Transcript Some More Micro-Foundations for CBA

Some More Micro-Foundations for
CBA
Consumer Surplus
• Consumer Surplus
– The difference between what consumers would
have been willing to pay and what they actually
did pay.
– Economic surplus gained by the buyers of a
product.
– Measured by the cumulative difference (adding up
over all consumers) between their reservation
price for each unit of the good, and the price they
pay .
LO3: Graphical
representation of consumer
surplus, producer surplus,
Ch7-2
© 2012 McGraw-Hill
Ryerson Limited
Producer Surplus
• Producer Surplus
– The difference between what producers do get for
output and the minimum price they would have
been willing to accept.
– Economic surplus gained by the sellers of a
product.
– Measured by the cumulative difference (adding up
over all producers) between the price they receive
and their reservation price for each unit of the
good.
LO3: Graphical
representation of consumer
surplus, producer surplus,
Ch7-3
© 2012 McGraw-Hill
Ryerson Limited
Consumer and Producer Surplus
Consumer surplus
Producer surplus
LO3: Graphical
representation of consumer
surplus, producer surplus,
Ch7-4
S
D
© 2012 McGraw-Hill
Ryerson Limited
: How Excess Demand Creates an Opportunity for a Surplus-Enhancing
Transaction
S
$0.75
1.25
$0.25
D
At a market price of $1/litre, the most intensely dissatisfied buyer is willing to pay $2
for an additional litre, which a seller can produce at a cost of only $1. If this buyer
pays the seller $1.25 for the extra litre, the buyer gains an economic surplus of $0.75
and the seller gains an economic surplus of $0.25.
© 2012 McGraw-Hill
Ch7-5
Ryerson Limited
How Excess Supply Creates an Opportunity for a Surplus-Enhancing
Transaction
S
1.75
$0.25
$0.75
D
Market Equilibrium and
Mutually Beneficial
Exchange
Ch7-6
At a market price of
$2/litre, dissatisfied sellers
can produce an additional
litre of milk at a cost of only
$1, which is $1 less than
a buyer would be willing
to pay for it. If the buyer
pays the seller $1.75 for an
extra litre, the buyer gains
an economic surplus of
$0.25 and the seller gains an
economic surplus of $0.75.
© 2012 McGraw-Hill
Ryerson Limited
Public vs. private goods
Private goods – demand sums
horizontally
MB is the marginal
social benefit
Consumer A
demand falls to 0
Public goods – demand sums
vertically
Valuation in efficient markets – no effect on price.
• Increase in supply has no effect on
price.
• Gross social benefits = net government
revenue generated by the program +
change in social surplus.
• Supply shift to the right (publicly
provided good) increases benefits to
consumers (S → S+q’).
− The cost to the consumer of the new
amount (q’) is offset by the benefits of
consuming more
− Only benefit is the increased revenue
to supplier – government or (abq1q0)
• Supply shifts due to cost reduction
which increases benefits to producers.
− Benefit is the increase in producer
surplus (abde)
Valuation in efficient markets – supply reduces price
• Downward sloping demand
• Increase in supply cases price to fall and
change in social surplus is abc.
Three scenarios
a. If goods are distributed free the
increase in consumer surplus is cbq1q0
and the total is area abc + cbq1q0
b. If good goes to consumers without
charge, some receive the product
who would not have purchased at P1.
c. Assume q due to increase in supply
arises from cost reduction
−increase in consumer surplus is
P0P1ab
−change in producer surplus is
P0ae-P1bd or ecbd-P0abP1
• Note that that the last scenario is the
most realistic.
Valuation in inefficient markets – monopoly power
reduces price
P0
X
• Monopoly – market demand is the revenue
schedule
• Marginal revenue is lower than the average
revenue (MA<AR).
• Profit maximization at MC=MR
• Consumer surplus – P0Pma
• Producer surplus – Pmabx
• The social surplus under monopoly is P0abx
• The social surplus under competition is P0cX.
• The deadweight loss is the reduction in social
surplus due to monopoly.
Natural Monopoly
• Always defined by falling average cost over the
region where demand exists for any price >0
• Typical in capital intensive industries, or
industries with high entry/exit barriers, and
knowledge barriers
• Policies to deal with natural monopoly
− Ignore and accept deadweight loss
− Regulate (price so that price set at AC =
AR)
− Regulate (price so that MC=AR)
− Allow free access (accept social cost that
demand exceeds marginal cost)
• Natural monopolies usually erode due to
technical change – high profits create incentives
to innovate.
• Policy may create temporary monopolies to
induce innovation (e.g., pharmaceuticals).
Demand > 0, AC falling
Information asymmetry
• Present in every market
• Imbalance between information held by
sellers and buyers
− Buyers can have the edge in labour
markets (they know what the job truly
entails)
− Sellers (job applicants) can have the
edge if they fabricate experience.
• Where sellers have information, the
presumption is that the demand would fall
as addition product/service attributes
become known to the buyer (Du → Di).
• The information asymmetry transfers PuPica
to the seller from the buyer, and the
deadweight loss is acd.
• Policies
− Caveat venditor and caveat emptor
− Private market (Consumer Reports)
− Public provision of information)
Negative Externality
Externalities create a divergence of marginal
private and marginal social costs.
• Negative externality MSC > MPC
• Positive externality MSC < MPC
• Negative externality reduces consumer and
producer surplus
• S# - S* = social costs = WTP to avoid the costs.
• Market will under price good/service and too
much is produced.
• Taxation is the standard policy with the level set
“t”, price shifts to P# and quantity drops to Q#.
Positive externalities work in reverse, subsidies to
increase consumption.
Benefits
Costs
Consumer
A+B
Producer
E+F
Third Parties
B+C+F
Gov. Rev.
A+E
Social Benefit
C