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Economics Chapter 7.pdf

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Ryerson University
ECN 104
Tsogbadral Galaabaatar

Economics Chapter 7 Recall, the allocation of resources refers to:  how much of each good is produced  which producers produce it  which consumers consume it  Welfare economics studies how the allocation of resources affects economic well-being.  First, we look at the well-being of consumers. Willingness to Pay (WTP) A buyer’s willingness to pay for a good is the maximum amount the buyer will pay for that good. WTP measures how much the buyer values the good. WTP and the Demand Curve Q: If price of iPod is $200, who will buy an iPod, and what is quantity demanded? A: Anthony & Flea will buy an iPod, Chad & John will not. Hence, Q = 2 when P = $200. Derive the demand schedule: WTP and the Demand Curve Consumer Surplus (CS) Consumer surplus is the amount a buyer is willing to pay minus the amount the buyer actually pays: CS = WTP – P Suppose P = $260. Flea’s CS = $300 – 260 = $40. The others get no CS because they do not buy an iPod at this price. Total CS = $40. CS with Lots of Buyers & a Smooth D curve How a higher Price Reduces CS Exercise 1 Consumer Surplus A. Find marginal buyer’s WTP at Q = 10. B. Find CS for P = $30. Suppose P falls to $20. How much will CS increase due to… C. buyers entering the market D. existing buyers paying lower price Answers: A. At Q = 10, marginal buyer’s WTP is $30. B. CS = ½ x 10 x $10 = $50 C. CS for the additional buyers = ½ x 10 x $10 = $50 D. Increase in CS on initial 10 units = 10 x $10 = $100 Cost and the Supply Curve  Cost is the value of everything a seller must give up to produce a good (i.e., opportunity cost).  Includes cost of all resources used to produce good, including value of the seller’s time.  Example: Costs of 3 sellers in the lawn-cutting business. A seller will produce and sell the good/service only if the price exceeds his or her cost. Hence, cost is a measure of willingness to sell. Derive the supply schedule from the cost data: Exercise 2 A. Find marginal seller’s cost at Q = 10. B. Find total PS for P = $20. Suppose P rises to $30. Find the increase in PS due to… C. selling 5 additional units D. getting a higher price on the initial 10 units Answer A. At Q = 10, marginal cost = $20 A. B. PS = ½ x 10 x $20 = $100 P rises to $30. B. PS on additional units = ½ x 5 x $10 = $25 C. Increase in PS on initial 10 units = 10 x $10 = $100 CS, PS, and Total Surplus CS = (value to buyers) – (amount paid by buyers) = buyers’ gains from participating in the market PS = (amount received by sellers) – (cost to sellers) = sellers’ gains from participating in the market Total surplus = CS + PS = total gains from trade in a market = (value to buyers) – (cost to sellers) The Market’s Allocation of Resources  In a market economy, the allocation of resources is decentralized, determined by the interactions of many self-interested buyers and sellers.  Is the market’s allocation of resources desirable? Or would a different allocation of resources make society better off?  To answer this, we use total surplus as a measure of society’s well-being, and we consider whether the market’s allocation is efficient. o (Policymakers also care about equality, though are focus here is on efficiency.) Efficiency An allocation of resources is efficient if it maximizes total surplus. Efficiency means:  The goods are consumed by the buyers who value them
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