valuing_inputs.article

valuing_inputs.article - Valuing Project Inputs Traded in...

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Unformatted text preview: Valuing Project Inputs Traded in Markets Perfectly Elastic Supply or Small Project If the supply curve for an input is perfectly elastic and price equals marginal cost (ie, no monopoly power distorting the market) there are no taxes distorting the market there are no externalities distorting the market we can use the market price as the marginal social cost of using the input Consider a project that uses q units of an input draw from a market with a perfectly elastic supply curve no distortions, where D is the market demand for the input without the project S is the market supply for the input, which re ects the marginal costs of production The project increases demand for the input by q units at every price; ie, the demand curve to the right by q units $/unit Quantity D q q' q 1 S = MC q' D + P In this situation, the amount spent purchasing the input re ects the social opportunity cost of the resources used to produce it s Remark: Many input markets inputs have supply curves that relatively at, so it's often reasonable to assume that the expenditures for project inputs equal their social opportunity costs if the market is undistorted Econ 370 Lecture 6: page 1 The observed market price also re ects the marginal social cost if the input is traded in a perfectly competitive market with an upward-sloping supply curve (ie, elastic supply) as long as the project does not cause the market price to change $/unit Quantity P P 1 q S D + q' D s Remark: A small project means the amount of the input a project uses is small relative to the amount currently being traded in the market. So the project will have a negligible e ect on the equilibrium price of the input even if the input supply function is upward sloping (ie, the project results in only a small rightward shift of the demand curve in the input market). In contrast, a large project uses enough of the input to have an appreciable e ect on the price of the input Econ 370 Lecture 6: page 2 Inelastic Supply If a project uses q units of an input with a perfectly inelastic supply curve (eg, land), the project raise the price and thereby reduces the amount of land used by others by q D Price Quantity P 1 P q 1 q q' P R S D + q ' In the previous example, the agency carrying out the project buys q units of land the price before the project is P the price after the project is P 1 (this is the price that the agency will probably have to pay to obtain all the land it wants) P R is the reservation or choke price (ie, the price at which demand falls to zero) So the social opportunity cost of the land used by the project is P q + 1 2 q ( P 1- P ) = P q + 1 2 q P 1- 1 2 q P = 1 2 P q + 1 2 q P 1 = P + P 1 2 q s Remark: Notice that the amount paid to acquire the land, P 1 q , is greater than the social opportunity cost of using the land P 1 q P + P 1 2 q Econ 370 Lecture 6: page 3 Elastic Supply and Large Project If project draws a large amount of an input from a market with an upward sloping supply, it...
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valuing_inputs.article - Valuing Project Inputs Traded in...

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