4-EfficiencyofMarkets

4-EfficiencyofMarkets - Consumers Producers and Efficiency...

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Consumers, Producers and Efficiency of Markets (Chapter 7) Principles of Microeconomics, Mankiw et al. 5th Cdn Edition Introduction to Microeconomics (ECO 1104F) University of Ottawa
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Seeking answers to these questions 1. What is consumer surplus? How is it related to the demand curve? 2. What is producer surplus? How is it related to the supply curve? 3. Do markets produce a desirable allocation of resources? Or could the market outcome be improved upon?
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Welfare Economics Welfare economics the study of how the allocation of resources affects economic well-being The allocation of resources refers to: how much of each good is produced which producers produce it which consumers consume it First, we look at the well-being of consumers.
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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 Anthony $250 Chad 175 Flea 300 John 125 Example: 4 buyers’ WTP for an iPod
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WTP and the Demand Curve If the price of iPods is $200, who will buy an iPod, and what is the quantity demanded? & John will not. Hence, Qd = 2 when P = $200. Name WTP Anthony $250 Chad 175 Flea 300 John 125
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WTP and the Demand Curve Derive the demand schedule: 4 John, Chad, Anthony, Flea 0 – 125 3 Chad, Anthony, Flea 126 – 175 2 Anthony, Flea 176 – 250 1 Flea 251 – 300 0 nobody Qd Who buys? P (price of iPod) Name WTP Anthony $250 Chad 175 Flea 300 John 125
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WTP and the Demand Curve P Qd $301 & up 0 251 – 300 1 176 – 250 2 126 – 175 3 0 – 125 4 P Q $0 $50 $100 $150 $200 $250 $300 $350 0 1 2 3 4
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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, there would be a huge # of very tiny steps , and it would look more like a smooth curve. $0 $50 $100 $150 $200 $250 $300 $350 0 1 2 3 4
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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 Flea’s WTP Anthony’s WTP Chad’s WTP John’s WTP $0 $50 $100 $150 $200 $250 $300 $350 0 1 2 3 4
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Consumer Surplus (CS) The amount a buyer is willing to pay minus what the buyer actually pays: CS = WTP PRICE Name WTP Anthony $250 Chad 175 Flea 300 John 125 Suppose P = $260. Flea’s 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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CS and the Demand Curve P Q Flea’s WTP P = $260 Flea’s CS = $300 – 260 = $40 Total CS = $40 $0 $50 $100 $150 $200 $250 $300 $350 0 1 2 3 4
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CS and the Demand Curve P Q Flea’s WTP Anthony’s WTP Instead, suppose P = $220 Flea’s CS = $300 – 220 = $80 Anthony’s CS = $250 – 220 = $30 Total CS = $110 $0 $50 $100 $150 $200 $250 $300 $350 0 1 2 3 4
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P Q The lesson: Total CS equals the area under the demand curve above the price, from 0 to Q . $0
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4-EfficiencyofMarkets - Consumers Producers and Efficiency...

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