Lecture Notes: Government Intervention and Deadweight Loss

Introduction

• Total Economic Surplus is maximized in a competitive equilibrium where marginal benefit equals marginal cost.
• Externalities and public goods can disrupt this equilibrium.
• This lecture focuses on government intervention in markets leading to deadweight loss.

Price Controls

• Prices act as signals and incentives in the market.
• Government Regulation of Prices leads to price controls.
• Two Types of Price Controls:
  • Price Floors - a minimum price level.
  • Price Ceilings - a maximum price level.

Price Floors

• Ensure a price is no less than a certain level.
• Common example: Minimum Wage.

Price Floors in Agricultural Products

• Often used to increase farmers' income.
• Example used: Tacos.

Market Dynamics

• Equilibrium Price: $3
• Equilibrium Quantity: 600 tacos
• Consumer Surplus: Difference between willingness to pay and actual price.
• Producer Surplus: Difference between willingness to sell and actual price.

Effects of Price Floors

• Non-Binding Price Floor: Below equilibrium, e.g., $2, no effect.
• Binding Price Floor: Above equilibrium, e.g., $4, creates surplus.
  • Consumers buy less: 300 tacos at $4.
  • Producers offer more: 900 tacos.
  • Surplus: 600 tacos not sold.

Impact on Surplus

• Consumer Surplus: Reduced to area A.
  • Lost: Areas B and C.
• Producer Surplus: Limited to sold quantity.
  • Gains area B from consumers.
  • Deadweight Loss: Areas C and E.

Deadweight Loss Explained

• Represents lost gains from trade.
• Value creation prevented by price floors.

Producer vs. Consumer Impact

• Producers gain if area B > area E.
• Increased producer surplus often at consumer's expense.
• Economic surplus is reduced overall due to deadweight loss.

Handling Surpluses

• Example of agricultural products: Government may buy surplus, ship abroad, or destroy.

Conclusion

• Price Floors impact both consumer and producer surplus, often resulting in deadweight loss.
• Upcoming topic: Minimum Wages as a form of price floor.