Efficiency+of+Markets - Efficiency of Markets...

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Efficiency of Markets
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2 Welfare Economics Allocation of resources refers to: how much of each good is produced which producers produce it which consumers consume it Welfare economics studies how the allocation of resources affects economic well-being. First, we look at the well-being of consumers.
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3 Willingness to Pay (WTP) A buyer’s willingness to pay for a good is the maximum amount the buyer will pay for that good. WTP measures how much the buyer values the good. name WTP Robert Plant $250 Jimmy Page 175 John Paul Jones 300 John Bonham 125 Example: 4 buyers’ WTP for an iPod
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4 WTP and the Demand Curve Q: If price of iPod is $200, who will buy an iPod, and what is quantity demanded? A: Plant & Jones will buy an iPod, Page & Bonham will not. Hence, Q d = 2 when P = $200. name WTP R. Plant $250 J. Page 175 J. P. Jones 300 J. Bonham 125
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5 WTP and the Demand Curve Derive the demand schedule: 4 Bonham, Page, Plant, and Jones 0 – 125 3 Page, Plant, and Jones 126 – 175 2 Plant, Jones 176 – 250 1 Jones 251 – 300 0 nobody $301 & up Q d who buys P (price of iPod) name WTP Plant $250 Page 175 Jones 300 Bonham 125
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6 $0 $50 $100 $150 $200 $250 $300 $350 0 1 2 3 4 WTP and the Demand Curve P Q d $301 & up 0 251 – 300 1 176 – 250 2 126 – 175 3 0 – 125 4 P Q
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7 $0 $50 $100 $150 $200 $250 $300 $350 0 1 2 3 4 About the Staircase Shape… This D curve looks like a staircase with 4 steps – one per buyer. P Q If there were a huge # of buyers, as in a competitive market, there would be a huge # of very tiny steps, and it would look more like a smooth curve.
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8 $0 $50 $100 $150 $200 $250 $300 $350 0 1 2 3 4 WTP and the Demand Curve At any Q , the height of the D curve is the WTP of the marginal buyer , the buyer who would leave the market if P were any higher. P Q Jones’ WTP Plant’s WTP Page’s WTP Bonham’s WTP
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9 Consumer Surplus (CS) Consumer surplus is the amount a buyer is willing to pay minus the amount the buyer actually pays: CS = WTP P name WTP Plant $250 Page 175 Jones 300 Bonham 125 Suppose P = $260. Jones’ CS = $300 – 260 = $40. The others get no CS because they do not buy an iPod at this price. Total CS = $40.
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10 $0 $50 $100 $150 $200 $250 $300 $350 0 1 2 3 4 CS and the Demand Curve P Q Jones’ WTP P = $260 Jones’ CS = $300 – 260 = $40 Total CS = $40
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11 $0 $50 $100 $150 $200 $250 $300 $350 0 1 2 3 4 CS and the Demand Curve P Q Jones’ WTP Plant’s WTP Instead, suppose P = $220 Jones’ CS = $300 – 220 = $80 Plant’s CS = $250 – 220 = $30 Total CS = $110
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12 $0 $50 $100 $150 $200 $250 $300 $350 0 1 2 3 4 CS and the Demand Curve P Q The lesson: Total CS equals the area under the demand curve above the price, from 0 to Q .
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13 0 10 20 30 40 50 60 0 5 10 15 20 25 30 P Q $ CS with Lots of Buyers & a Smooth D Curve The demand for shoes D 1000s of pairs of shoes Price per pair At Q = 5(thousand), the marginal buyer is willing to pay $50 for pair of shoes. Suppose P = $30.
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