Chapter 16 39
Chapter 16
Equilibrium
Some people have suggested that it would make more sense to save this
chapter until after deriving supply curves, but I still feel that it is in a better
position here. After all, the students have seen labor supply curves and net
supply curves earlier in the course, and it isn’t any shock to see demand and
supply treated together now.
The first part of the chapter is pretty standard, although I go to extra pains
to be clear to emphasize the idea of the inverse demand and supply curves. I tell
the students that the inverse functions describe the same relationship, but just
from a different viewpoint.
The treatment of taxes is more thorough than is usually the case. I like
the idea of looking at taxation in several different ways. It is a good idea to
emphasize that there are really four different variables in a taxation problem:
the demand price pd, the supply price ps, the amount demanded qd,andthe
amount supplied qs. When confronted with a tax problem, the first thing you
should do is write down the relationships between these four variables.
The most typical set of relationships is
pd=ps+t
qd=qs
But other relationships are possible. For example, if a tax-in-kind is levied,
as in the King Kanuta problem in the workbook, then the amount demanded
will be different than the amount supplied. In fact the only systematic way to
work out the King Kanuta problme is to be very careful about writing down the
relationships among the four variables.
You should emphasize that the incidence of the tax doesn’t depend on the
legal requirements of who is responsible for paying the tax. The Social Security
tax is a really nice example for this. The Social Security tax is based on 15% of
the nominal wage. The employer “pays” half of the tax and the worker “pays”
the other half. But of course, this is a fiction. Show the students how we could
redefine the nominal wage so that the worker paid all the tax or the employer
paid all the tax, and leave the take-home pay of the worker unchanged.
This leads naturally to a discussion of the real incidence of a tax, the ideas
of “passing along a tax,” and so on.
40 Chapter Highlights
I like to use the old red pencil/blue pencil example at this point. If red pencils
and blue pencils are perfect substitutes in consumption and production, what is
the impact of a tax on red pencils? There is a big output effect—consumption
and production of red pencils would drop to zero. But what is the effect on
consumer utility and producer profits? Zero—consumers and producers just
substitute to other activities. This leads naturally to the idea of measuring the
impact of a tax via consumer and producer surplus, as is done in Section 16.8.
The two examples that end the chapter, the market for loans and the food
subsidies, are really wonderful examples and deserve careful discussion. I like to
point out to the students how confused they would be in trying to understand
these examples without the analytic methods of economics.
Equilibrium
A. Supply curves — measure amount the supplier wants to supply at each price
1. review idea of net supply from Chapter 9
B. Equilibrium
1. competitive market — each agent takes prices as outside his or her control
2. equilibrium price — that price where desired demand equals desired supply
3. special cases — Figure 16.1.
4. an equivalent definition of equilibrium: where inverse demand curve crosses
inverse supply curve
5. examples with linear curves
C. Comparative statics
1. shift each curve separately
2. shift both curves together
D. Taxes — nice example of comparative statics
1. demand price and supply price — different in case of taxes
4. put equations together:
5. also can solve using inverse demands:
6. see Figure 16.3. and Figure 16.4.
E. Passing along a tax — Figure 16.5.
1. flat supply curve
2. vertical supply curve
Chapter 16 41
F. Deadweight loss of a tax — Figure 16.7.
1. benefits to consumers
2. benefits to producers
3. value of lost output
G. Market for loans
1. tax system subsidizes borrowing, tax lending
5. see Figure 16.8.
H. Food subsidies
1. buy up harvest and resell at half price.
5. subsidized mortgages — unless the housing stock changes, no effect on
I. Pareto efficiency
1. efficient output is where demand equals supply
2. because that is where demand price equals supply price.