Review: Illustrating the effect of a tax.
Tax: PF = PC  Tax
PF = PC  .40
Question: How can we quantify the burden
borne by consumers and firms?
PC = 2.40 P = 2.10
PF = 2.00
P ($/gallon)
First, the no tax


equilibrium.
Quantity Demanded
Quantity Supplied
8,000
7,500
PC** = 2.40
==

Equilibrium
8,000
7,500
.40
S
P* = 2.10
PF** = 2.00
D
Quantity supplied
determined by PF
Quantity demanded
determined by PC
Question: Why do we move to
the left rather than the right?
Q** = 7,500
Q* = 8,000 Q (thousands of gallon per day)
Start
at the no taxquantity
equilibrium
and move left until the vertical gap between the demand and
The equilibrium
decreases.
supply
curves
the amount
the tax. increases, but by less than the full amount of the tax.
The price
fromequals
the perspective
ofof
consumers
The associated quantity is the new equilibrium quantity.
The price from the perspective of firms decreases, but by less than the full amount of the tax.
The
on the
the legal
demand
curve isisthe
equilibrium
price
of consumers.
Evenpoint
though
incidence
entirely
borne by
thefrom
firm,the
theperspective
burden is shared
by both firms
The
point on the supply curve is the equilibrium price from the perspective of firms.
and consumers.
Consumer Surplus and Producer Surplus
P
300
Market Demand Curve for Tutors
Student
Andy
Kate
Dan
Liz
Meg
Ned
Greatest Amount a
Student Would Pay
275
225
175
100
75
25
250
How many students would hire a
tutor if the tutor’s “price” was
______,
100
180
225
230
275
280
300
175
25 given that …? 1234560
75
200
150
Question: By how
much does each
student value the
benefits of tutoring
services?
100
50
D
Q
1
2
3
4
Revealed Preference
When the price of a good is $xxx and an individual, call him Joe,
does purchase the good

Joe values the benefits of the
good by at least $xxx

Value Joe places on the benefits  $xxx
Joe’s actions
reveal his
preferences.
5
6
does not purchase the good

Joe values the benefits of the
good by less than $xxx

Value Joe places on the benefits < $xxx
Value of Benefits
Student
Andy
Kate
Dan
Liz
Meg
Ned
Greatest Amount
a Student Would Pay
275
225
175
125
75
25
Question: By how much does each student value the
benefits of tutoring services?
Claim:
The value a student
places on the benefits
of tutoring services
equals
Greatest amount the
student would pay for
tutoring services
Question: Why do the values differ from student to student?
Question: By how much does Andy value the benefits of tutoring services?
If the price of tutoring
services $275
If the price of tutoring
services were $276

Andy would purchase
tutoring services.

Andy would not purchase
tutoring services.

Value Andy places on the
benefits  $275

Value Andy places on the
benefits < $276
Value Andy places on the benefits of tutoring services = $275.
Consumer Surplus
The value a student
places on the benefits
of tutoring services
Student
Andy
Kate
Dan
Liz
Meg
Ned
Value of
Tutoring Benefits
equals
Greatest amount the
student would pay for
tutoring services
Net Benefit of Receiving Tutoring Services
If price = $250 If price = $150
If price = $50
275
225
175
125
75
25
$25
-
$125
75
25
-
$225
175
125
50
25
-
Consumer Surplus
$25
$225
$600
Consumer Surplus: Net benefit buyers enjoy from purchasing and consuming the good.
Student
Andy
Kate
Dan
Liz
Meg
Ned
Greatest Amount
a Student Would Pay
Value of Benefits
Net Benefit of Receiving Tutoring Services
If price = $250 If price = $150
If price = $50
275
225
175
125
75
25
$25
-
P
Consumer Surplus
$25
300
Consumer Surplus: Net benefit buyers enjoy
from purchasing and consuming the good.
250
Height of Market Demand Curve: Reflects
the benefit a buyer enjoys from consuming a
200
specific unit of the good.
150
Consumer Surplus: The benefit each buyer
enjoys from consuming the good less what
each buyer must pay for the good.
Area Beneath the Market Demand Curve
Lying Above the Price: Reflects all the net
benefits buyers enjoy, the consumer surplus,
from purchasing and consuming the good.
$125
75
25
-
$225
175
125
50
25
-
$225
$600
100
50
D
Q
1
2
3
4
5
6
Market Supply Curve for Tutors
Student
Kim
John
Adam
Lisa
Walt
Beth
Least Amount Required
to Induce a Major
to Be a Tutor
275
225
200
125
75
25
How many majors would agree
P to be a tutor if the tutor’s “price”
5601234
275
225
200
125
75
25
20
300 was ______, given that …?
S
250
200
150
Question: What is
each major’s
opportunity cost of
providing tutoring
services?
100
50
Q
1
2
3
Revealed Preference
When the price of a good is $xxx and an individual, Joe,
4
5
does purchase the good

Joe values the benefits of the
good by at least $xxx
does not purchase the good

Joe values the benefits of the
good by less than $xxx

Value Joe places on the benefits  $xxx

Value Joe places on the benefits < $xxx
6
Opportunity Cost
Question: What is each major’s opportunity cost of
providing tutoring services?
Least Required to Induce
Claim:
a Major to Provide
The value of a major’s
Student
Tutoring Services
The least amount
opportunity cost of
Kim
275
equals required to induce a
providing tutoring
major to provide
John
225
services
tutoring services
Ralph
200
Lisa
125
If the price of tutoring
If the price of tutoring
Walt
75
services were $24
services were $25
Beth
25


Question: What is Beth’s
Beth would not provide
Beth would provide
opportunity cost of
tutoring services.
tutoring services.
providing tutoring services?


Opportunity cost
Beth would pursue the
Beth would not pursue
represents whatever is
“other activity.”
the “other activity.”
foregone when an activity


is pursued.
Value Beth places on the
Value Beth places on the
“other activity” > $24
“other activity”  $25
Beth’s opportunity cost of
providing tutoring services
Value Beth places on the “other activity” = $25.
equals

the value she places on the
Beth’s opportunity cost of providing tutoring services = $25.
benefits she receives from
the “other activity.”
Question: Why do the opportunity costs of the majors differ?
Producer Surplus
The value of a major’s
opportunity cost of
providing tutoring services
Least Required to Induce
a Major to Provide
Tutoring Services
Student
Opportunity Cost
Kim
275
John
225
Ralph
200
Lisa
125
Walt
75
Beth
25
The least required to
induce a major to
provide tutoring services
equals
Net Benefit of Providing Tutoring Services
If price = $50
If price = $150
If price = $250
25
50
25
125
75
175
25
125
225
Producer Surplus
25
225
Producer Surplus: Net benefit sellers enjoy from production and sale the good.
600
Student
Kim
John
Ralph
Lisa
Walt
Beth
Opportunity Cost
of Providing
Tutoring Services
275
225
200
125
75
25
Net Benefit of Providing Tutoring Services
If price = $50
If price = $150
If price = $250
25
50
25
125
75
175
25
125
225
Producer Surplus
25
Producer Surplus: The net benefit sellers
enjoy from producing and selling the good.
Height of Market Supply Curve: The
seller’s opportunity cost of providing a
specific unit of the good.
Producer Surplus: What each seller receives
from the sale of the good less the opportunity
cost each seller incurs by providing it.
Area Above the Market Supply Curve
Lying Beneath the Price: Reflects all the net
benefit sellers enjoy, the producer surplus,
from producing and selling the good.
225
P
600
S
300
250
200
150
100
50
1
2
3
4
5
6
Q
Summary: Consumer and Producer Surplus
Consumer Surplus: The net benefit buyers enjoy from purchasing and consuming the good.
Height of Market Demand Curve: Reflects the benefit a buyer
enjoys from consuming a specific unit of the good.
Consumer Surplus: The net benefit buyers enjoy from purchasing
and consuming the good; the benefit each buyer enjoys from
consuming the good less what each buyer must pay.
Area Beneath the Demand Curve Lying Above the Price: Reflects
all the net benefits buyers enjoy, the consumer surplus, from
purchasing and consuming the good.
Producer Surplus: The net benefit sellers enjoy from producing and selling the good
Height of Market Supply Curve: The seller’s opportunity cost of
providing a specific unit of the good.
Producer Surplus: The net benefit sellers enjoy from producing
and selling the good; what each seller receives from the sale of the
good less the opportunity cost each seller incurs by providing it.
Area above the Supply Curve Lying beneath the Price: Reflects
all the net benefit sellers enjoy, the producer surplus, from
producing and selling the good.