problem set 2 review november 2010

Problem Set 2

Review

• In the neoclassical model, amount people will pay is the Marginal Utility (or Marginal Value). MU curve is the demand curve.

– If something becomes less desirable, demand shifts in: people will pay less for it.

– If something becomes more desirable, demand shifts out: people will pay more for it.

• In production, look for the marginal, extra workers (and stuff) needed to make another product. The extra workers are the change in worker hours.

– Marginal cost is then wage times extra workers (plus cheese).

– Note that MC increases because it takes more and more workers to make more pies (on the margin).

Start with what people are willing to pay, or their marginal utility

Ice cream scoops

MU

1 $10.00 2 $9.00 3 $8.10 4 $7.29 5 $6.56 6 $5.90 7 $5.31 8 $4.78 9 $4.30

10 $3.87

Downward sloping because of satiation

Leads to a downward sloping demand curve – will buy more but only at lower prices

Supply depends on the cost of producing one more unit, or MC

Ice cream scoops Workers

1 0.0502 0.1253 0.2384 0.4065 0.6596 1.0397 1.6098 2.4639 3.74410 5.667

This many workers are needed to produce 1, 2, 3 … scoops of ice cream.

Marginal workers, the workers needed to add one more scoop:

the change in total workers.Ice cream scoops

Workers M Workers

1 0.050 0.0502 0.125 0.0753 0.238 0.1134 0.406 0.1695 0.659 0.2536 1.039 0.3807 1.609 0.5708 2.463 0.8549 3.744 1.28110 5.667 1.922

Change in the number of workers from 1 to 2, 2 to 3, etc.

MC depends on the cost of the Marginal Workers and ingredients.

Ice cream scoops

Workers M Workers Ingredients Cost of M Workers

MC

1 0.050 0.050 $0.75 $0.40 $1.15 2 0.125 0.075 $0.75 $0.60 $1.35 3 0.238 0.113 $0.75 $0.90 $1.65 4 0.406 0.169 $0.75 $1.35 $2.10 5 0.659 0.253 $0.75 $2.03 $2.78 6 1.039 0.380 $0.75 $3.04 $3.79 7 1.609 0.570 $0.75 $4.56 $5.31 8 2.463 0.854 $0.75 $6.83 $7.58 9 3.744 1.281 $0.75 $10.25 $11.00 10 5.667 1.922 $0.75 $15.38 $16.13

You can graph MC

It is upward sloping because of diminishing MP, more Marginal Workers needed for additional cones.

Minimum price to get producers to supply each cone

Put MC and MU together to get perfect competition

Note that I limited the vertical axis to make the graph clearer

Equilibrium at a quantity where the price is such that supply and demand are equal.

Producers are being myopic.They could earn more profit by producing less at higher prices.

Ice cream scoops

MU TR=MU*Scoops MR=Change in TR

1 $10.00 $10.00 $10.002 $9.00 $18.00 $8.003 $8.10 $24.30 $6.304 $7.29 $29.16 $4.865 $6.56 $32.81 $3.656 $5.90 $35.43 $2.627 $5.31 $37.20 $1.778 $4.78 $38.26 $1.069 $4.30 $38.74 $0.4810 $3.87 $38.74 $0.00

Can sell more only by lowering prices and losing some of the revenue from earlier sales.

Put MR on graph and produce where MC=MR, selling at higher price

Consumer Surplus is difference between value and price.

Producer Surplus is difference between price and cost

Ice cream scoops

CS PC PS PC CS Mono PS Mono

1 $4.69 $4.16 $3.94 $4.912 $3.69 $3.96 $2.94 $4.713 $2.79 $3.66 $2.04 $4.414 $1.98 $3.21 $1.23 $3.965 $1.25 $2.54 $0.50 $3.296 $0.59 $1.527 $0.00 $0.0089

p=5.31 p=5.31 p=6.06 p=6.06Sum: $15.00 $19.05 $10.65 $21.28Total $34.05 $31.93

Monopoly redistributes surplus to producers by raising prices.Monopoly also reduces surplus by producing less.

More Review

PC equilibrium where MU=MC. This is for a firm that is stupid.

– Monopolists look at MR or the change in total revenue with another sale at lower price. Total revenue = Q*P. MR is the change in this.

– Monopolists produce where MR=MC and sell at the price for this amount (on the MU or demand curve).

– Consumer surplus for each pie is P-MU. Total is the sum of CS for each.

– Producer surplus for each pie is P-MC. Total is sum of PS for each.

Still more Review

Distinguish between things that change marginal values and other things.

Think about equity as situation where people pay for what they get and get back what they put in. Efficiency minimizes collection costs.