 9 10 $ Equivalent Utility Gains 1 2 3 4 5 6 7 8 9 10 11 © 2010 W. W. Norton & Company, Inc. 21

$ Equivalent Utility Gains p. G 1 2 3 4 5 6 7 8 $ Equivalent Utility Gains p. G 1 2 3 4 5 6 7 8 9 10 11 © 2010 W. W. Norton & Company, Inc. 22

$ Equivalent Utility Gains $ value of net utility gains-to-trade p. G © 2010 $ Equivalent Utility Gains $ value of net utility gains-to-trade p. G © 2010 W. W. Norton & Company, Inc. 23

$ Equivalent Utility Gains u Finally, if gasoline can be purchased in any quantity $ Equivalent Utility Gains u Finally, if gasoline can be purchased in any quantity then. . . © 2010 W. W. Norton & Company, Inc. 24

$ Equivalent Utility Gains ($) Res. Prices Reservation Price Curve for Gasoline © 2010 $ Equivalent Utility Gains ($) Res. Prices Reservation Price Curve for Gasoline © 2010 W. W. Norton & Company, Inc. 25

$ Equivalent Utility Gains ($) Res. Prices Reservation Price Curve for Gasoline p. G $ Equivalent Utility Gains ($) Res. Prices Reservation Price Curve for Gasoline p. G Gasoline © 2010 W. W. Norton & Company, Inc. 26

$ Equivalent Utility Gains ($) Res. Prices Reservation Price Curve for Gasoline $ value $ Equivalent Utility Gains ($) Res. Prices Reservation Price Curve for Gasoline $ value of net utility gains-to-trade p. G Gasoline © 2010 W. W. Norton & Company, Inc. 27

$ Equivalent Utility Gains u Unfortunately, estimating a consumer’s reservation-price curve is difficult, u $ Equivalent Utility Gains u Unfortunately, estimating a consumer’s reservation-price curve is difficult, u so, as an approximation, the reservation-price curve is replaced with the consumer’s ordinary demand curve. © 2010 W. W. Norton & Company, Inc. 28

Consumer’s Surplus u. A consumer’s reservation-price curve is not quite the same as her Consumer’s Surplus u. A consumer’s reservation-price curve is not quite the same as her ordinary demand curve. Why not? u A reservation-price curve describes sequentially the values of successive single units of a commodity. u An ordinary demand curve describes the most that would be paid for q units of a commodity purchased simultaneously. © 2010 W. W. Norton & Company, Inc. 29

Consumer’s Surplus u Approximating the net utility gain area under the reservation-price curve by Consumer’s Surplus u Approximating the net utility gain area under the reservation-price curve by the corresponding area under the ordinary demand curve gives the Consumer’s Surplus measure of net utility gain. © 2010 W. W. Norton & Company, Inc. 30

Consumer’s Surplus ($) Reservation price curve for gasoline Ordinary demand curve for gasoline Gasoline Consumer’s Surplus ($) Reservation price curve for gasoline Ordinary demand curve for gasoline Gasoline © 2010 W. W. Norton & Company, Inc. 31

Consumer’s Surplus ($) Reservation price curve for gasoline Ordinary demand curve for gasoline p. Consumer’s Surplus ($) Reservation price curve for gasoline Ordinary demand curve for gasoline p. G Gasoline © 2010 W. W. Norton & Company, Inc. 32

Consumer’s Surplus ($) Reservation price curve for gasoline Ordinary demand curve for gasoline $ Consumer’s Surplus ($) Reservation price curve for gasoline Ordinary demand curve for gasoline $ value of net utility gains-to-trade p. G Gasoline © 2010 W. W. Norton & Company, Inc. 33

Consumer’s Surplus ($) Reservation price curve for gasoline Ordinary demand curve for gasoline $ Consumer’s Surplus ($) Reservation price curve for gasoline Ordinary demand curve for gasoline $ value of net utility gains-to-trade Consumer’s Surplus p. G Gasoline © 2010 W. W. Norton & Company, Inc. 34

Consumer’s Surplus ($) Reservation price curve for gasoline Ordinary demand curve for gasoline $ Consumer’s Surplus ($) Reservation price curve for gasoline Ordinary demand curve for gasoline $ value of net utility gains-to-trade Consumer’s Surplus p. G Gasoline © 2010 W. W. Norton & Company, Inc. 35

Consumer’s Surplus u The difference between the consumer’s reservation-price and ordinary demand curves is Consumer’s Surplus u The difference between the consumer’s reservation-price and ordinary demand curves is due to income effects. u But, if the consumer’s utility function is quasilinear in income then there are no income effects and Consumer’s Surplus is an exact $ measure of gains-to-trade. © 2010 W. W. Norton & Company, Inc. 36

Consumer’s Surplus The consumer’s utility function is quasilinear in x 2. Take p 2 Consumer’s Surplus The consumer’s utility function is quasilinear in x 2. Take p 2 = 1. Then the consumer’s choice problem is to maximize subject to © 2010 W. W. Norton & Company, Inc. 37

Consumer’s Surplus The consumer’s utility function is quasilinear in x 2. Take p 2 Consumer’s Surplus The consumer’s utility function is quasilinear in x 2. Take p 2 = 1. Then the consumer’s choice problem is to maximize subject to © 2010 W. W. Norton & Company, Inc. 38

Consumer’s Surplus That is, choose x 1 to maximize The first-order condition is That Consumer’s Surplus That is, choose x 1 to maximize The first-order condition is That is, This is the equation of the consumer’s ordinary demand for commodity 1. © 2010 W. W. Norton & Company, Inc. 39

Consumer’s Surplus p 1 Ordinary demand curve, CS © 2010 W. W. Norton & Consumer’s Surplus p 1 Ordinary demand curve, CS © 2010 W. W. Norton & Company, Inc. 40

Consumer’s Surplus p 1 Ordinary demand curve, CS © 2010 W. W. Norton & Consumer’s Surplus p 1 Ordinary demand curve, CS © 2010 W. W. Norton & Company, Inc. 41

Consumer’s Surplus p 1 Ordinary demand curve, CS © 2010 W. W. Norton & Consumer’s Surplus p 1 Ordinary demand curve, CS © 2010 W. W. Norton & Company, Inc. 42

Consumer’s Surplus p 1 Ordinary demand curve, CS © 2010 W. W. Norton & Consumer’s Surplus p 1 Ordinary demand curve, CS © 2010 W. W. Norton & Company, Inc. is exactly the consumer’s utility gain from consuming x 1’ units of commodity 1. 43

Consumer’s Surplus u Consumer’s Surplus is an exact dollar measure of utility gained from Consumer’s Surplus u Consumer’s Surplus is an exact dollar measure of utility gained from consuming commodity 1 when the consumer’s utility function is quasilinear in commodity 2. u Otherwise Consumer’s Surplus is an approximation. © 2010 W. W. Norton & Company, Inc. 44

Consumer’s Surplus u The change to a consumer’s total utility due to a change Consumer’s Surplus u The change to a consumer’s total utility due to a change to p 1 is approximately the change in her Consumer’s Surplus. © 2010 W. W. Norton & Company, Inc. 45

Consumer’s Surplus p 1(x 1), the inverse ordinary demand curve for commodity 1 © Consumer’s Surplus p 1(x 1), the inverse ordinary demand curve for commodity 1 © 2010 W. W. Norton & Company, Inc. 46

Consumer’s Surplus p 1(x 1) CS before © 2010 W. W. Norton & Company, Consumer’s Surplus p 1(x 1) CS before © 2010 W. W. Norton & Company, Inc. 47

Consumer’s Surplus p 1(x 1) CS after © 2010 W. W. Norton & Company, Consumer’s Surplus p 1(x 1) CS after © 2010 W. W. Norton & Company, Inc. 48

Consumer’s Surplus p 1(x 1), inverse ordinary demand curve for commodity 1. Lost CS Consumer’s Surplus p 1(x 1), inverse ordinary demand curve for commodity 1. Lost CS © 2010 W. W. Norton & Company, Inc. 49

Consumer’s Surplus x 1*(p 1), the consumer’s ordinary demand curve for commodity 1. Lost Consumer’s Surplus x 1*(p 1), the consumer’s ordinary demand curve for commodity 1. Lost CS measures the loss in Consumer’s Surplus. p 1 © 2010 W. W. Norton & Company, Inc. 50

Compensating Variation and Equivalent Variation u Two additional dollar measures of the total utility Compensating Variation and Equivalent Variation u Two additional dollar measures of the total utility change caused by a price change are Compensating Variation and Equivalent Variation. © 2010 W. W. Norton & Company, Inc. 51

Compensating Variation u p 1 rises. u Q: What is the least extra income Compensating Variation u p 1 rises. u Q: What is the least extra income that, at the new prices, just restores the consumer’s original utility level? © 2010 W. W. Norton & Company, Inc. 52

Compensating Variation u p 1 rises. u Q: What is the least extra income Compensating Variation u p 1 rises. u Q: What is the least extra income that, at the new prices, just restores the consumer’s original utility level? u A: The Compensating Variation. © 2010 W. W. Norton & Company, Inc. 53

Compensating Variation x 2 p 1=p 1’ p 2 is fixed. u 1 x Compensating Variation x 2 p 1=p 1’ p 2 is fixed. u 1 x 1 © 2010 W. W. Norton & Company, Inc. 54

Compensating Variation x 2 p 1=p 1’ p 1=p 1” p 2 is fixed. Compensating Variation x 2 p 1=p 1’ p 1=p 1” p 2 is fixed. u 1 u 2 x 1 © 2010 W. W. Norton & Company, Inc. 55

Compensating Variation x 2 p 1=p 1’ p 1=p 1” p 2 is fixed. Compensating Variation x 2 p 1=p 1’ p 1=p 1” p 2 is fixed. u 1 u 2 x 1 © 2010 W. W. Norton & Company, Inc. 56

Compensating Variation x 2 p 1=p 1’ p 1=p 1” p 2 is fixed. Compensating Variation x 2 p 1=p 1’ p 1=p 1” p 2 is fixed. u 1 u 2 CV = m 2 - m 1. x 1 © 2010 W. W. Norton & Company, Inc. 57

Equivalent Variation u p 1 rises. u Q: What is the least extra income Equivalent Variation u p 1 rises. u Q: What is the least extra income that, at the original prices, just restores the consumer’s original utility level? u A: The Equivalent Variation. © 2010 W. W. Norton & Company, Inc. 58

Equivalent Variation x 2 p 1=p 1’ p 2 is fixed. u 1 x Equivalent Variation x 2 p 1=p 1’ p 2 is fixed. u 1 x 1 © 2010 W. W. Norton & Company, Inc. 59

Equivalent Variation x 2 p 1=p 1’ p 1=p 1” p 2 is fixed. Equivalent Variation x 2 p 1=p 1’ p 1=p 1” p 2 is fixed. u 1 u 2 x 1 © 2010 W. W. Norton & Company, Inc. 60

Equivalent Variation x 2 p 1=p 1’ p 1=p 1” p 2 is fixed. Equivalent Variation x 2 p 1=p 1’ p 1=p 1” p 2 is fixed. u 1 u 2 x 1 © 2010 W. W. Norton & Company, Inc. 61

Equivalent Variation x 2 p 1=p 1’ p 1=p 1” p 2 is fixed. Equivalent Variation x 2 p 1=p 1’ p 1=p 1” p 2 is fixed. u 1 u 2 EV = m 1 - m 2. x 1 © 2010 W. W. Norton & Company, Inc. 62

Consumer’s Surplus, Compensating Variation and Equivalent Variation u Relationship 1: When the consumer’s preferences Consumer’s Surplus, Compensating Variation and Equivalent Variation u Relationship 1: When the consumer’s preferences are quasilinear, all three measures are the same. © 2010 W. W. Norton & Company, Inc. 63

Consumer’s Surplus, Compensating Variation and Equivalent Variation u Consider first the change in Consumer’s Consumer’s Surplus, Compensating Variation and Equivalent Variation u Consider first the change in Consumer’s Surplus when p 1 rises from p 1’ to p 1”. © 2010 W. W. Norton & Company, Inc. 64

Consumer’s Surplus, Compensating Variation and Equivalent Variation If © 2010 W. W. Norton & Consumer’s Surplus, Compensating Variation and Equivalent Variation If © 2010 W. W. Norton & Company, Inc. then 65

Consumer’s Surplus, Compensating Variation and Equivalent Variation If then and so the change in Consumer’s Surplus, Compensating Variation and Equivalent Variation If then and so the change in CS when p 1 rises from p 1’ to p 1” is © 2010 W. W. Norton & Company, Inc. 66

Consumer’s Surplus, Compensating Variation and Equivalent Variation If then and so the change in Consumer’s Surplus, Compensating Variation and Equivalent Variation If then and so the change in CS when p 1 rises from p 1’ to p 1” is © 2010 W. W. Norton & Company, Inc. 67

Consumer’s Surplus, Compensating Variation and Equivalent Variation If then and so the change in Consumer’s Surplus, Compensating Variation and Equivalent Variation If then and so the change in CS when p 1 rises from p 1’ to p 1” is © 2010 W. W. Norton & Company, Inc. 68

Consumer’s Surplus, Compensating Variation and Equivalent Variation u Now consider the change in CV Consumer’s Surplus, Compensating Variation and Equivalent Variation u Now consider the change in CV when p 1 rises from p 1’ to p 1”. u The consumer’s utility for given p 1 is and CV is the extra income which, at the new prices, makes the consumer’s utility the same as at the old prices. That is, . . . © 2010 W. W. Norton & Company, Inc. 69

Consumer’s Surplus, Compensating Variation and Equivalent Variation © 2010 W. W. Norton & Company, Consumer’s Surplus, Compensating Variation and Equivalent Variation © 2010 W. W. Norton & Company, Inc. 70

Consumer’s Surplus, Compensating Variation and Equivalent Variation So © 2010 W. W. Norton & Consumer’s Surplus, Compensating Variation and Equivalent Variation So © 2010 W. W. Norton & Company, Inc. 71

Consumer’s Surplus, Compensating Variation and Equivalent Variation u Now consider the change in EV Consumer’s Surplus, Compensating Variation and Equivalent Variation u Now consider the change in EV when p 1 rises from p 1’ to p 1”. u The consumer’s utility for given p 1 is and EV is the extra income which, at the old prices, makes the consumer’s utility the same as at the new prices. That is, . . . © 2010 W. W. Norton & Company, Inc. 72

Consumer’s Surplus, Compensating Variation and Equivalent Variation © 2010 W. W. Norton & Company, Consumer’s Surplus, Compensating Variation and Equivalent Variation © 2010 W. W. Norton & Company, Inc. 73

Consumer’s Surplus, Compensating Variation and Equivalent Variation That is, © 2010 W. W. Norton Consumer’s Surplus, Compensating Variation and Equivalent Variation That is, © 2010 W. W. Norton & Company, Inc. 74

Consumer’s Surplus, Compensating Variation and Equivalent Variation So when the consumer has quasilinear utility, Consumer’s Surplus, Compensating Variation and Equivalent Variation So when the consumer has quasilinear utility, CV = EV = DCS. But, otherwise, we have: Relationship 2: In size, EV < DCS < CV. © 2010 W. W. Norton & Company, Inc. 75

Producer’s Surplus u Changes in a firm’s welfare can be measured in dollars much Producer’s Surplus u Changes in a firm’s welfare can be measured in dollars much as for a consumer. © 2010 W. W. Norton & Company, Inc. 76

Producer’s Surplus Output price (p) Marginal Cost y (output units) © 2010 W. W. Producer’s Surplus Output price (p) Marginal Cost y (output units) © 2010 W. W. Norton & Company, Inc. 77

Producer’s Surplus Output price (p) Marginal Cost y (output units) © 2010 W. W. Producer’s Surplus Output price (p) Marginal Cost y (output units) © 2010 W. W. Norton & Company, Inc. 78

Producer’s Surplus Output price (p) Marginal Cost Revenue = y (output units) © 2010 Producer’s Surplus Output price (p) Marginal Cost Revenue = y (output units) © 2010 W. W. Norton & Company, Inc. 79

Producer’s Surplus Output price (p) Marginal Cost Variable Cost of producing y’ units is Producer’s Surplus Output price (p) Marginal Cost Variable Cost of producing y’ units is the sum of the marginal costs y (output units) © 2010 W. W. Norton & Company, Inc. 80

Producer’s Surplus Output price (p) Revenue less VC is the Producer’s Surplus. Marginal Cost Producer’s Surplus Output price (p) Revenue less VC is the Producer’s Surplus. Marginal Cost Variable Cost of producing y’ units is the sum of the marginal costs y (output units) © 2010 W. W. Norton & Company, Inc. 81

Benefit-Cost Analysis u Can we measure in money units the net gain, or loss, Benefit-Cost Analysis u Can we measure in money units the net gain, or loss, caused by a market intervention; e. g. , the imposition or the removal of a market regulation? u Yes, by using measures such as the Consumer’s Surplus and the Producer’s Surplus. © 2010 W. W. Norton & Company, Inc. 82

Benefit-Cost Analysis Price The free-market equilibrium Supply p 0 Demand q 0 © 2010 Benefit-Cost Analysis Price The free-market equilibrium Supply p 0 Demand q 0 © 2010 W. W. Norton & Company, Inc. Q D, Q S 83

Benefit-Cost Analysis Price The free-market equilibrium and the gains from trade generated by it. Benefit-Cost Analysis Price The free-market equilibrium and the gains from trade generated by it. Supply CS p 0 PS Demand q 0 © 2010 W. W. Norton & Company, Inc. Q D, Q S 84

Benefit-Cost Analysis Price The gain from freely trading the q 1 th unit. Supply Benefit-Cost Analysis Price The gain from freely trading the q 1 th unit. Supply Consumer’s gain CS p 0 PS Producer’s gain q 1 © 2010 W. W. Norton & Company, Inc. q 0 Demand Q D, Q S 85

Benefit-Cost Analysis Price p 0 The gains from freely trading the units from q Benefit-Cost Analysis Price p 0 The gains from freely trading the units from q 1 to q 0. Consumer’s gains CS PS Producer’s gains q 1 © 2010 W. W. Norton & Company, Inc. q 0 Supply Demand Q D, Q S 86

Benefit-Cost Analysis Price p 0 The gains from freely trading the units from q Benefit-Cost Analysis Price p 0 The gains from freely trading the units from q 1 to q 0. Consumer’s gains CS PS Producer’s gains q 1 © 2010 W. W. Norton & Company, Inc. q 0 Supply Demand Q D, Q S 87

Benefit-Cost Analysis Price Consumer’s gains CS p 0 PS Producer’s gains q 1 © Benefit-Cost Analysis Price Consumer’s gains CS p 0 PS Producer’s gains q 1 © 2010 W. W. Norton & Company, Inc. q 0 Any regulation that causes the units from q 1 to q 0 to be not traded destroys these gains. This loss is the net cost of the regulation. Q D, Q S 88

Benefit-Cost Analysis Price pb An excise tax imposed at a rate of $t per Benefit-Cost Analysis Price pb An excise tax imposed at a rate of $t per traded unit destroys these gains. Deadweight Loss CS Tax Revenue t ps PS q 1 © 2010 W. W. Norton & Company, Inc. q 0 Q D, Q S 89

Benefit-Cost Analysis Price pf An excise tax imposed at a rate of $t per Benefit-Cost Analysis Price pf An excise tax imposed at a rate of $t per traded unit destroys these gains. Deadweight Loss CS So does a floor price set at pf PS q 1 © 2010 W. W. Norton & Company, Inc. q 0 Q D, Q S 90

Benefit-Cost Analysis Price An excise tax imposed at a rate of $t per traded Benefit-Cost Analysis Price An excise tax imposed at a rate of $t per traded unit destroys these gains. Deadweight Loss CS pc So does a floor price set at pf, a ceiling price set at pc PS q 1 © 2010 W. W. Norton & Company, Inc. q 0 Q D, Q S 91

Benefit-Cost Analysis Price pe pc CS PS An excise tax imposed at a rate Benefit-Cost Analysis Price pe pc CS PS An excise tax imposed at a rate of $t per traded unit destroys these gains. Deadweight Loss So does a floor price set at pf, a ceiling price set at pc, and a ration scheme that allows only q 1 units to be traded. q 1 q 0 Q D, Q S Revenue & Company, Inc. by holders of ration coupons. © 2010 W. W. Norton received 92