Transcript 08--CS and PS - UTA Economics

8
Mutual Gains from Trade
We rely on other people to produce
things we want:
We are not forced to rely on others.
 Why do we voluntarily rely on others
through the market process?

We must answer this question:

What are the gains from mutually
beneficial exchange?
Mutual gains—Simple Example

You buy food from a grocer because she is willing to sell to you at
a price that is:
 1) less than the value you place on the good, and/or
 2) less than your costs of producing it yourself

Therefore, you gain from shopping at grocer (consumer surplus)

Grocer sells to you. You are willing to pay a price that is:
 1) more than the cost of producing the good, and/or
 2) more than the seller’s next best alternative

Therefore, grocer gains from selling to you (producer surplus)

We are joined together by mutual gains through market exchange
The consumers’ perspective

Look at demand side of market and ask:
What is the total value in use
to consumers of the quality Q*?
It is the total area under demand
curve from 0 to Q* (OABQ*)
Price
A
People usually do not
have to give up all of this
because suppliers will
deliver at a price of P*

B
P*
O
Demand
Q*
Quantity
Consumer surplus

The gains from trade going to consumers:
Total use value (ABQ*0)
minus
Total expenditures (P*BQ*0)
equals
Consumer surplus (ABP*)
Price
A
P*
B
Demand
0
Q*
Quantity
The producers’ perspective
Look at supply side of market and ask:
What is the total cost to producers
of the quantity Q*?”

Three equal descriptions are:
1. minimum you would accept to
produce Q* rather than Q=0
2. sum of the marginal costs
from 0 to Q*
3. area under the supply curve
from 0 to Q*
Producers usually do not have
to settle for MC, because
demanders will pay a price of P*
Price
Supply = MC
P*
0
B
Q*
Quantity
Producer surplus
The gains from trade going to the producer:



Total revenue (P*BQ*0)
Minus
Total costs (0CBQ*) [Costs must be recovered or no production.]
Equals
Producer surplus (P*BC)
Price
S = MC
P*
B
C
0
Q*
Quantity
Putting It All Together
Price
Demand
A
Price
Market
A
0
Q*
Quantity
D
C
0
Q*
S
P*
P*
D
Supply
S
B
B
P*
Price
B
C
Quantity 0
Q*
Quantity
There are gains to suppliers and demanders — room for bargaining.
Who gets producer and consumer surplus? Area ABC is up for grabs!