Transcript Net Surplus

Intermediate Microeconomics
Equilibrium
1
Partial Equilibrium

We have now derived both the market demand curve
(Qd(p)) and market supply curve (Qs(p)) from first
principles.

Equilibrium price and quantity is determined by finding
price that equates these two curves (picture):
Qd(p*) = Qs(p*)

Ex: Consider the following demand and supply curves:

Qd(p) = 55 – 5p

Qs(p) = 0 if p < 5
= p/2
What is equilibrium price and quantity?

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Comparative Statics

Often we are interested in analyzing how changes in the
market affect equilibrium price and quantity.


Generally called “comparative statics”
Given we know where our supply and demand functions
come from, comparative statics are often
straightforward.

Changes in production technology, price of inputs, affect
MC and therefore cause a shift in supply curve and cause
movement along the demand curve.

Changes in preferences, or prices of complements or
substitutes, will shift the demand curve and cause
movement along supply curve.
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Consumer/Producer Surplus

Equilbrium under perfect competition results in a given
allocation of goods to consumers and revenue to firms (which
are owned by still other consumers).
 How does this allocation compare to other ways of
allocating resources?

To answer this question, first consider what the area
underneath the demand curve but above the equilibrium price
tells us.

How about area underneath the price but above supply curve?
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Consumer/Producer Surplus (cont.)

So we can think of the change in Consumers’ Surplus associated
with an increase in price.
$
p’’
p’
1
2
Qd(p)
q”


q’
q
(1) Loss in CS due to having to pay more for each unit consumed.
(2) Loss in CS due to fewer overall units consumed.
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Consumer/Producer Surplus (cont.)

We can also think of the change in Producers’ Surplus associated
with an increase in price.
$
Qs(p)
p”
1
2
p’
q”


q’
q
(1) Gain in PS due to higher profits for each unit sold.
(2) Gain in PS due to more overall units sold.
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Consumer/Producer Surplus and Comparative Statics

We can think about changes in Consumer/Producer
Surplus to think about who is affected by changes in
economic environment.


Impacts often depend on relative slopes of Supply and
Demand Curves
Examples:

Price controls (e.g. a price ceiling of $3/gal on
gasoline).

Who benefits from change in technological efficiency?
(e.g. costs of production and ease of entry into
computer market over last 20 years).

How does increase in drug enforcement affect drug
market?
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Comparative Statics (cont.)

Example:
 Let’s use these tools to analyze article about impact of biofuel demand
on Guatemalan economy described in the NYT article.
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Net Surplus

We often interested in Net Surplus in the
economy, or simply the sum of consumer
surplus plus producer surplus.


This is some measure of how much value a market is
creating
As we will see, this relates to Pareto Efficiency

(Pareto) Efficient Outcome: No one can be made
better off without making someone else worse off.
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Net Surplus

Example: Consider the allocation of apartments.

Suppose there are four types of people (20 of each)
 Type 1 – will pay up to $1000 for an apartment
 Type 2 – will pay up to $800 for an apartment
 Type 3 – will pay up to $600 for an apartment
 Type 4 – will pay up to $400 for an apartment

Supply of apartments given by supply function
Qs(p) = p/7.5
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Net Surplus

Consider rent control of $300

Total supply of apartments: Qs(300) = (300)/7.5 = 40
Demand exceeds supply at $300, so apartments randomly allocated,
10 to each type.

Net Surplus

$1000
$800
Qs(p)
$600
$400
$300
20

40
60
80 apartments
Is this Pareto Efficient?
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Net Surplus

What if we kept rent control and random initial allocation, but let
people trade apartments for cash after initial allocation?

E.g. suppose a side market was enacted where apartments could be
traded for $610.
$1000
$800
Qs(p)
$600
$400
$300
20

40
60
80 apartments
Is this Pareto Efficient?
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Net Surplus

What if market dictated apartments?


Consider a price of $450
 60 apartments demanded (Type 1s, Type 2s, Type 3s)
 Qs(450) = (450)/7.5 = 60 apartments supplied
Net Surplus
$1000
$800
Qs(p)
$600
$400
$300
20
40
60
80 apartments
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Markets and Efficiency

First Welfare Theorem: Under perfect competition, markets lead
to Pareto Efficient outcomes.

Generally it will be true that Pareto Efficient outcomes are outcomes
that maximize net surplus (why is this true?)

Markets achieve Pareto Efficiency by essentially performing two
functions:
1.
2.
Rations scarce resources to those who “value” goods the most (however,
do note that value depends on income!)
Provide allocative signals, telling those with factors of production how
those factors will be valued in alternate uses.
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Markets and Efficiency (cont.)

Another way of saying this is that perfect markets mean that all mutually
beneficial trades have been made.


Not only between producers and consumers,
but also between those with factors of production to invest and those who
need such factors for production.
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Markets and Efficiency (cont.)

So our First Welfare Theorem shows that markets lead to efficiency.



No trades between any two people can make one better off without hurting the
other.
Production of goods maximized in the sense that cost of producing another unit
will exceed the willingness to pay of the marginal consumer of that product.
So can we say that society is “better off” under market allocation than rent
control allocation?
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Markets and Efficiency (cont.)
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Markets and Efficiency (cont.)
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Markets and Efficiency (cont.)

Other figures of note:
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Since 2000, median income fell by 12.4 percent, but during that time
economy grew by 18 percent.
Top 1 percent of households garnered 65 percent of the nation’s income
growth from 2002-2007.
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Markets and Efficiency (cont.)


This reveals a fundamental insight that comes out of studying
economics.

How do you weigh one person’s utility against another’s?

What is the correct social welfare function?
Therefore, economists tend to focus on evaluating how much
efficiency might we have to give up to get more equality and/or
achieve other social goals (This leads to Taxation)
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Taxes and Tax Incidence

Consider two ways of collecting taxes:

From consumers (e.g. pay some amount t for each unit purchased)
 How would this affect equilibrium?

From firms (e.g. pay some amount t for each unit sold)
 How would this affect equilibrium?
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Taxes and Tax Incidence

Does who nominally pays tax really matter?

How much of incidence is borne by consumers? How much is borne by
producers?
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Tax Incidence

How does tax incidence depend on relative responsiveness of supply
and demand?
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Taxes and Net Surplus

Besides tax incidence, what else do we notice happens when we
impose a tax?

Given this, what kind of goods are best to tax?
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How do income taxes fit into this?
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