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APPLIEDCOMPETITIVEANALYSISTHEMODELOFAPERFECTLYCOMPETITIVEMARKETWEDEVELOPEDINTHEPREVIOUSCHAPTERPROVIDESTHEBASISFORMUCHAPPLIEDMICROECONOMICANALYSISUSINGTHESEPRINCIPLESOFSUPPLYANDDEMANDHASPROVENTOBEAGOODWAYTOGETSTARTEDINANINVESTIGATIONOFMANYREALWORLDMARKETSINTHISCHAPTERWEPROVIDEABRIEFDESCRIPTIONOFSOMEOFTHESEUSESBEFOREBEGINNING,TWOWARNINGSMAYBEAPPROPRIATEFIRST,OURANALYSISHEREWILLLOOKONLYATASINGLEMARKETTHATIS,WEWILLEMPLOYAPARTIALEQUILIBRIUMAPPROACHINCHAPTER16WEEXPLOREASERIESOFGENERALEQUILIBRIUMMODELSTHATPERMITANINVESTIGATIONOFREPERCUSSIONSINMANYMARKETSSIMULTANEOUSLYINSUCHMODELSSOMEOFTHESIMPLERESULTSOFSUPPLYANDDEMANDANALYSISMAYNOTHOLDSIMILARLY,AWARNINGABOUTTHESTRICTASSUMPTIONSTHATUNDERLIETHECOMPETITIVEMODELSHOULDALSOBEKEPTINMINDTHEMOSTIMPORTANTSUCHASSUMPTIONISTHATOFPRICETAKINGBEHAVIORONTHEPARTOFBOTHSUPPLIERSANDDEMANDERSWHENECONOMICACTORSHAVESOMEINUENCEONMARKETPRICE,ALTERNATIVEMODELSAREREQUIREDSEVERALSUCHMODELSAREEXAMINEDINPARTVOFTHISBOOK15CHAPTERECONOMICEFCIENCYANDWELFAREANALYSISLONGRUNCOMPETITIVEEQUILIBRIAMAYHAVETHEDESIRABLEPROPERTYOFALLOCATINGRESOURCES“EFCIENTLY”ALTHOUGHWEWILLHAVEFARMORETOSAYABOUTTHISCONCEPTINAGENERALEQUILIBRIUMCONTEXTINCHAPTER17,HEREWECANOFFERAPARTIALEQUILIBRIUMDESCRIPTIONOFWHYTHERESULTMIGHTHOLDREMEMBERFROMCHAPTER5THATTHEAREABELOWADEMANDCURVEANDABOVEMARKETPRICEREPRESENTSCONSUMERSURPLUSTHEEXTRAUTILITYCONSUMERSRECEIVEFROMCHOOSINGTOPURCHASEAGOODVOLUNTARILYRATHERTHANBEINGFORCEDTODOWITHOUTITSIMILARLY,ASWESAWINCHAPTER14,PRODUCERSURPLUSISMEASUREDASTHEAREABELOWMARKETPRICEANDABOVETHELONGRUNSUPPLYCURVE,WHICHREPRESENTSTHEEXTRARETURNTHATPRODUCTIVEINPUTSRECEIVERATHERTHANHAVINGNOTRANSACTIONSINTHEGOODOVERALLTHEN,THEAREABETWEENTHEDEMANDCURVEANDTHESUPPLYCURVEREPRESENTSTHESUMOFCONSUMERANDPRODUCERSURPLUSITMEASURESTHETOTALADDITIONALVALUEOBTAINEDBYMARKETPARTICIPANTSBYBEINGABLETOMAKEMARKETTRANSACTIONSINTHISGOODITSEEMSCLEARTHATTHISTOTALAREAISMAXIMIZEDATTHECOMPETITIVEMARKETEQUILIBRIUMAGRAPHICPROOFFIGURE151SHOWSASIMPLIEDPROOFGIVENTHEDEMANDCURVEDANDTHELONGRUNSUPPLYCURVES,THESUMOFCONSUMERANDPRODUCERSURPLUSISGIVENBYDISTANCEABFORTHERSTUNITPRODUCEDTOTALSURPLUSCONTINUESTOINCREASEASADDITIONALOUTPUTISPRODUCEDUPTOTHECOMPETITIVEEQUILIBRIUMLEVEL,QTHISLEVELOFPRODUCTIONWILLBEACHIEVEDWHENPRICEISATTHECOMPETITIVELEVEL,PTOTALCONSUMERSURPLUSISREPRESENTEDBYTHELIGHTSHADEDAREAINTHEGURE,TOTALPRODUCERSURPLUSBYTHEDARKERSHADEDAREACLEARLY,FOROUTPUTLEVELSLESSTHANQ,SAY,Q1,TOTALSURPLUSWOULDBEREDUCEDONESIGNOFTHISMISALLOCATIONISTHATATQ1,DEMANDERSWOULDVALUEANADDITIONALUNITOFOUTPUTATP1,WHEREASMARGINALCOSTSWOULDBEGIVENBYP2BECAUSEP1H11022P2,TOTALWELFAREWOULDCLEARLYINCREASEBYPRODUCINGONEMOREUNITOFOUTPUTATRANSACTIONTHATINVOLVEDTRADINGTHISEXTRAUNITATANYPRICEBETWEENP1ANDP2WOULDBEMUTUALLYBENECIALBOTHPARTIESWOULDGAINTHETOTALWELFARELOSSTHATOCCURSATOUTPUTLEVELQ1ISGIVENBYAREAFEGTHEDISTRIBUTIONOFSURPLUSATOUTPUTLEVELQ1WILLDEPENDONTHEPRECISENONEQUILIBRIUMPRICETHATPREVAILSINTHEMARKETATAPRICEOFP1CONSUMERSURPLUSWOULDBEREDUCEDSUBSTANTIALLYTOAREAAFP1,WHEREASPRODUCERSMIGHTACTUALLYGAINBECAUSEPRODUCERSURPLUSISNOWP1FGBATALOWPRICESUCHASP2THESITUATIONWOULDBEREVERSED,WITHPRODUCERSBEINGMUCHWORSEOFFTHANTHEYWEREINITIALLYHENCETHEDISTRIBUTIONOFTHEWELFARELOSSESFROMPRODUCINGLESSTHANQWILLDEPENDONTHEPRICEATWHICHTRANSACTIONSARECONDUCTEDTHESIZEOFTHETOTALLOSS,HOWEVER,ISGIVENBYFEG,REGARDLESSOFTHEPRICESETTLEDUPON1AMATHEMATICALPROOFMATHEMATICALLY,WEWISHTOMAXIMIZECONSUMERSURPLUSH11001PRODUCERSURPLUSH11005151UQH11002PQH11001PQH11002H20885Q0PQDQH11005UQH11002H20885Q0PQDQ,402PARTVPERFECTCOMPETITION1INCREASESINOUTPUTBEYONDQALSOCLEARLYREDUCEWELFARESEEPROBLEM151WHEREUQISTHEUTILITYFUNCTIONOFTHEREPRESENTATIVECONSUMERANDPQISTHELONGRUNSUPPLYRELATIONINLONGRUNEQUILIBRIAALONGTHELONGRUNSUPPLYCURVE,PQH11005ACH11005MCMAXIMIZATIONOFEQUATION151WITHRESPECTTOQYIELDSUH11032QH11005PQH11005ACH11005MC,152SOMAXIMIZATIONOCCURSWHERETHEMARGINALVALUEOFQTOTHEREPRESENTATIVECONSUMERISEQUALTOMARKETPRICEBUTTHISISPRECISELYTHECOMPETITIVESUPPLYDEMANDEQUILIBRIUM,BECAUSETHEDEMANDCURVEREPRESENTSCONSUMERSMARGINALVALUATIONS,WHEREASTHESUPPLYCURVEREECTSMARGINALAND,INLONGTERMEQUILIBRIUM,AVERAGECOSTAPPLIEDWELFAREANALYSISTHECONCLUSIONTHATTHECOMPETITIVEEQUILIBRIUMMAXIMIZESTHESUMOFCONSUMERANDPRODUCERSURPLUSMIRRORSASERIESOFMOREGENERALECONOMICEFCIENCY“THEOREMS”WEWILLEXAMINEINCHAPTER17DESCRIBINGTHEMAJORCAVEATSTHATATTACHTOTHESETHEOREMSISBESTDELAYEDUNTILTHATMOREEXTENDEDDISCUSSIONHEREWEAREMOREINTERESTEDINSHOWINGHOWTHECOMPETITIVEMODELISUSEDTOEXAMINETHECONSEQUENCESOFCHANGINGECONOMICCONDITIONSONTHEWELFAREOFMARKETPARTICIPANTSUSUALLYSUCHWELFARECHANGESAREMEASUREDBYLOOKINGATCHANGESINCONSUMERANDPRODUCERSURPLUSCHAPTER15APPLIEDCOMPETITIVEANALYSIS403COMPETITIVEEQUILIBRIUMANDCONSUMER/PRODUCERSURPLUSATTHECOMPETITIVEEQUILIBRIUMQTHESUMOFCONSUMERSURPLUSSHADEDLIGHTERGRAYANDPRODUCERSURPLUSSHADEDDARKERISMAXIMIZEDFORANOUTPUTLEVELLESSTHANQ,SAY,Q1,THEREISADEADWEIGHTLOSSOFCONSUMERANDPRODUCERSURPLUSGIVENBYAREAFEGPRICEQUANTITYPERPERIOD0ABP1Q1P2PQFEGSDFIGURE151EXAMPLE151WELFARELOSSCOMPUTATIONSUSEOFCONSUMERANDPRODUCERSURPLUSNOTIONSMAKESPOSSIBLETHEEXPLICITCALCULATIONOFWELFARELOSSESFROMRESTRICTIONSONVOLUNTARYTRANSACTIONSINTHECASEOFLINEARDEMANDANDSUPPLYCURVES,THISCOMPUTATIONISESPECIALLYSIMPLEBECAUSETHEAREASOFLOSSAREFREQUENTLYTRIANGULARFOREXAMPLE,IFDEMANDISGIVENBYQDH1100510H11002P153ANDSUPPLYBYQSH11005PH110022,154MARKETEQUILIBRIUMOCCURSATTHEPOINTPH110056,QH110054RESTRICTIONOFOUTPUTTOQH33526H110053WOULDCREATEAGAPBETWEENWHATDEMANDERSAREWILLINGTOPAYPDH1100510H11002QH33526H110057ANDWHATSUPPLIERSREQUIREPSH110052H11001QH33526H110055THEWELFARELOSSFROMRESTRICTINGTRANSACTIONSISGIVENBYATRIANGLEWITHABASEOF2H11005PDH11002PSH110057H110025ANDAHEIGHTOF1THEDIFFERENCEBETWEENQANDQH33526HENCETHEWELFARELOSSISONEDOLLARIFPISMEASUREDINDOLLARSPERUNITANDQISMEASUREDINUNITSMOREGENERALLY,THELOSSWILLBEMEASUREDINTHEUNITSINWHICHPH11080QISMEASUREDCOMPUTATIONSWITHCONSTANTELASTICITYCURVESMOREREALISTICRESULTSCANUSUALLYBEOBTAINEDBYUSINGCONSTANTELASTICITYDEMANDANDSUPPLYCURVESBASEDONECONOMETRICSTUDIESINEXAMPLE143,WEEXAMINEDSUCHAMODELOFTHEUSAUTOMOBILEMARKETWECANSIMPLIFYTHATEXAMPLEABITBYASSUMINGPISMEASUREDINTHOUSANDSOFDOLLARS,QINMILLIONSOFAUTOMOBILES,ANDTHATDEMANDISGIVENBYQDH11005200PH1100212155ANDSUPPLYBYQSH1100513P156EQUILIBRIUMINTHEMARKETISGIVENBYPH11005987,QH11005128SUPPOSENOWTHATGOVERNMENTPOLICYRESTRICTSAUTOMOBILESALESTO11MILLIONTOCONTROLEMISSIONSOFPOLLUTANTSANAPPROXIMATIONTOTHEDIRECTWELFARELOSSFROMSUCHAPOLICYCANBEFOUNDBYTHETRIANGULARMETHODUSEDEARLIERWITHQH33526H1100511,PDH1100511/200H1100283H11005111,PSH1100511/13H11005846HENCE,THEWELFARELOSS“TRIANGLE”ISGIVENBY5PDH11002PSQH11002QH33526H110055111H11002846128H1100211H11005238HERETHEUNITSARETHOSEOFPTIMESQBILLIONSOFDOLLARSTHEAPPROXIMATE2VALUEOFTHEWELFARELOSSISTHEREFORE24BILLION,WHICHMIGHTBEWEIGHEDAGAINSTTHEEXPECTEDGAINFROMEMISSIONSCONTROLDISTRIBUTIONOFLOSSINTHEAUTOMOBILECASE,THEWELFARELOSSISSHAREDABOUTEQUALLYBYCONSUMERSANDPRODUCERSANAPPROXIMATIONFORCONSUMERSLOSSESISGIVENBY404PARTVPERFECTCOMPETITION2AMOREPRECISEESTIMATEOFTHELOSSCANBEOBTAINEDBYINTEGRATINGPDH11002PSOVERTHERANGEQH1100511TOQH11005128WITHEXPONENTIALDEMANDANDSUPPLYCURVES,THISINTEGRATIONISOFTENQUITESIMPLEINTHEPRESENTCASE,THETECHNIQUEYIELDSANESTIMATEDWELFARELOSSOF228,THEREBYSHOWINGTHATTHETRIANGULARAPPROXIMATIONISNOTTOOBAD,EVENFORRELATIVELYLARGEPRICECHANGESINLATERANALYSIS,THEREFORE,WEWILLUSESUCHAPPROXIMATIONS5PDH11002PQH11002QH33526H110055111H11002987128H1100211H11005111,ANDFORPRODUCERSBY5987H11002846128H1100211H11005127BECAUSETHEPRICEELASTICITYOFDEMANDISSOMEWHATGREATERINABSOLUTEVALUETHANTHEPRICEELASTICITYOFSUPPLY,CONSUMERSINCURSOMEWHATLESSTHANHALFTHELOSSANDPRODUCERSSOMEWHATMORETHANHALFWITHANEVENMOREPRICEELASTICDEMANDCURVE,CONSUMERSWOULDINCURANEVENSMALLERSHAREOFTHELOSSQUERYHOWDOESTHESIZEOFTHETOTALWELFARELOSSFROMAQUANTITYRESTRICTIONDEPENDONTHEELASTICITIESOFSUPPLYANDDEMANDWHATDETERMINESHOWTHELOSSWILLBESHAREDPRICECONTROLSANDSHORTAGESSOMETIMESGOVERNMENTSMAYSEEKTOCONTROLPRICESATBELOWEQUILIBRIUMLEVELSALTHOUGHADOPTIONOFSUCHPOLICIESMAYBEBASEDONNOBLEMOTIVES,THECONTROLSDETERLONGRUNSUPPLYRESPONSESANDCREATEWELFARELOSSESFORBOTHCONSUMERSANDPRODUCERSASIMPLEANALYSISOFTHISPOSSIBILITYISPROVIDEDBYFIGURE152INITIALLYTHEMARKETISINLONGRUNEQUILIBRIUMATP1,Q1POINTEANINCREASEINDEMANDFROMDTODH11032WOULDCAUSETHEPRICETORISETOP2INTHESHORTRUNANDENCOURAGEENTRYBYNEWRMSASSUMINGTHISMARKETISCHARACTERIZEDBYINCREASINGCOSTSASREECTEDBYTHEPOSITIVELYSLOPED,LONGRUNSUPPLYCURVE,LS,PRICEWOULDFALLSOMEWHATASARESULTOFTHISENTRY,ULTIMATELYSETTLINGATP3IFTHESEPRICECHANGESWEREREGARDEDASUNDESIRABLE,THEGOVERNMENTCOULD,INPRINCIPLE,PREVENTTHEMBYIMPOSINGALEGALLYENFORCEABLECEILINGPRICEOFP1THISWOULDCAUSERMSTOCONTINUETOSUPPLYTHEIRPREVIOUSOUTPUTQ1AND,BECAUSEATP1DEMANDERSNOWWANTTOPURCHASEQ4,THEREWILLBEASHORTAGE,GIVENBYQ4H11002Q1WELFAREEVALUATIONTHEWELFARECONSEQUENCESOFTHISPRICECONTROLPOLICYCANBEEVALUATEDBYCOMPARINGCONSUMERANDPRODUCERSURPLUSMEASURESPREVAILINGUNDERTHISPOLICYTOTHOSETHATWOULDHAVEPREVAILEDINTHEABSENCEOFCONTROLSFIRST,THEBUYERSOFQ1GAINCONSUMERSURPLUSGIVENBYAREAP3CEP1BECAUSETHEYCANBUYTHISGOODATALOWERPRICETHANWOULDEXISTINANUNCONTROLLEDMARKETTHISGAINREECTSAPURETRANSFERFROMPRODUCERSOUTOFTHEAMOUNTOFPRODUCERSURPLUSTHATWOULDEXISTWITHOUTCONTROLSWHATCURRENTCONSUMERSHAVEGAINEDFROMTHELOWERPRICE,PRODUCERSHAVELOSTALTHOUGHTHISTRANSFERDOESNOTREPRESENTALOSSOFOVERALLWELFARE,ITDOESCLEARLYAFFECTTHERELATIVEWELLBEINGOFTHEMARKETPARTICIPANTSSECOND,THEAREAAEH11032CREPRESENTSTHEVALUEOFADDITIONALCONSUMERSURPLUSTHATWOULDHAVEBEENATTAINEDWITHOUTCONTROLSSIMILARLY,THEAREACEH11032EREECTSADDITIONALPRODUCERSURPLUSAVAILABLEINTHEUNCONTROLLEDSITUATIONTOGETHER,THESETWOAREASTHATIS,AREAAEH11032EREPRESENTTHETOTALVALUEOFMUTUALLYBENECIALTRANSACTIONSTHATAREPREVENTEDBYTHEGOVERNMENTPOLICYOFCONTROLLINGPRICETHISIS,THEREFORE,AMEASUREOFTHEPUREWELFARECOSTSOFTHATPOLICYCHAPTER15APPLIEDCOMPETITIVEANALYSIS405DISEQUILIBRIUMBEHAVIORTHEWELFAREANALYSISDEPICTEDINFIGURE152ALSOSUGGESTSSOMEOFTHETYPESOFBEHAVIORTHATMIGHTBEEXPECTEDASARESULTOFTHEPRICECONTROLPOLICYASSUMINGTHATOBSERVEDMARKETOUTCOMESAREGENERATEDBYQP1H11005MINQDP1,QSP1,157SUPPLIERSWILLBECONTENTWITHTHISOUTCOME,BUTDEMANDERSWILLNOTBECAUSETHEYWILLBEFORCEDTOACCEPTASITUA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