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Week 5 Competitive markets

Week 5 Competitive markets - Competitive Markets(TF Chapter...

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1 Competitive Markets (TF Chapter 7)
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2 Last week… Utility and profit Marginal benefit and the demand curve Marginal cost and the supply curve Consumer and producer surplus An efficient market maximises consumer and producer surplus
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3 Today’s Agenda Why are competitive markets efficient? Sources of inefficiency (market failure) Deadweight loss The effects of a price floor and a price ceiling The effects of taxes and subsidies The incidence of a tax and elasticity Deadweight loss and elasticity
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4 The Invisible Hand Adam Smith - Wealth of Nations in 1776 A participant in a competitive market is “led by an invisible hand to promote an end which was not part of his intention.”
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5 Producer surplus Consumer surplus Quantity (thousands of pizzas per day) 0 5 10 15 20 Price (dollars per pizza) S 5 10 15 20 25 D An Efficient Market for Pizza
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6 Efficiency requires… 1. MB = MC for the last item produced 2. MC of a good should be equal for every producer 3. MB of consuming the good should be equal for all consumers
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7 Market Efficiency Recall: CS = MB – P PS = P – MC Total Surplus = CS + PS As a result: TS = MB - MC
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8 Market Efficiency Total surplus is the value to consumers minus the cost to producers. Total surplus is maximised at the equilibrium market price Goods and services are produced by the firms with the lowest opportunity costs of production… …and are consumed by buyers with the greatest willingness to pay for them
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9 Pareto Efficiency An outcome is Pareto efficient if it is not possible to make someone better off without making someone else worse off.
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10 Deadweight Loss (DWL) Deadweight loss is the decrease in consumer and producer surplus that results from an inefficient allocation of resources
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11 Quantity (thousands of pizzas per day) 0 5 10 15 20 Price (dollars per pizza) S 5 10 15 20 25 D Underproduction Efficient output If output is reduced to 5,000 Deadweight loss
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12 Deadweight loss Quantity (thousands of pizzas per day) 0 5 10 15 20 Price (dollars per pizza) D S 5 10 15 20 25 Overproduction If output is increased to 15,000 pizzas
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13 Sources of Inefficiency (that we will discuss today) Price controls Price ceilings Price floors Taxes and subsidies
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14 Sources of Inefficiency (that we will discuss later) Quotas A quota is a restriction on the maximum quantity a firm can produce and sell e.g. an import quota Monopoly A monopolist restricts output and raises price relative to a competitive firm
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