economics 110 introduction to economic theory professor tanya rosenblat
DESCRIPTION
Perfectly Competitive Markets. Economics 110 Introduction to Economic Theory Professor Tanya Rosenblat. Experiment (Session 1). Widget Market (48 participants). Supply Schedule. Demand Schedule. Session 1: Supply and Demand for Widgets. 40 30 20 10. P R I C E. - PowerPoint PPT PresentationTRANSCRIPT
1
Economics 110Introduction to Economic Theory
Professor Tanya Rosenblat
Perfectly Perfectly Competitive MarketsCompetitive Markets
2
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
3
Supply ScheduleSupply Schedule
Price Range Amount Supplied
P<10 0
10<P<30 16
P>30 24
4
Demand ScheduleDemand Schedule
Price Range Amount Demanded
P>40 0
20<P<40 8
P<20 24
5
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
6
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
7
Experimental DataExperimental Data
• Round 2 – Average Price 17.4 (17.3)
Round 2 Prices
05
101520253035
0 5 10 15 20
Transactions
Pric
e
8
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
9
$-
$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
10
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
11
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!
12
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 $9.00, is the aggregate difference between what consumers are willing to pay and what they actually pay.
Consumer Surplus:Willingness to pay - Actual payment
13
The Concept of Consumer Surplus Also Applies to The Concept of Consumer Surplus Also Applies to “Smooth” Demand Curves“Smooth” Demand Curves
P ($ 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
14
$-
$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)
15
$-
$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
16
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
17
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
18
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!
19
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
20
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
21
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 //
22
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 //
23
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
24
ExamplesExamples
• Linear Demand• Q = a – bP• Elasticity =
abP
bPb
Q
P
dP
dQ
Q
P
PdP
QdQ
)(
/
/
25
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.
26
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.
27
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
28
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