Transcript Equilibrium and Efficiency in Competitive Markets or The Interaction

Review of Results from Double
Auctions
• 20 different markets
• 10 buyers and 10 sellers in each market
– the 5 buyers and 5 sellers on page 178-179
plus their clones
– Prediction: P = $13 and Q = 26
– results were very close to prediction
• For $6 increase in MC, the equilibrium
price P = $16 and equilibrium Q = 20
Properties of Competitive
Markets
• One price in the market which is the
equilibrium price P
• Each firm produces a quantity such that
MC equals the equilibrium price P
– Hugo, Mimi,...
• Each consumer buys a quantity such that
MB equals the equilibrium price P
– Maria, Ken,...
Are Competitive Markets
Efficient
• Definition (need to be careful)
• Pareto efficiency:
– a situation where it is impossible to make one
person better off without hurting another
person
Conditions for Pareto Efficiency
• marginal benefit equals marginal cost (for
last item produced)
• marginal cost of each good should be the
same for all producers
• marginal benefit of each good should be the
same for all consumers
Are the conditions satisfied for a
competitive market? Check ‘em
– first: MC = MB because equilibrium occurs at
the intersection of the demand (MB) curve and
the supply (MC) curve
– second: MB = P for each consumer, because
each consumer sets MB = P and because there
is a single equilibrium price P in the market
equilibrium
– third: MC = P for each firm, because each firm
sets MC = P and because there is a single
equilibrium price P in market equilibrium
Answer: YES! ALL THREE
CONDITIONS ARE SATISFIED
07_06
PRICE
Market supply
(derived from firms'
marginal costs)
Market demand
(derived from
consumers'
marginal benefits)
D
E
F
Too little
Efficient
Too much
QUANTITY
We can measure how well the
market works:
• Use producer and consumer surplus
• in an equilibrium of a competitive market
the sum of producer surplus and consumer
surplus is as large as possible
• OR, the marginal benefit less the marginal
cost of all items produced is as large as
possible
• Or, Deadweight Loss is eliminated
07_07
PRICE
Deadweight loss:
area A + B
Supply
A
Market
price
B
Demand
QUANTITY
Too little
PRICE
Supply
Market
price
Demand
QUANTITY
Efficient
PRICE
Supply
C
D
Market
price
Negative
producer
surplus and
negative
consumer
surplus:
area C + D
Demand
QUANTITY
Too much
Deadweight Loss from a Tax
• A tax on firms raises the marginal cost for
each firm
• Supply curve shifts up by the amount of the
tax
• Quantity produced falls
• Price rises, but by less than the tax
• Deadweight loss is created
07_08A
PRICE
New supply curve
Old supply curve
Deadweight loss
New price
Amount of
sales tax
Price rises by this amount.
Old price
Price received
by sellers after
sending tax to
government
Demand curve
QUANTITY
New quantity
Old quantity
Quantity declines by this amount.
Deadweight Loss from a Sales Tax