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CHAPTER 16 - PHALL-82241 PINDYCK CHAPTER 16 page 3 of 13...

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Unformatted text preview: PHALL-82241 PINDYCK CHAPTER 16 page 3 of 13 FIGURE 16.1 Two Interdependent Markets: (a) Movie Tickets and (b) DVD Rentals Price ($) * SM 6.82 6.75 SM 6.35 * DM 6.00 � DM Price ($) SV 3.58 3.50 3.00 D* V D′ V DM QM Q ′′ Q* QM � MM (a) Number of movie tickets DV QV QV Q* �V Number of DVDs (b) When markets are interdependent, the prices of all products must be simultaneously determined. Here a tax on movie tickets shifts the supply of movies upward from SM to , as shown in (a). The higher price of movie tickets ($6.35 rather than $6.00) initially shifts the demand for DVDs upward (from DV to D_V ), causing the price of DVDs to rise (from $3.00 to $3.50), as shown in (b). The higher video price feeds back into the movie ticket market, causing demand to shift from DM to and the price of movies to increase from $6.35 to $6.75. This continues until a general equilibrium is reached, as shown at the intersection of and in (a), with a movie ticket of $6.82, and the intersection of and SV in (b), with a DVD price of $3.58. Fig 16-01.eps PHALL-82241 PINDYCK CHAPTER 16 page 4 of 13 FIGURE 16.2 Removing the Ethanol Tariff on Brazilian Exports (a) Million gallons 2500 Brazil Exports without Tariff 2000 1500 1000 Brazil Exports with Tariff 500 0 05 06 07 08 09 (b) 11 12 13 14 15 14 15 U.S. Ethanol Price with Tariff 2.1 Dollars per gallon 10 Year 2.0 1.9 1.8 U.S. Ethanol Price without Tariff 1.7 1.6 1.5 05 06 07 08 09 10 Year 11 12 13 If U.S. tariffs on ethanol produced abroad were to be removed, Brazil would export much more ethanol to the United States, displacing much of the more expensive cornbased ethanol produced domestically. As a result, the price of ethanol in the U.S. would fall, benefiting U.S. consumers. Fig 16-02.eps PHALL-82241 PINDYCK CHAPTER 16 page 5 of 13 FIGURE 16.3 Exchange in an Edgeworth Box 6C Karen’s Food 4F 3F 10F OK Karen’s Clothing James’s Clothing B 2C 4C +1C 1C –1F OJ James’s Food 6F 5C A 7F 10F 6C Each point in the Edgeworth box simultaneously represents James’s and Karen’s market baskets of food and clothing. At A, for example, James has 7 units of food and 1 unit of clothing, and Karen 3 units of food and 5 units of clothing. Fig 16-03.eps PHALL-82241 PINDYCK CHAPTER 16 page 6 of 13 FIGURE 16.4 Efficiency in Exchange 6C Karen ’s Food 10F OK D James’s Clothing C Karen ’s Clothing 3 UJ B 3 UK OJ James’s Food A 2 UK 1 UK U2 J U1 J 10F 6C The Edgeworth box illustrates the possibilities for both consumers to increase their satisfaction by trading goods. If A gives the initial allocation of resources, the shaded area describes all mutually beneficial trades. Fig 16-04.eps PHALL-82241 PINDYCK CHAPTER 16 page 7 of 13 FIGURE 16.5 The Contract Curve Karen’s Food OK G James’s Clothing Contract Curve F E OJ James’s Food The contract curve contains all allocations for which consumers’ indifference curves are tangent. Every point on the curve is efficient because one person cannot be made better off without making the other person worse off. Fig 16-05.eps Karen’s Clothing PHALL-82241 PINDYCK CHAPTER 16 page 8 of 13 FIGURE 16.6 Competitive Equilibrium 6C Karen’s Food 10F OK Price Line P James’s Clothing Karen’s Clothing C U2 J A 2 UK OJ 1 UK U1 J P′ James’s Food In a competitive market the prices of the two goods determine the terms of exchange among consumers. If A is the initial allocation of goods and the price line PP? represents the ratio of prices, the competitive market will lead to an equilibrium at C, the point of tangency of both indifference curves. As a result, the competitive equilibrium is efficient. Fig 16-06.eps 6C 10F PHALL-82241 PINDYCK CHAPTER 16 FIGURE 16.7 Utility Possibilities Frontier Karen’s Utility OJ L E F H G OK James’s Utility The utility possibilities frontier shows the levels of satisfaction that each of two people achieve when they have traded to an efficient outcome on the contract curve. Points E, F, and G correspond to points on the contract curve and are efficient. Point H is inefficient because any trade within the shaded area will make one or both people better off. Fig 16-07.eps page 9 of 13 PHALL-82241 PINDYCK CHAPTER 16 page 10 of 13 FIGURE 16.8 Production Possibilities Frontier Clothing (units) 60 OF B 1C B A C D 2C D 0 Enlarged Areas 1F 1F OC 100 Food (units) The production possibilities frontier shows all efficient combinations of outputs. The production possibilities frontier is concave because its slope (the marginal rate of transformation) increases as the level of production of food increases. Fig 16-08.eps PHALL-82241 PINDYCK CHAPTER 16 page 11 of 13 FIGURE 16.9 Output Efficiency Clothing (units) MRS = MRT 60 Production Possibilities Frontier 0 Indifference Curve C 100 Food (units) The efficient combination of outputs is produced when the marginal rate of transformation between the two goods (which measures the cost of producing one good relative to the other) is equal to the consumer’s marginal rate of substitution (which measures the marginal benefit of consuming one good relative to the other). Fig 16-09.eps PHALL-82241 PINDYCK CHAPTER 16 page 12 of 13 FIGURE 16.10 Competition and Output Efficiency Clothing (units) C1 1 1 PF /PC * * PF/PC A B C2 C* C U2 U1 0 F1 F * F2 Food (units) In a competitive output market, people consume to the point where their marginal rate of substitution is equal to the price ratio. Producers choose outputs so that the marginal rate of transformation is equal to the price ratio. Because the MRS equals the MRT, the competitive output market is efficient. Any other price ratio will lead to an excess demand for one good and an excess supply of the other. Fig 16-10.eps PHALL-82241 PINDYCK CHAPTER 16 page 13 of 13 FIGURE 16.11 The Gains from Trade Cheese (pounds) World Prices CB Pre-trade Prices B Exports A D CD U2 U1 WB Imports WD Wine (gallons) Without trade, production and consumption are at point A, where the price of wine is twice the price of cheese. With trade at a relative price of 1 cheese to 1 wine, domestic production is now at B, while domestic consumption is at D. Free trade has allowed utility to increase from U1 to U2. Fig 16-11.eps ...
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