Unformatted text preview: Lecture 8 Lecture Mutual Gains from Trade Mutual We rely on other people to produce things We we want: we We are not forced to rely on others. Why do we voluntarily rely on others Why voluntarily through the market process? through We must answer this question: What What are the gains from mutually beneficial exchange? beneficial Mutual gains—Simple Example Mutual You buy food from a grocer because she is willing to sell to you at You a price that is: price 1) less than the value you place on the good, and/or 2) less than your costs of producing it yourself Therefore, you gain from shopping at grocer (consumer surplus) Grocer sells to you. You are willing to pay a price that is: 1) more than the cost of producing the good, and/or 2) more than the seller’s next best alternative Therefore, grocer gains from selling to you (producer surplus) We are joined together by mutual gains through market exchange The consumers’ perspective The Look at demand side of market and ask: What is the total value in use What to consumers of the quality Q*? to It is the total area under demand It curve from 0 to Q* (OABQ*) curve People usually do not have to give up all of this because suppliers will because deliver at a price of P* deliver Price A B P* Demand O Q* Quantity What Will the Price Be? What Price and value may have little relationship. -- Suppose you have a treasure chest with $10 -million in it and you know you must get it open quickly or you lose the money. How much would you be willing to pay for a $5 tool to let you break the chest open? break The difference in value to a user and price paid in The exchange is consumers’ surplus. exchange Consumer surplus Consumer The gains from trade going to consumers:
Price A P* B Demand 0 Q* Quantity Total use value (ABQ*0) minus Total expenditures (P*BQ*0) equals Consumer surplus (ABP*) The producers’ perspective The
Look at supply side of market and ask: What is the total cost to producers of the quantity Q*?” of Three equal descriptions are: 1. minimum you would accept to 1. produce Q* rather than Q=0 produce 2. sum of the marginal costs 2. from 0 to Q* from 3. area under the supply curve 3. from 0 to Q* from Producers usually do not have Producers to settle for MC, because demanders will pay a price of P* demanders Price Supply = MC P* B 0 Q* Quantity Producer surplus Producer
The gains from trade going to the producer: Total revenue (P*BQ*0) Minus Total costs (0CBQ*) [Costs must be recovered or no production.] Total must Equals Producer surplus (P*BC) Price S = MC B P* C 0 Q* Quantity Putting It All Together Putting
Price A P* B D 0 Q* Quantity Demand Price A P* C 0 B D Market S P* C Q* Quantity B Price Supply S Q* Quantity 0 There are gains to suppliers and demanders — room for bargaining. Who gets producer and consumer surplus? Area ABC is up for grabs! ...
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This note was uploaded on 12/21/2010 for the course BUSA 5311 taught by Professor Miners during the Fall '07 term at UT Arlington.
- Fall '07