Lecture 4 i Announcements Lecture Aplia Experiment Thur or Friday 3 rounds around 10 minutes If participate add 1 5 bonus to HW4 1 Review Consumer Surplus and Producer Surplus in Market Allocation Choose between 4 different times Thur 9am 6pm 10pm Friday 4pm Only participate once Evening Midterm in two weeks Mon Oct 6 7 00 8 00 pm If you have conflict you need to register with headgrader gmail com for makeup Wed 4 5pm Makeup Registration Deadline for no penalty Mon Sept 29 4pm 2 Pareto Efficiency 3 Link between efficiency and the market allocation A After midterm m willl introdu uce conc c ceptt off exttern nalitiies Pay y atte entio on to o the e Last class we figured out what happens when Econland has a market economy Q 5 P 5 S1 S2 S3 S4 S5 produce D1 D2 D3 D4 D5 consume Market determines the P Q and who Gains from Trade We calculated Consumer surplus of particular buyer reservation price price paid Producer surplus of seller price received cost Fill table in to get TS CS PS 20 10 10 Price rec 5 5 5 5 5 Cost PS 1 2 3 4 5 6 7 8 9 10 4 3 2 1 0 0 0 0 0 0 10 Consumer Surplus and Producer Surplus in Competitive Equilibrium Dollars Q Res price CS Price paid 1 9 5 4 2 8 5 3 3 7 5 2 4 6 5 1 5 5 5 0 6 4 0 7 3 0 8 2 0 9 1 0 10 0 0 Total 10 10 9 8 7 6 5 4 3 2 1 0 S D 0 1 2 3 4 5 Quantity 6 7 8 9 1 See in graph 10 9 8 S 7 6 Dollars Consumer Surplus Area between demand curve and price line 5 4 Producer Surplus Area between price line and supply curve D 3 2 1 0 0 1 2 3 4 5 Quantity In Econland demand and supply curves look like steps In economy with lots of people we won t notice the steps things will smooth out CS Area of Triangle 5 5 12 5 PS 5 5 12 5 TS CS PS 25 6 7 8 9 10 So that is market allocation Vilfrredo o Pareto 184 48 1923 And the social surplus or pie And the division of the surplus who get s what slice The next step is to examine the efficiency of the market Need a concept of efficiency The standard concept is Pareto Efficiency A An alloca ation is Pare P eto Effici E ent if it iis fe easib ble a and therre is no way w to make m e so ome eone e bettter off o witho w out maki m ing so ome eone e worse off orr T The P Pie is big g as s it ca an be b If so ome eone e is tto ge et a bigg ger slice s it ca an o only com me from som meon ne ellse ge ettin ng a sma aller slic ce Concept is easy to understand if pies are the only thing in the economy Pretty simplistic view of the world that there is a fixed pie out there and the only economic question is how the pie is divided up Somebody has to bake the pie Redistribution policies could very well affect how many pies are baked This brings us back to Econland Widgets are NOT scattered about on the ground waiting to be picked up they have to be produced In Econland there are dollars and widgets The S people can produce widgets and the D people can consume them Everyone likes dollars The fundamental economic questions that need to be addressed How many widgets should be produced Who should produce widgets Who should consume widgets How many dollars does each person get Reservation Prices and Costs for Widgets Name Res Cost Name Price D1 9 1 S1 D2 8 2 S2 D3 7 3 S3 D4 6 4 S4 D5 5 5 S5 D6 4 6 S6 D7 3 7 S7 D8 2 8 S8 D9 1 9 S9 D10 0 10 S10 The following allocation is not Pareto efficient An allocation where D8 consumes a widget but D2 does not can not be Pareto efficient Because D8 gives widget D2 D2 gives 5 to D8 D8 better off get 5 for widget he values at 2 D2 better off pays 5 dollars for widget he values at 8 And no one worse off Note this is just one possible trade that can make some people better off with no one worse off Other possibilities General Principle 1 Efficient Allocation of Consumption In any efficient allocation consumers with highest willingness to pay consume Reservation Prices and Costs for Widgets Name Res Cost Name Price D1 9 1 S1 D2 8 2 S2 D3 7 3 S3 D4 6 4 S4 D5 5 5 S5 D6 4 6 S6 D7 3 7 S7 D8 2 8 S8 D9 1 9 S9 D10 0 10 S10 Next consider an allocation where S7 produces a widget but S3 does not Is this Pareto efficient General Principle 2 Efficient Allocation of Production In any efficient allocation producers with the lowest cost produce What about quantity Let s see what we can learn from the next two examples Next consider an allocation where 3 widgets are produced by S1 S2 S3 and 3 widgets are consumed by D1 D2 and D3 Pareto efficient Next consider an allocation where 8 widgets are produced by S1 through S8 and 8 widgets are consumed by D1 through D8 Let s say S8 is supposed to deliver a widget to D8 Pareto efficient Relative to the initial allocation S8 can give 5 instead of a widget Paying 5 is cheaper for S8 than making a widget D8 would rather have 5 than a widget So both better off no one worse off So what do we learn from these last two examples 10 General Principle 3 Efficient Quantity 9 8 Marginal Cost 7 Dollars In any efficient allocation the quantity is where the marginal valuation of the last unit consumed equals the marginal cost of the last unit produced 6 5 4 Marginal reservation price 3 2 1 0 0 Principles 1 2 and 3 imply that in an efficient allocation for the widget industry in Econ land Q 5 S1 S2 S3 S4 S5 produce D1 D2 D3 D4 D5 consume 1 2 3 4 5 6 7 8 9 10 efficient Quantity Q Qefficient 5 Social Surplus equals 8 6 4 2 0 20 All of this should look familiar Let s link this to the market