Microeconomics III

Katarzyna Metelska-SzaniawskaMichał Krawczyk

Contact

• http://www.microeconomics.wne.uw.edu.pl(Micro 3)

• kmetelska@wne.uw.edu.pl– office hours: TBA

• mkrawczyk@wne.uw.edu.pl– office hours: Friday, 1.15 PM room 5, please

send an e-mail first

Agenda for today

• requirements for passing the course• readings• introduction: demand, supply,

consumer/producer surplus, efficiency• what will follow…?

Class organization

• this is a seminar class – activeparticipation is expected!

• short theoretical introductions – readinggiven chapters before class is expected!

• case studies: readings+discussions+experiments+problem-solving

• student presentations/debates

COURSE REQUIREMENTS

• 4 elements: A) active participation in class (20%)B) participation in debate in class (10%)C) written paper (20%)D) final test (exam) (50%)

Details: www.microeconomics.wne.uw.edu.pl

Written papers• should tackle an interesting question• gathering data/information on your own (in

groups) • analysis with direct relation to concepts and

theories discussed in class (e.g. externalities, efficiency)

• best suggest a topic yourselves, if not –suggestions from me

E.g.: cigarettes are subject to excise tax, restrictions concerningadvertisement, sale, consumption etc. Which of theseregulations, if any, should also concern e-cigarettes?

Example of an exam questionAssume: goods x, y; consumers A, M; totalendowment of good x equals that of y; A’spreference: U=min{x,y}, M’s preference: U=max{x,y}. In an Edgeworth Box the set of Pareto-efficientallocations will consist of:a. Two diagonals.b. One of the diagonals.c. The entire diagram (box).d. The diagonals and the outer borders of the

diagram (box).e. The outer borders of the diagram (box).

Readings

Varian H.R. (1999), Intermediate Microeconomics– A Modern Approach, 5th ed. (or more recenteditions)

Additional handbooks: Borland (2008); Mansfieldand Peoples (2003); Estrin, Laidler, Dietrich (2008); Pindyck and Rubinfeld (2004); Schotter(2009)…

Workouts: Bergstrom and Varian (1993 or later)(in Polish: Czarny and Nojszewska, Laidler and Estrin)

Reservation price

Reservation price – the highest price thatthe buyer is willing to pay or the lowest pricethat the seller is willing to accept

Having the possibility to buy or sell at the reservation price we are indifferent.

Reservation prices determine the shape of demand and supply curves.

Supply

Changes in supply (supplied quantities) –movement along the supply curve caused by price changes

Changes of the supply – shifts of the supplycurve caused by e.g. changes in the production costs

Demand

Changes in demand (demanded quantities) –movement along the demand curve causedby price changes

Changes of demand – shifts of the demandcurve cause by e.g. changes in consumerincome or preferences

Partial equilibrium

Partial equilibrium – equality of demand and supply in the market of a single good orservice

(partial because we omit interrelationshipsbetween prices and quantities in differentmarkets; general equilibrium will be tackledlater)

Changes of demand and supply

Demand (downward-sloping)↑D (shift to the right) => ↑Q and ↑P↓D (shift to the left) => ↓Q and ↓P

Supply (upward-sloping)↑S (shift to the right) => ↑Q and ↓P↓S (shift to the left) => ↓Q and ↑P

Simultaneous changes of demand and supply

In the case of simultaneous changes of demand and supply their effect on prices and market quantity is determined by:• the size and direction of the changes of demand and supply• the shape of the demand and supply curves

Disequilibrium:excess supply (a supply surplus)

in the market

P’ > P*=> Qs > Qd

=> ↓P=> ↑Qd and ↓Qs

=> equilibrium

P

QQ*

P*

S

D

nadwyżka

P'

Qd Qs

surplus

Disequilibrium:excess demand (a supply deficit)

in the market

P”< P*=> Qd > Qs

=> ↑P=> ↓Qd and ↑Qs

=> equilibrium

P

QQ*

P*

S

Dniedobór

P"

Qs Qd

deficit

Consumer and producer surplus

Consumer surplus (CS) – the total benefit of the consumer from a given good aftersubstracting the costs of buying it. Representedby the area between the demand curve and the market price.

Producer surplus (PS) – the total benefit of the producer from selling a given good aftersubstracting the costs of manufacturing it. Represented by the area above the supply curveand below the market price.

Economic surplus

Economic surplus (ES) – the sum of the consumer surplus and the producersurplus; the sum of the differencesbetween reservation prices of buyers and sellers of consecutive units of a goodexchanged in the market; the differencebetween total social benefits and totalsocial costs

ES is a (simplified) measure of welfare

Optimality criterionPareto optimum – improving the situationof any economic agent must necessarilylead to worsening the situation of anotheragent

(no possibility of Pareto-improvement)

Consumer surplus and producer surplus(perfect competition)

CS

Q

P

S

D

PS

Equilibrium in the Pareto optimum

(Consumer) surplus depends on elasticity (of demand)

P P

Q Q

D D

S S

Relatively high elasticity of demand (~elastic demand)

Relatively low elasticity of demand (~inelastic demand)

BA

Loss of consumer surplus As a result of a higher

equilibrium pricethe consumer

loses A+B, whilethe producer

gains A-C.

C

Deadweight loss resulting from monopoly

Q

AR=D

MR

MC

QC

PC

Pm

Qm

P

Deadweight lossresulting from

monopoly

The case of perfect pricediscrimination

• Every consument faces his or herreservation price.

• Those whose reservation price is higher orequal to marginal cost make a purchase. No deadweight loss compared to perfectcompetition

The case of two-part tariffs

• Lump-sum fee + per-unit charge• (vacuum cleaner + bags, party entrance

fee + drinks etc. )• In the typical case of non-identical

customers, the per-unit price is lower thanwould have been if lump-sum fee was not an option but higher than marginal cost

• Non-zero deadweight loss, but lower thanwould have been without lump-sum fees

Consumer surplus: somealgebraic examples

• Assume Q(p)=a-bp. Then the change in surplusresulting from a change in price from p to r>p is:

• Cobb-Douglas utilityU(x,y)=xay1-a with a budget of m gives demand:x(p)=am/p. Then

∫−

−−=−=−r

p

r

p

prbpratbatdtbta2

)()2

()(222

|

∫ −==r

p

r

ppramtamdt

tam )ln(lnln |

What will follow…?

www.microeconomics.wne.uw.edu.pl