8. Monetary Measures, Benefit & CostConsumers, Surplus, Producers SurplusCompensating Variation & Equivalent Variation

Monetary Measures of Gains-to-Trade Can buy as much gas as you want at $! Per gallon once you enter gas market What is the most you would pay to enter market? Would pay up to the dollar value of the utility you would enjoy once in the market How can such gains-to-trade be measured?

Monetary Measured of Utility (gains-to-trade) 3 measures: consumers surplus equivalent variation compensating variation only on 1 special case all three measures coincide

Evaluating goodness of allocations of resources what makes a good allocation of resources? Utilitarianism

Utilitarianism Problem of applying can we measure the happiness of different people in society? no way to if a reallocation that makes one person better off but someone else worse off has increased the SUM of happiness cant measure & cant compare happiness levels

Workable Criterion appeal to freedom of exchange approximate benefit in something measurable (money) the MAX amount that an individual would be willing to pay to obtain it no rational individual will pay more for something that it is subjectively worth dollar measure of benefit is not same as amount paid

Bernoulli Utility Subjective Valuation explain behavior under risk value of an item must not be based on its price, but rather on the utility that it yields distinguished between monetary value of something *what it can be sold for) and it subjective value (want-satisfier) utility

Rational Consumer Behavior consumer will not pay more for something that it is subjectively worth to them is consumer obtains unit for less than the max they are willing to pay bargain (better off) if subjective value is subject to diminishing Marginal Utility then max a consumer is willing o pay for each successive unit diminishes as Q purchases increases amount willing to pay.?

$ Equivalent Utility Gains gas can be bought in lumps of 1 gallon R1 the most consumer would pay for a 1st gallon (reservation price) for 1st gallon R1 = dollar equivalend of the marginal utility of the 1st gallon Has 1 gallon R2 most would pay for 2nd gallon R2 = dollar equivalent of marginal utility of 2nd gallon She already has (n 1) gallons of gas Rn most shell pay for nth gallon Rn $ equiv of MU of nth gallon $ equiv of the total change to utility acquiring n gallons of gas at price $Pg each r1,r2.rn plotted against n = reservation price curve monetary value of our consumers gain on trading in the gas market at price $Pg? $ equiv net utility gain for 1st gallon is $(r1-pg) + $(r2-Pg).. as long as Rn Pg > 0

highest amount youre willing to pay more than the price is the price of the good no more than the highest amount I am willing to pay? knowing max amount we are willing to pay gains us nothing takes time and thought to ascertain

MV, Willingness to Pay, Individuals Demand Curve height of individuals demand curve showing highest amount they are willing to pay for each additional unit of good marginal value presumes that person knows the amount they are willing to pay for each successive unit rather than go without it consumers are willing to pay more for the first unit than for subsequent units MV of 1st unit + MV of 2nd unit + . total value to the consumer of all units purchased Not same as the amount consumer must pay

Consumer Surplus Get Total value then can compare this to the amount the consumer actually spends for all those units Consumer surplus: difference between total value and amount spent

Example: Buy digital camera Advertised for $300 Will not pay $301 $300 is max you will pay for it Camera on sale for $250 at store Left with extra $50 consumer surplus

Measuring CS for all Buyers, Cont Demand Function QD is a continout function of price To find CS at some market price Invert demand function to get P as function of Qd Then1. Find Qd(P)2. Find area under Demand function from 0 to Qd(P)*a. By integrating or adding area of triangle & area of rectangle) total value to all buyers3. Find area representing total expenditure (P*[Qd(P)])4. Cs different between TV & TE

Example: Qd(P) = 200 20P Market price = $5 Total CS (to all actual buyers) ?

Compensating Variation & Equivalent Variation Compensating & Equivalent Var: 2 additional $ measures of total utility caused by price change

Compensating Variation P1 rises Consumer worse off busget set shrinks What is the least extra income that , at the new prices (higher prices of g1) just restores the original utility What is the least extra income that COMPENSATES for the price rise?

A tax is put on 1 good raise revenue on commodity taxation Can determine tax revenue (tax/unit x # of units bought) What is the sacrifice made by consumer when tax introduced Can measure as amount of required compensation for price increase one money measure sacrifice Always more than tax revenue raised (excess burden)

Equivalent Variation P1 rises What is the least extra income that (at the original prices) just restores consumers original utility level? What is the LOSS of income (if prices didnt change) that is equivalent to the sacrifice made by consumer when the price of g1 increased Monetary measure of loss

Relationship 1: when consumers preferences are quasilinear all 3 measures are the sameProducer Surplus Difference between min price at which producers make a unit available (marginal cost of production) and the price actually received For all units but last (marginal unit), price received will exceed min price (Marginal cost) Bonus PS = Revenue Total Variable Cost (Revenue less avoidable costs)

Total Surplus CS = (value to buyers) (amount paid by buyers) Measures net benefit buyers receive from buying the good PS = (amount received by sellers) (cost to sellers) Measures the net benefit sellers receive from producing/selling good Total surplus = CS + PS Measures the NET BENEFIT from trade in a market Value created Excess of value of the g/s over value of resources used in producing it

Implication Unit of a good more highly valued by buyers than it costs (good subjectively worth more than resources used to produce it) value created by production if all units for which buyers valuation is at least as large as value of resources used are produced and made available then max net benefit (value) is created if for marginal unit (last) produced buyers are willing to pay more then marginal resource cost OR marginal cost of production exceeds buyers valuations the wrong quantity is traded there is scope for an increase in amount of value created

Markets Allocation of Resources determined by interaction of many self-interest buyers and sellers is the markets allocation of resources desirable? Would different allocation of resources make society better off? Use total surplus as a measure of societys well-being Total surplus CS + PS = (value to buyers cost to sellers)

Allocative Efficiency Q traded is consistent with allocative efficiency when Sum of CS & PS is maximized All units for which buyers are willing to pay at least the marginal cost of production are produced and sold At that specific Q

Deadweight Loss less of a g/s than that Q at which willingness to pay = marginal production cost is produced some units might have been produced when valuation > marginal resource cost not produced anymore exceed of benefit over cost represent net surplus that couldve been obtained but is not

Causes of DWL taxes price controls externalities market power monopoly firms produce too little

Benefit- Cost Analysis measure in money units the net gain/loss caused by market intervention (imposition/removal of market regulation) by using measures CS & PS