Economics 110 Introduction to Economic Theory Professor Tanya Rosenblat
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Transcript of Economics 110 Introduction to Economic Theory Professor Tanya Rosenblat
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Economics 110Introduction to Economic Theory
Professor Tanya Rosenblat
Perfectly Perfectly Competitive MarketsCompetitive Markets
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Experiment (Session 1). Widget Market (48 Experiment (Session 1). Widget Market (48 participants)participants)
Type of Agent Number of Agents
Cost Value
Low-Cost Supplier
16 10
High-Cost
Supplier
8 30
High-Value Demander
8 40
Low-Value Demander
16 20
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Supply ScheduleSupply Schedule
Price Range Amount Supplied
P<10 0
10<P<30 16
P>30 24
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Demand ScheduleDemand Schedule
Price Range Amount Demanded
P>40 0
20<P<40 8
P<20 24
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Session 1: Supply and Demand for WidgetsSession 1: Supply and Demand for Widgets
8 16 24
40
30
20
10
P
R
I
C
E
Number of Bushels
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Experimental DataExperimental Data
• Round 1 – Average Price 18.3 (19.5)
Round 1 Prices
0
10
20
30
40
0 10 20 30
Transactions
Pri
ce
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Experimental DataExperimental Data
• Round 2 – Average Price 17.4 (17.3)
Round 2 Prices
05
101520253035
0 5 10 15 20
Transactions
Pric
e
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A Demand Curve Can Be Thought of as a Schedule A Demand Curve Can Be Thought of as a Schedule of Buyers’ Maximum Willingnesses to Payof Buyers’ Maximum Willingnesses to Pay
$-
$0.50
$1.00
$1.50
$2.00
$2.50
$3.00
$3.50
$4.00
$4.50
$5.00
$5.50
$6.00
$6.50
0 1 2 3 4 5 6 7 8 9 10 11 12Quantity
$ per unit#1 6.00$ #2 5.50$ #3 5.00$ #4 4.50$ #5 4.00$ #6 3.50$ #7 3.00$ #8 2.50$ #9 2.00$ #10 1.50$ #11 1.00$ #12 0.50$
PotentialBuyer
Highest priceat which individualis willing to buy
• Only one buyer has a maximum willingness to pay greater than $5.75• Thus: at a price of $5.75, only one potential buyer (#1) would buy.• Quantity demanded at $5.75 = 1
• At a price of $2.25, eight potential buyers would buy (#1 - #8). • Quantity demanded at $2.25 = 8.
$5.75
$2.25
Notice that the demand curve also describes the maximum willingness to pay of all potential buyers in the market!
Demand Curve
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$-
$0.50
$1.00
$1.50
$2.00
$2.50
$3.00
$3.50
$4.00
$4.50
$5.00
$5.50
$6.00
$6.50
0 1 2 3 4 5 6 7 8 9 10 11 12Quantity
$ per unit
A Supply Curve Can Be Thought of as a Schedule of A Supply Curve Can Be Thought of as a Schedule of Seller’s Minimum Willingnesses to SellSeller’s Minimum Willingnesses to Sell
#1 0.50$ #2 1.00$ #3 1.50$ #4 2.00$ #5 2.50$ #6 3.00$ #7 3.50$ #8 4.00$ #9 4.50$ #10 5.00$ #11 5.50$ #12 6.00$
PotentialSeller
Lowest priceat which selleris willing to sell*
• The price of $5.75 is greater than the minimum willingness to sell for 11 potential sellers• Thus: quantity supplied at $5.75 = 11
$5.75
$2.25
Supply Curve
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Is There An Equilibrium in Our Market? Yes!Is There An Equilibrium in Our Market? Yes!
$-
$0.50
$1.00
$1.50
$2.00
$2.50
$3.00
$3.50
$4.00
$4.50
$5.00
$5.50
$6.00
$6.50
0 1 2 3 4 5 6 7 8 9 10 11 12Quantity
$ per unit
equilibrium price “band”
• At any price above $3.00 but below $3.50, exactly 6 potential buyers are willing to buy
• At a price above $3.00 but below $3.50, exactly 6 potential sellers are willing to sell.
• For any price in this band, quantity supplied equals quantity demanded at this price.
Supply Curve
Demand Curve
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How Much Do How Much Do BuyersBuyers Gain at the Market Gain at the Market Equilibrium?Equilibrium?
$-
$0.50
$1.00
$1.50
$2.00
$2.50
$3.00
$3.50
$4.00
$4.50
$5.00
$5.50
$6.00
$6.50
0 1 2 3 4 5 6 7 8 9 10 11 12Quantity
$ per unit#1 6.00$ #2 5.50$ #3 5.00$ #4 4.50$ #5 4.00$ #6 3.50$ #7 3.00$ #8 2.50$ #9 2.00$ #10 1.50$ #11 1.00$ #12 0.50$
PotentialBuyer
Highest priceat which individualis willing to buy
$3.25
Demand Curve
Buyer #1:winning to pay as much as: $6.00actually pays: $3.25net gain (consumer surplus): $2.75 (area A)
AB
F
Buyer #2:winning to pay as much as: $5.50actually pays: $3.25net gain (consumer surplus): $2.25 (area B)
Buyer #6:winning to pay as much as: $3.50actually pays: $3.25net gain (consumer surplus): $0.25 (area F)
These buyers do not buyTheir consumer surplus is zero!
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Consumer SurplusConsumer Surplus
$-
$0.50
$1.00
$1.50
$2.00
$2.50
$3.00
$3.50
$4.00
$4.50
$5.00
$5.50
$6.00
$6.50
0 1 2 3 4 5 6 7 8 9 10 11 12Quantity
$ per unit
$3.25
Demand Curve
AB
CD
EF
• Consumer surplus: the aggregate net gain to consumers from purchasing at a given market price.• Equal to: the area underneath the demand curve above the market price• In our picture: consumer surplus at a market price of $3.25 equals area A+B+C+D+E+F.• This number, which equals $9.00, is the aggregate difference between what consumers are willing to pay and what they actually pay.
Consumer Surplus:Willingness to pay - Actual payment
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The Concept of Consumer Surplus Also Applies to The Concept of Consumer Surplus Also Applies to “Smooth” Demand Curves“Smooth” Demand Curves
P ($ per liter)
Q (liters per year)4000
$6A
• Consumers demand 4000 liters at $6 per unit.• Consumers surplus = difference between total willingness to pay andactual amount paid = area A = $8,000.
$10
MARKETDEMAND CURVE
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$-
$0.50
$1.00
$1.50
$2.00
$2.50
$3.00
$3.50
$4.00
$4.50
$5.00
$5.50
$6.00
$6.50
0 1 2 3 4 5 6 7 8 9 10 11 12Quantity
$ per unit
How Much Do Sellers Gain at the Market How Much Do Sellers Gain at the Market Equilibrium?Equilibrium?
#1 0.50$ #2 1.00$ #3 1.50$ #4 2.00$ #5 2.50$ #6 3.00$ #7 3.50$ #8 4.00$ #9 4.50$ #10 5.00$ #11 5.50$ #12 6.00$
PotentialSeller
Lowest priceat which selleris willing to sell*
$3.25
Supply Curve
Seller #1:actually receives: $3.25must receive at least: $0.50net gain (producer surplus): $2.75 (area A)
AB
F
Seller #2:actually receives: $3.25must receive at least: $1.00net gain (producer surplus): $2.25 (area B)
Seller #6:actually receives: $3.25must receive at least: $3.00net gain (producer surplus): $0.25 (area F)
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$-
$0.50
$1.00
$1.50
$2.00
$2.50
$3.00
$3.50
$4.00
$4.50
$5.00
$5.50
$6.00
$6.50
0 1 2 3 4 5 6 7 8 9 10 11 12Quantity
$ per unit
Producer SurplusProducer Surplus
$3.25
Supply Curve
AB
F
CD
E
• Producer surplus: the aggregate net gain to sellers from selling at a given market price.• Equal to: the area underneath the market price above the supply curve.• In our picture: producer surplus at a market price of $3.25 equals area A+B+C+D+E+F.• This number, which equals $9.00, is the aggregate difference between what sellers actually receive and the smallest amount they need to receive.
Producer Surplus:Actual payment - required payment
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Producer Surplus Also Applies to “Smooth” Supply Producer Surplus Also Applies to “Smooth” Supply CurvesCurves
$6
$2
4000
P ($ per liter)
Q (liters per year)
A• Firms supply 4000 liters at $6 per liter.• Producer surplus is area A in the diagram = $8,000.
Market Supply Curve
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Total Economic Value Created in a Market = Total Economic Value Created in a Market = Consumer Surplus + Producer SurplusConsumer Surplus + Producer Surplus
$-
$0.50
$1.00
$1.50
$2.00
$2.50
$3.00
$3.50
$4.00
$4.50
$5.00
$5.50
$6.00
$6.50
0 1 2 3 4 5 6 7 8 9 10 11 12Quantity
$ per unitSupply Curve
Demand Curve
$3.25
• Total economic value created whenmarket price is $3.25= Consumer surplus at $ 3.25 + Producer surplus at $3.25= $9.00 + 9.00= $18.00
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If The Market is Prevented From Reaching If The Market is Prevented From Reaching Equilibrium, Economic Surplus is Not RealizedEquilibrium, Economic Surplus is Not Realized
$-
$0.50
$1.00
$1.50
$2.00
$2.50
$3.00
$3.50
$4.00
$4.50
$5.00
$5.50
$6.00
$6.50
0 1 2 3 4 5 6 7 8 9 10 11 12Quantity
$ per unitSupply Curve
Demand Curve
• If, for some reason, potential buyers #3,4,5 and potential sellers #3,4,5 were prevented
from participating in the market, consumer and producer surplus would
be lost.• Gains from exchange would not be realized!
• We say there is a deadweight loss: unrealized economic benefits.
• How could this happen? Government interventions!
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The Economics of Price ControlsThe Economics of Price Controls
Price($ per unit)
Quantity (units per period)
$2,000
$1,400
A
B D
C E
F
QS Q*
D
S
QD
Free market (no price control)
Price controls
Difference due to price controls
Producer surplus
F + C+ E F - C - E
Consumer surplus
A + B + D A + B + C C – D
Total surplus
A + B + C + D + E + F
A + B + C + F
- E - D
E + D = Deadweight loss
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ElasticityElasticity
• Where is the Demand Curve coming from? How do we measure its slope?
• The Demand Curve tells us how much consumers will buy for different prices of the good
• From Consumer Behavior, we know how to deduce from tastes how much an individual consumer will buy at a given price. Summing over consumers, we get the Demand Curve
• The Demand Curve is (assumed to be) decreasing (The “Law of Demand”): The higher the price, the lower the consumption
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How to measure elasticity?How to measure elasticity?
• It is important to measure how sensitive Demand is to changes in Prices
• Preferably, this measure should not depend on units: are we counting in dollars, cents, or euros? Pounds, Kilograms or Tons?
• The price elasticity of demand provides such a measure:
In words, it is the % change in quantity for (or divided by) a given % change in prices
(sometimes, the elasticity is defined as the opposite number: the precise convention does not matter, as long as one realizes that the law of demand applies)
PPQQ
EDD
p //
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The Importance of Elasticity The Importance of Elasticity
• The Concept of Elasticity is used for other concepts:
- Income elasticity of Demand:
- Price Elasticity of Supply:
• What affects the Slope? When is it steep? It is steep when there is no good substitute
PPQQ
ESS
S //
IIQQ
EDD
I //
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Using CalculusUsing Calculus
dI
dQ
Q
I
IdI
QdQ
incomeinchange
demandedquantityinchange
/
/
%
%
%
%
/
/
change in quantity demanded
change in price
dQ Q
dP P
P
Qx
dQ
dP
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ExamplesExamples
• Linear Demand• Q = a – bP• Elasticity =
abP
bPb
Q
P
dP
dQ
Q
P
PdP
QdQ
)(
/
/
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ElasticityElasticity• Elastic – responsive to price changes• Inelastic – not responsive to price changes
Examples:- An unconscious bleeding man is brought to the hospital emergency room.
- Among hospital patients whose insurance will pay all charges, what would the demand be like for nurse-administered propoxyphene (Darvon), a pain-killer?
- Now suppose that the patients are in managed care plans that pressure physicians to use lower-price drugs. What might demand for the Darvon be?
- A patient is given a presciption for a drug to control high blood pressure. The patient's insurance doesn't cover drugs, so the patient must pay out of pocket.
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ElasticityElasticity
• Demand is more elastic if the decision-maker has an incentive to save money and if there is an adequate substitute for the product or service.
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What Shifts Demand Curves?What Shifts Demand Curves?
• Change in income
• Change in a price of a substitute
• Change in a price of a complement
• Change in composition of population
• Change in tastes
• Change in information
• Change in availability of credit
• Change in expectations
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What Shifts Supply Curve?What Shifts Supply Curve?
• Change in price of inputs
• Change in technology
• Change in natural environment
• Change in availability of credit
• Change in expectations