1Chapter 9Applying the Competitive ModelKey topics1. consumer welfare2. producer welfare3. competition maximizes welfare4. policies that shift supply curves5. policies that create a wedge between supply and demand6. comparing both types of policies: importsApplications & Problems• occupational licenses and zoning•trucking• restriction on entry across countries• FTC fights bans of Internet sales of wine• government barriers on entry: milk• recent fights over barriers to trade2Definition of welfare• most people: welfare = government payments to poor people• economists: welfare = well-being of various groups such as consumers and producersConsumer’s welfare• using a consumer's utility function is not practical for 2 reasons:• we don't know individuals' utility functions• we cannot compare utilities across individuals• instead, we measure consumer welfare in dollars• easier to measure than utility• can compare dollars across individualsMeasuring consumer welfare• consumer surplus (CS) from a good =• benefit a consumer gets from consuming it (in $'s) minus its price• how much more you'd be willing to pay than you did pay for a good• demand curve contains this information • demand curve reflects a consumer's marginal willingness to pay: amount a consumer will pay for an extra unit3Graph individual's CSarea under individual's demand curve and above market price up to quantity that consumer buysFigure 9.1a Consumer Surplus54321543210CS2=$1CS1=$2E1=$3 E2=$3 E3=$3Price =$3abcq, Magazines per weekp, $ per magazine(a) David’s Consumer SurplusDemandGraph market consumer surplus area under market demand curve above market price up to quantity consumers buy4Figure 9.1b Consumer Surplusp1p, $ pertrading cardq1q, Trading cards per yearDemandExpenditure, EConsumersurplus, CSMarginal willingness topay for the last unit of output’Consumer surplus from TV• how much for you to "give up watching absolutely all types of television" for rest of your life?• 23% would do so for $25,000• 46% want at least $1 million• 25% wouldn't give it up for $1 million • 25% of those earning < $20,000/year wouldn't give up TV for $1 million (50 years of earnings)• thus, we use demand curves rather than asking consumers Bruce Springsteen’s Gift to His Fans • 2002 average rock concert ticket price was $51• $75 that Bruce Springsteen and the E Street Band charged for their concerts was below the market clearing price• when tickets went on sale at the Bradley Center in Milwaukee, 9,000 tickets sold in the first 10 minutes and all were gone after 20 minutes5Scalpers• some tickets were available from scalpers, ticket brokers, or on the Internet at higher prices• a web site offered tickets for Dallas American Airlines Center concert for $540 to $1,015• according to a survey, the average price of a resold ticket at the Philadelphia First Union Center concert was $280Springsteen’s pricing• says he set the price relatively low to give value to his fans• (in addition, he may have helped promote his new album)• assuming that he could have sold all the tickets at $280, he gave almost $3 million of consumer surplus to his Philadelphia fans — double the ticket revenue for that concertEffect of a price change on CS• price increase reduces CS• could be caused by• leftward shift of supply curve• new government tax6Figure 9.02 Fall in Consumer Surplus from Roses as Price Risesp, ¢ per stemQ, Billion rose stems per year57.832301.1601.25baA = $149.64 millionB = $23.2 millionC = $0.9 millionDemandWhere CS losses are largea price increase causes a larger CS loss, the• greater the initial revenues spent on the good (further to the right is the demand curve)• less elastic is the demand curve Solved problem• 2 linear demand curves go through the initial equilibrium e1• one demand curve is less elastic than another at e1• for which demand curve will a price increase cause largest consumer surplus loss?7Solved Problem 9.1p, $ per unitQ, Units per weekQ1Q3Q2p1p2e1e2e3DCBARelatively inelastic demand (at e1)Relatively elastic demand (at e1)Producer surplus1. supplier's gain from participating in a market 2. difference between amount for which good sells and minimum amount necessary for seller to produce good3. minimum amount a seller must receive to be willing to produce is firm's avoidable production cost (shut-down rule)Measuring PS using supply curve• producer surplus for a competitive firm or market:• area above supply curve (MC curve), below price line, up to quantity sold8432143210PS2=$2 PS3=$1PS1=$3MC2=$2 MC3=$3MC4=$4MC1=$1pSupplyq, Units per weekp, $ per unit(a) A Firm’s Producer Surplusp*p , Price per unitQ*Market supply curveQ, Units per yearMarket priceVariable cost, VCProducer surplus, PS’(b) Market Producer SurplusFigure 9.3Producer surplus and profitPS = R - VC• profit = revenue - (variable cost plus fixed cost):π = R - C = R - [VC + F]⇒ PS - π = F• which is zero in LR when F = 0 • PS differs from π by fixed costInterpreting producer surplus• producer surplus is a gain to trade:• in SR, if firm produces it earnsπ = R -VC -F• if firm shuts down it loses its fixed cost, F• thus, PS = profit from trade - profit (loss) from not trading isPS = [R -VC -F] - [-F] = R - VC9Shocks and PS• shocks change PS by same amount as π(because fixed costs do not change)• market PS measures effect of a shock on all firms - so we don't have to measure π of each firm separatelySolved problem• if estimated supply curve for roses is linear, • how much PS is lost when price of roses falls from 30¢ to 21¢ per stem• so that quantity sold falls from 1.25 billion to 1.16 billion rose stems per yearSolved Problem 9.2p, ¢per stemQ, Billion rose stems per yearE = $4.05 million30210 1.16 1.25SupplybaD = $104.4 millionF10Common measure of welfare • welfare = consumer surplus + producer surplus W = CS + PS• weights well-being of consumers and producers equally (value judgment)Welfare maximized at competitive output• producing more or less than competitive level reduces welfare• competition maximizes welfare because p = MC in competitive equilibriumFigure 9.4 Why Reducing Output from the Competitive Level Lowers Welfarep, $ per unitQ, Units per yearSupplyDemandp2MC1= p1Q2Q1e1MC2e2CEBDAF11Figure 9.5 Why Increasing Output from the Competitive Level Lowers Welfarep, $ per unitQ, Units per yearSupplyDemandp2MC1=
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