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UMass Amherst ECON 103 - class 15 Market equilibrium Fall 2014

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Slide 1Slide 2Slide 3Slide 4Slide 5Slide 6Slide 7A monopoly lowers consumer surplus in two waysSlide 9Slide 10Slide 11Slide 12Slide 13Pareto Optimality is only about efficiencySlide 15Pareto Optimality is trivialIn case you forgotSlide 18Slide 19Slide 20Slide 21Slide 22Slide 23Slide 24Slide 25Slide 26Slide 27Apple continues to profit from IPodI got my IPad for free!Slide 30Slide 31Slide 32Slide 33Slide 34Slide 35Slide 36Slide 37Slide 38Slide 39Slide 40Slide 4108:57:30 AMCaseyLacey08:57:30 AMFreedom is just another word for nothing left to lose.And nothin' ain't worth nothin' but it's free.08:57:30 AMJanis Joplin has absolutely nothing to do with this course.So much the worse for us.Market Equilibriumand the wonders of perfect competitionIdeological concepts?08:57:30 AMBig IDEASIn a perfectly competitive market, equilibrium in price and quantity maximizes the sum of consumer and producer surplus.If a perfectly competitive market maximizes social welfare, then government regulations must make things worse.But markets are never perfectly competitive; and they always have problems: externalities, maldistribution of income, monopolistic behavior..08:57:30 AMSocial Welfare is the Sum of Consumer and Producer SurplusThe difference between costs (sum of MC) and benefits (sum of MU).08:57:30 AMPerfect competition and market equilibrium: Enjoy it if you canSupply = demand and everyone is as happy as possible. They might be happier if costs were lower . . . But this is as good as it gets in this world.A monopoly lowers consumer surplus in two waysPriceQDemand (MU)MRMCIt reduces output by not producing where MU>MC, causing a loss of both consumer and producer surplus.It redistributes surplus from consumers to producers by raising prices.LostTransferred from Consumers to producerMonopoly reduces total surplusIt doesn’t produce some units where MU>MC.It also redistributes consumer surplus to producers.M o n o p o l y a n d P e r f e c t C o m p e ti ti o n$ 0 . 0 0$ 2 . 0 0$ 4 . 0 0$ 6 . 0 0$ 8 . 0 01 2 3 4 5 6 7 8 9 1 0Q u a n ti t yPriceM C D e m a n d P r i c e A v e r a g e t o t a l c o s t s M R M o n o p o l y p r i c eR e d u c e d o u t p u tL o s t w e l f a r eR e d i s t r i b u t e d w e l f a r ePerfectly Competitive markets maximize net welfare. If and only if:1. Externalities are included in MC;2. Income is distributed fairly, so that demand reflects real social MU;3. There is no nonmarket production;4. Perfect competition, producers sell at MC=MU.08:57:31 AMUnder these extreme circumstances,We will be in EQUILIBRIUMPrices will be such that no one wants to produce more, or consume less.There are no opportunities to increase welfare by changing the output level.08:57:31 AMIn perfect competition, market equilibrium, the right amount is producedWhere MU> MC: produce.Where MU<MC: don’tThis happens spontaneously, no need for inefficient social planners!So why do we get junk like this?08:57:31 AMIn equilibrium:Everyone is satisfied with their situation given the prices they face.No one could be made better off except by making someone else worse off.We owe this way of thinking to Vilfredo Pareto (1848-1923).08:57:31 AMPareto Optimality is only about efficiencyAs long as we are efficient, produce as much as possible with existing technology and resources, Pareto has nothing more to say.Can you evaluate efficiency without regard for the distribution of income?Pareto optimality is about being on the production possibility frontier, as if any point is of equal value.08:57:31 AMIs Paris Hilton’s bejeweled dog collar equal to these children’s food?08:57:31 AMPareto Optimality is trivialIf one person had everything, it would be Pareto Optimal because no one could be made better off without taking from him.Or her.08:57:31 AMIn case you forgotHe admits that he has about $250 million.08:57:31 AMThey don’t have a car to live in.In the orthodox world, market competition will make everything as good as it can be. People could be happier. If they were richer, younger, prettier. Or if they lived in Paris. Or Amherst.But life is hard.08:57:31 AMThese are pretty strong assumptionsEasily violatedExternalitiesNonmarket productionIncome DistributionMonopoly08:57:31 AMParis Hilton versus orthodox welfare economics: She wins. Of course.1. She has inherited money, so she distorts consumer demand leading producers to make more of what she wants and less of what others want.2. She works at home caring for needy puppies and this work is not included in our social product.3. Her alcohol consumption produces negative externalities on others driving in LA.4. She is a monopolist – the only one of her celebrity status.08:57:32 AMPerfect competition rewards productivity and innovationWith better technology, productive firms can earn extra profits – rents on their innovations.08:57:32 AMWith perfect competition, consumers benefit from innovation and technological progress•First innovator makes huge profits.•These encourage others to copy to get a share of the profits.•New entrants drive down prices to the new, lower cost of production, eliminating super profits.•Consumers benefit.08:57:32 AMOnce one company innovates, others follow to earn super profitsThey drive down prices until extra rents disappear.Consumers benefit from cheap good stuff.12:52:0108:57:32 AMOops, that was a little too interesting visually. Try this.12:52:0208:57:32 AMThis happened to XeroxThis happened to Xerox. In the early 1960s, Xerox made super profits on its photocopiers. So much that the company president commissioned a musical.A Dream of DestinyWho is the outfit that gives you the breaks - Long on the profits and short on mistakes -Who's copy business is all that they claim?Why Xerox! Xerox! Xerox's the name! Xerox! Xerox! Xerox's the name!- "Xerox's the Name", from Take It From Here, Xerox, 196312:52:0208:57:32 AMXerox invented the office copierIn the 1960s, its 914 plain paper copier was called the “most successful product ever marketed in America.” Profits were huge.In 1970, IBM introduced a copier, followed by Kodak, Ricoh, Canon . . . Xerox’s market share fell from 85% to 40% and down. Profits fell for everyone. By the 1990s, Xerox was laying off workers.12:52:0208:57:32 AMAnother Example: AppleApple invented the home computer and made a ton of money.Soon others (IBM) entered the business. Apple’s market share and profits disappeared.Until the IPod.12:52:0208:57:32 AMApple


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