Measuring the Gains from Trade Gains from Trade and the Effects of Market Regulation Are Markets Efficient Economists often claim competitive markets are efficient at generating gains to buyers and sellers and that this is a primary reason why most market driven economies have prospered while almost all command economies have collapsed Why What does it mean Measuring Gains from Trade Buyers and sellers gain from free trades By how much do they gain Is this gain as large as possible How is the total gain distributed Can regulation of markets improve total gain or alter its distribution between buyers and sellers Calculating a Firm s Gains Summing up the per unit Producer s Surpluses amounts to calculating the area between the output unit 50 Figure 1 Marginal Cost 40 30 20 10 0 p Marginal Revenue Per output unit Producer Surpluses 0 1 2 3 4 5 6 7 8 9 10 Output Level Calculating a Firm s Gains Summing up the per unit Producer s Surpluses amounts to calculating the area between the marginal revenue curve and the marginal cost curve Calculating a Firm s Gains Summing up the per unit Producer s Surpluses amounts to calculating the area between the marginal revenue curve and the marginal cost curve What if the firm makes a commodity available in any quantity not just integer quantities Calculating a Firm s Gains Infinitely Divisible Commodity MC q MR p TPS is sum of MR MC q q Calculating a Firm s Gains Infinitely Divisible Commodity MC q MR p TPS is sum of MR MC q q Calculating a Firm s Gains Infinitely Divisible Commodity MC q MR p TPS is sum of MR MC Area between MC MR curves TPS q q q Exercise on Calculating a Firm s Gain A firm s marginal cost curve has the equation MC q 5 q 2 output unit Graph the marginal cost curve Figure 3 output unit 40 MC q 5 q 2 unit 30 20 10 0 0 FC 60 10 20 30 40 50 Output Level Figure 3 output unit 40 MC q 5 q 2 unit MC 0 5 per unit 30 20 10 0 0 FC 60 10 20 30 40 50 Output Level Figure 3 output unit 40 MC q 5 q 2 unit MC 0 5 per unit MC 50 30 per unit 30 20 10 0 0 FC 60 10 20 30 40 50 Output Level Figure 3 output unit If p 25 per unit then what quantity 40 should the firm supply to max its profit Ans 30 20 10 0 0 FC 60 10 20 30 40 50 Output Level Figure 3 output unit If p 25 per unit then what quantity 40 should the firm supply to max its profit Ans Solve p 5 q 2 30 20 10 0 0 FC 60 10 20 30 40 50 Output Level Figure 3 output unit If p 25 per unit then what quantity 40 should the firm supply to max its profit Ans Solve p 5 q 2 q 40 30 20 10 0 0 FC 60 10 20 30 40 50 Output Level Figure 3 output unit Total Producer s Surplus 40 30 20 10 0 0 FC 60 10 20 30 40 50 Output Level Figure 3 output unit Total Producer s Surplus 40 0 5 25 5 40 400 30 20 10 0 0 FC 60 10 20 30 40 50 Output Level Figure 3 output unit Total Producer s Surplus 40 0 5 25 5 40 400 Profit 30 20 10 0 0 FC 60 10 20 30 40 50 Output Level Figure 3 output unit Total Producer s Surplus 40 0 5 25 5 40 400 Profit TPS FC 400 60 340 30 20 10 0 0 FC 60 10 20 30 40 50 Output Level Calculating Total Gains The sum of the gains over all suppliers is total PRODUCERS SURPLUS The sum of the gains over all consumers is total CONSUMERS SURPLUS TOTAL SURPLUS PRODUCERS SURPLUS CONSUMERS SURPLUS Calculating Total Gains The sum of the gains over all suppliers is total PRODUCERS SURPLUS Suppose there are just two firms supplying the market Figure 5 p unit p unit Firm 2 s Supply Curve Firm 1 s Supply Curve 15 15 5 5 p unit 20 q1 30 q2 The Market Supply Curve 15 5 50 QS q1 q2 Figure 5 p unit p unit Firm 2 s Supply Curve Firm 1 s Supply Curve 15 15 100 5 150 5 20 p unit q1 30 q2 Total PS 0 5 10 50 250 The Market Supply Curve 15 250 5 50 QS q1 q2 Figure 6 p unit p unit Consumer B s Demand 35 Consumer A s 35 Demand Curve Curve 15 15 10 p unit 35 qA 40 qB The Market Demand Curve 15 50 QD qA qB Figure 6 p unit p unit Consumer B s Demand 35 Consumer A s 35 Demand Curve Curve 15 100 400 15 qA 10 40 p unit Total CS 0 5 20 50 500 35 The Market Demand Curve qB 500 15 50 QD qA qB Calculating Total Gains The sum of the gains over all buyers and all sellers is TOTAL SURPLUS PRODUCERS SURPLUS CONSUMERS SURPLUS Combine the two sellers and the two buyers from before Figure 7 p unit 35 Market Supply 15 Market Demand 5 50 QD QS Figure 7 p unit 35 Total Surplus CS PS 500 250 750 500 Market Supply 15 250 Market Demand 5 50 QD QS Economic Efficiency In what type of economy is the total gain from trading made as large as is possible This is the ECONOMIC EFFICIENCY question Economic Efficiency Vilfredo Pareto 1909 devised the following efficiency criterion For an economy to function efficiently it must not be possible to make any individual in the economy better off without making some other individual worse off Economic Efficiency Think of allocating 60 between three people A B and C Economic Efficiency Divide the 60 into 4 lots of 15 each Give 15 to each of A B and C Hold back 15 Can one person be made better off without making anyone else worse off Economic Efficiency Divide the 60 into 4 lots of 15 each Give 15 to each of A B and C Hold back 15 Can one person be made better off without making anyone else worse off Yes e g give the last 15 to someone or give some of the last 15 to everyone Economic Efficiency Divide the 60 into 4 lots of 15 each Give 15 to each of A B and C Hold back 15 Can one person be made better off without making anyone else worse off Yes e g give the last 15 to someone or give some of the last 15 to everyone Why can the welfare of at least one person be improved without the other two people Because the original allocation of the 60 created Economic Efficiency Divide the 60 into 4 lots of 15 each Give 15 to each of A B and C …