101+Class+08+W2009 - Principles of Economics I Economics...

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Unformatted text preview: Principles of Economics I Economics 101 Section 400 Class 8 Readings Today and Monday Chapter 4 Problem Set available on line No quiz this week Material for Q6 and Q7 will be covered in Monday's lecture Written answers for those questions will be made available on CTools Exam coming up next week Class 8 2 2/4/2009 Exam Details Wednesday, Feb 11, 8:00pm 10:00pm Location: TBA No lecture that day Review Sessions: Office Hours Sat & Sun, 4:00 6:00, AH Auditorium C Thurs, 10:00 11:30, Lorch 102 Fri, 9:00 10:30, Lorch 104 Sat, 12:00 2:00, AH G127 Mon, 10:30 12:00, Lorch M109** Mon, 4:00 5:30, Lorch 116 Tues, 10:00 11:30, Lorch 104 Wed, 10:30 12:00, Lorch M109** Wed, 12:00 1:30, Lorch 102 Class 8 3 2/4/2009 Exam Details Around 110 minutes long 30 multiple choice questions 4 points for correct answer 1 point for no answer 0 points for incorrect answer No calculators or other electronic devices Practice Exam available this evening Class 8 4 2/4/2009 Market Outcomes and Efficiency Suppose the market allocates resources as described by the Supply and Demand model Is it possible to reallocate resources in such a way that we make some people better off without harming others? If so, should we produce more or less of the good? Should we distribute those goods that are produced differently? Class 8 5 2/4/2009 Social Surplus Method for measuring the net benefits of allocating resources in any given way Social surplus is the difference between: 1. The value of other goods consumers were prepared to give up in order to obtain the goods produced; and 2. The value of other goods the economy had to give up in order to produce those goods 2/4/2009 Class 8 6 Consumers' valuation of goods produced $/unit Gross consumer valuation of Q* units Demand Marginal Valuation Q* 2/4/2009 Class 8 Units of output 7 Opportunity cost of goods produced $/unit Supply Marginal Opportunity Cost Gross opportunity cost of Q* units Q* 2/4/2009 Class 8 Units of output 8 Social Surplus $/unit Gross consumer valuation of Q* units Marginal Opportunity Cost Additional social Consumer surplus from the valuation of the marginal unit Marginal Valuation Opportunity cost of the marginal unit Gross opportunity cost of Q* units Q* 2/4/2009 Class 8 Social Surplus Units of output 9 Social Surplus and Pareto Efficiency In the previous example, we had Q* units produced Showed that producing a marginal unit could increase social surplus Explicitly, the marginal unit provides benefits to somebody that exceed the opportunity cost of producing the good Suggests that this allocation is not efficient Efficiency demands that social surplus be maximized 2/4/2009 Class 8 10 Maximizing Social Surplus Possible to increase social surplus if the value of the marginal unit exceeds the cost of that unit i.e. MV > MC Conclude that we should increase output of this good until MV = MC Class 8 11 2/4/2009 Social Surplus $/unit Gross consumer valuation of Q units MC Social surplus MV Consumer valuation of the marginal unit Lost social surplus Q Q* 2/4/2009 Class 8 Opportunity cost of the marginal unit Gross opportunity cost of Q units Units of output 12 Efficient Output Level Efficient allocation of resources demands Social Surplus is maximized MV = MC If producers and consumer face the same price, and Consumers purchase Q such that P = MV Producers produce Q such that P = MC Then market clears and output level is efficient 2/4/2009 Class 8 13 The Efficiency of the Market $/unit Consumer surplus MC Supply Social surplus P* Producer surplus MV Demand Q* 2/4/2009 Class 8 Units of output 14 Beware... The efficiency of the market is a powerful and important result More important to understand it than simply to know it Implicit in the result are a series of hidden assumptions that may or may not be satisfied in any given market environment Much of the course will be spent talking about those conditions and identifying when the result applies and when it doesn't Class 8 15 2/4/2009 What happens when the market is unable to operate freely? Prices are unable to direct resources efficiently Observe inefficient allocation of resources 1. Price controls Two main examples: Price ceiling Price floor Examples: rent control, NBA cap on rookie salaries Example: minimum wage legislation, agricultural price supports 2. Price distortions 2/4/2009 Taxes Subsidies Class 8 16 The price floor Price support regulation for market where the equilibrium price would be deemed "too low" Example: Minimum wages Example: Agricultural price supports Illegal to pay less than the minimum wage Undesirable to sell for less than the minimum wage: the regulator promises to purchase any quantity at the regulated price Class 8 17 2/4/2009 Minimum Wage w Transfer from Extra Lost W consumers to min Producer producers Consumer Surplus Surplus W* Unemployment Labor Supply Deadweight Loss Lost Producer Surplus Labor Demand Ld L* Ls Class 8 2/4/2009 L 18 Agricultural Price Support P Net effect on consumer and Increased Producer Surplus Government purchase producer surplus Supply Psupport P* Lost consumer surplus Deadweight Loss (if Deadweight Loss (if the govt purchase is the govt purchase is distributed to the not distributed to the public) public) Demand Taxes Raised Qd Q* Qs Q 2/4/2009 Class 8 19 Price ceiling: Rent Control Rent control takes various forms Simple case ceiling imposed on prices To charge higher rents is illegal Rent control is supposed to be a benefit to renters Is it? 2/4/2009 Class 8 20 Rent Control $/apartment Underestimate of Lost consumer surplus Deadweight loss P P* P Supply Price Ceiling Lost Increased producer consumer surplus surplus Price Ceiling Demand Q Q* Class 8 # of Apartments 21 2/4/2009 Price controls Preventing prices from adjusting to equilibrium levels distorts the market Generates inefficiencies Lesson: if efficient allocation of resources is your goal; if conditions are satisfied that ensure market outcomes are efficient; then don't interfere with the way prices are determined Class 8 22 2/4/2009 ...
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This note was uploaded on 05/16/2010 for the course ECON Section 40 taught by Professor Hogan during the Winter '09 term at University of Michigan.

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