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Lecture 5

ECON 1B03 Lecture 5: Unit 5 modules

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Hannah Holmes

Unit 5.1 : economic welfare consumer + producer surplus economic welfare - benefits consumers + firms receive by participating in the market (buying + selling) consumer surplus - every buyer in economy is only willing to pay up to certain amount for good or service - willingness - to - say : - max amount that buyer will pay for good - measures value buyer places on good - reservation price - measure in $ - anyone would have paid more than 50$ gets benefit - benefit = willingness to pay — 50$ they actually payed - consumer surplus related to demand curve How a rice change affects consumer surplus - if price drops to 30$ producer surplus - every selling in economy has bottom line - least amount of money it is willing to take in order to producer + offer a good for sale - willingness - to - sell : - lowest price supplier will take to produce good + offer it for sale - sellers reservation price - measure in $ - when seller receives more than they are willing to take , they enjoy a benefit - producer surplus - benefit producer receives when price he receives is greater than his bottom line willingness to sell - producer surplus related to supply curve - supply curve reflects producers cost - area below selling price + above supply curve measures producer surplus in market - producer surplus is not same as producer profit - suppose selling price is 50$ total producer surplus How price change affects producer surplus 5.2 Economic welfare : total surplus + deadweight loss Total surplus - consumer surplus = value to buyer — amount buyer pays - producer surplus = amount sellers receive — cost to sellers - since amount buyer pays = amount sellers receive - total surplus = consumer surplus + producer surplus - total surplus = value to buyers — cost to sellers in summary, free markets do 3 things 1. allocate supply of goods to buyers who value them most highly (have highest willingness to pay) 2. allocate demand for goods to producers who can produce them at least cost 3. produce quantity of goods the maximizes the sum of consumer + producer surplus - total surplus is maximized at equilibrium - equilibrium outcome is efficient outcome deadweight losses - whenever market outcome is one of equilibrium, total surplus is maximized - but its not always the case that the market is in a competitive equilibrium - loss in total surplus happens when quantity traded is less than what would be traded when the market is in competitive equilibrium - consider price of P 1 - at P1only Q i1 traded in market - since only Q1 is produce + traded, all the buyers + sellers who got to buy + sell when Qe was available miss out - pink triangle is surplus no one gets anymore because Qe is not being traded - area of this triangle is deadweight loss, DWL, in welfare Unit 5.3 externalities I Externalities - benefits + costs that arise in market that go uncompensated positive externality - benefit enjoyed by individuals even though they did not pay to receive it - ex : your neighbour goes to garden centre, buys a big tree + you enjoy the shade the tree casts in your yard every afternoon — positive externality consumption - ex : a beekeeper farms bees to produce honey, but bees also pollinate flowers that you enjoy in park next door — positive externality in production negative externality - cost suffered by individuals for which they are not compensated - ex : you neighbour buys a dog from breeder + its barking keeps you awake all night — negative externality in consumption - ex : a local factory emits nasty chemicals into the lake during the production of steel + pollutes water so you cant swim anymore — negative externality in production Marginal private benefit, MPB - max price someone would pay to consume one more unit of good - generally MPB decreases as more of good is consume — downward slopping demand curve - demand curve is also marginal private benefit curve Marginal Private Cost, MPC - to produce more costs producers more ; the supply curve gives the added cost to producers of producing an additional good - supply curve is marginal private cost curve or marginal cost, MC - addition to total cost for firm to produce one more unit of a good - when there are no externalities, in the competitive equilibrium MPB = MPC + the market outcome is efficient - when there are externalities that are unaccounted for, the market outcome is not efficient - negative externalities result in too much output - positive externalities result in too little output produced Negative externalities - production of steel also leads to air + water pollution - cost of steel to society, marginal social cost, MSC, is greater than just private cost borne by producers of steel because we add in cost of accompanying pollution - if factories don't account for externality, there’ll be overproduction + deadweight loss in welfare because real costs outweighs value to society resulting in negative surplus - the government can internalize and externality : - it can tax offenders to reduce negative externalities - it can regulate behaviour ( command + control policy where legislation dictates what can/ cant be done ) - government can also regulate amount of pollution a firm may produce - it may sell permits to firms allowing them a certain amount of pollution - firms which can reduce pollution at lower costs can sell these permits to other firms which can only reduce pollution at high costs + may not even bother to try Unit 5.4 externalities II Positive externalities - consider university education - education benefits not only those who go to school ; all of society benefits by having an educated more productive population - value of education to everyone, marginal social benefit, MSB, is greater than just private benefit to those who receive education - government can internalize externality by subsidizing production of good — get firms to supply more - in case of education, government does in fact subs
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