applying the competitive model perloff chapter 9
TRANSCRIPT
Applying the Competitive Model
Perloff Chapter 9
Consumer Welfare
• Measure how much consumers are affected by shocks which affect the equilibrium.
• Marginal Willingness to Pay– The maximum amount a consumer will pay for
an extra unit.
• The monetary difference between what a consumer is willing to pay and what the good actually costs.
Consumer Surplus5
4
3
2
1
543210
CS2 = $1CS1 = $2
E1 = $3 E2 = $3 E3 = $3
Price = $3
a
b
c
q, Magazines per week
p, $ per magazine
Demand
Consumer Surplus with Continuous Demand
p1
p, $ pertrading card
q1 q, Trading cards per year
DemandExpenditure, E
Consumersurplus, CS
Marginal willingness topay for the last unit of output
Aggregate consumer surplus and the effect of a price change
¢ per stem
Q, Billion rose stems per year
57.8
3230
1.160 1.25
b
a
A = $149.64 million
B = $23.2 million
C = $0.9 million
Demand
Influenced by:• Position of the demand curve (revenue)• Elasticity of demand
Producer Welfare
• Difference between the amount that a good sells for and the minimum they have to be paid to produce (avoidable cost).
• VC: costs that change as output changes.
• MC: change in cost when output changes by one unit.
• VCn=MC1+MC2+ … +MCn
Producer Surplus4
3
2
1
43210
PS 2 = $2 PS 3 = $1PS1 = $3
MC2 = $2 MC3 = $3 MC4 = $4MC1 = $1
p
Supply
q, Units per week
p, $ per unit
Producer Surplus in the Market
p*
p, Price per unit
Q*
Market supply curve
Q, Units per year
Market price
Variable cost, VC
Producer surplus, PS
Producer surplus and profit
• Producer surplus is revenue minus variable costs.• In the long run:
– all costs are variable– profit is zero– producer surplus is zero– Long run supply curve is horizontal
• In an increasing cost industry fixed factors earn a return equal to their opportunity cost, rent.– Producer surplus is rent in the long run.
Competition maximises welfare
• How should we measure societies welfare?– W = CS + PS– Weights both producers and consumers equally
• If output is either more or less than the competitive equilibrium, welfare is reduced.
The effect of reducing output on welfare
p, $ per unit
Q, Units per year
Supply
Demand
p 2
MC 1 = p1
Q 2 Q1
e1
MC 2
e 2
CE
B
D
A
F
Explanation
• At competitive equilibrium P = MC• Consumers are prepared to pay (value) the last
unit produced at exactly what it costs to produce.• P > MC consumers increase in satisfaction
outweighs producers reduction as output expands.• P < MC consumers reduction in satisfaction
folowing a reduction in output is less than producers increase.
Effect of a restriction on the number of taxis
p, $ per ride
q 2q1
q, Rides per month
E1
D
S1
S2
E 2
B
A
C
AC 2
AC 1 MC
e 2
e1
p 2
p1
p 2
p1
p, $ per ride
n2q 1 Q2 = n2q 2 Q1 = n1 1
Q, Rides per month
q
Accounting for the effects of a tax
• Prices to consumers and producers change. PS and CS change.
• Government raises tax revenues which is spent to raise peoples welfare.
• W = PS + CS +T
Effects of a tax p, ¢ per stem
Q, Billion rose stems per year
21
0
= 11
1.16 1.25
e1e2
D
Supply
Demand
C
E
BA
F
3230
Effects of a price floorp, $ per bushel
Qd = 1.9 Q1 = 2.1
G
D
Qs = 2.20
Q, Billion bushels of soybeans per yearQg
= 0.3
p1 = 4.59
3.60
Supply
Demand
Price support
e
F
B
MC
A
C
E
p = 5.00
Trade Policies (imports)
• Allow free trade (domestic price is the world price).
• Ban all imports.
• Set a non-zero import quota.
• Set a tariff on imported goods.
Free trade versus an import banp, 1988 dollars
per barrel
9.0 10.28.2 11.8 13.1
Q, Million barrels of oil per day
Imports = 4.9
14.70
0
29.04
S a = S2
S1, World price
e 2
e1
D
B
A
C
Demand
Tariff or quota versus import banp, 1988 dollars
per barrel
9.08.2 11.8 13.1
Q, Million barrels of oil per day
Imports = 2.8
0
14.70
19.70
29.04
Sa =S2
S3
Demand
S1, World price
e2
e3
e1 = 5.00
FG H
B
A
C ED