MSU EC 201 - Chap4 (24 pages)

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Chap4



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Chap4

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Pages:
24
School:
Michigan State University
Course:
Ec 201 - Introduction to Microeconomics
Introduction to Microeconomics Documents
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Krugman and Wells Chapter 4 Steven J Haider EC201 Spring 2015 Overview Chap 2 the US and Brazil could benefit from trade They each specialized in producing the good in which they had a comparative advantage Both gained from trade even though the US had an absolute advantage in producing both goods Chap 3 we learned how competitive markets work Participating in the market is trading you use money perhaps earned from your job to buy trade for other goods This chapter Measure the benefits from the existence of markets a type of trade Consumer Producer and Total Surplus Markets are efficient Caution we re now using our supply demand model which will only make sense if you know how the model works Do problems p2 Willingness to Pay and Demand Willingness to pay maximum price a person is willing to pay for a good Example willingness to pay for a used textbook Assume individuals are willing to buy only one Assume individuals buy when price willingness to pay by convention and then derive a market demand curve We did this for the muffin market already Note step function because there are only five consumers p3 Calculating consumer surplus If the price were 30 only Aleisha Brad and Claudia would buy Individual consumer surplus WtP P for each individual Market consumer surplus sum of individual CS p4 Graphical representation of CS CS the area between the demand curve and the price Fig 4 2 graphical representation of textbook example Fig 4 3 graphical representation of CS more generally Note you will need to know how to calculate the area of triangles and squares See Chap 2 appendix for refresher p5 Changes in CS textbook example Suppose price drops from 30 to 20 How does CS change We could do this with a table New CS 39 25 15 5 84 Change in CS 84 49 35 NOTE there are gains to original buyers and new buyer s 20 39 20 25 20 15 20 5 p6 Changes in CS textbook example Suppose price drops from 30 to 20 How does CS change But we ll generally work with the graph Change 30 20 x 3 25 20 x 1 30 5 35 p7 NOTE Common Mistake Change in CS is the blue area Refers to the difference between CS in two situations This use of English is standard Change in CS vs New CS vs CS Changes to p8 Changes in CS iPad example Suppose iPad prices dropped from 2000 to 500 Gains to original buyers Area of a rectangle 2000 500 x 200 000 300m Gains to new buyers Area of a triangle 2000 500 x 800 000 x 600m Total change in CS with price drop 900m p9 And now the producer side Consumer Surplus vs Producer Surplus Willingness to pay vs Willingness to sell Market individual demand vs Market individual supply Individual CS vs Individual PS Area below demand vs Area above supply Every component has a direct analog so I will go a little more quickly for these definitions p10 Willingness to Sell and Supply Willingness to sell minimum price a seller is willing to accept for a good The book defines this as cost but I prefer WtS Example willingness to sell a used textbook Assume individuals sell when price willingness to sell We can use this information to derive a market supply curve We did this with the muffin example as well There are few individuals so we again have a step function Willingness to sell p11 Calculating PS Calculating PS We can use a table or the graph Andrew Betty and Carlos are willing to sell but not Donna and Engelbert Market PS is sum of individual PS For graph calculate area between price and supply curve p12 More generally PS is the area between price and the supply curve p13 Changes in PS p14 Gains from trade in a market Total surplus CS PS Total surplus the total gains from trade The existing picture is the gains from a competitive market p15 Competitive Markets Are Efficient The much celebrated result Key word competitive Suppose markets are competitive then the equilibrium outcome is efficient Efficiency no one can be made better off without someone being made worse off In case at hand efficiency maximizes total surplus Three thought experiments to see why the competitive equilibrium is efficient Try to reallocate consumption among consumers Try to reallocate sales among sellers Try to change quantity transacted p16 Efficiency of Competitive Equilibrium Try to change the quantity transacted Total surplus will decline if you move in either direction Try to reallocate among consumers Move book from A to B Consumer surplus declines Try to reallocate among sellers Producer surplus declines Bottom line no trades can be made to make anyone better off p17 Another example muffins Producer surplus Value to the producers for participating in the market Only those who s minimum price is less than equilibrium price will sell For individual price WtS Player S s willingness to sell 1 1 00 2 50 1 50 2 3 69 2 50 3 1 99 2 50 51 4 4 75 2 50 5 2 75 2 50 Total Equilibrium price S s individual PS 2 01 p18 Another example muffins Consumer surplus Value to the consumers for participating in the market Only those who s maximum price is more than equilibrium price will buy For individual WtP price Player D s willingness to pay 1 1 50 2 50 2 2 25 2 50 3 2 75 2 50 0 25 4 4 25 2 50 1 75 5 1 00 2 50 Total Equilibrium price D s Individual CS 2 00 p19 View of efficiency from book Trading 2 muffins at a market clearing price of 2 50 maximizes total surplus CS 2 01 PS 2 00 TS 4 01 You can check this make any additional trades you would like and see if the surplus increases Example if we make D1 buy he pays 2 50 for a muffin he values at only 1 50 he d be worse off Example if we make S2 sell she gets 2 50 for a muffin she values at 3 69 she d be worse p20 Another view of efficiency Player D s willingness to pay Equilibrium price S s willingness to sell 1 1 50 2 50 1 00 2 2 25 2 50 3 69 3 2 75 2 50 1 99 4 4 25 2 50 4 75 5 1 00 2 50 2 75 Who got the muffins The five individuals with the highest valuations Bottom line those who valued the muffins most ended up with the muffins regardless of initial allocation Why Transactions were allowed to freely occur This is the sense in which free markets are efficient p21 Another view of efficiency Result from previous slide the 5 who valued the muffins most ended up with the muffins if we allowed individuals to freely trade in the market In other words the competitive market does the same thing as if a dictator simply allocated the muffins to those with the …


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