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ECON 1000 Quiz: Micro4th ppt notes ch7
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Department
Economics
Course Code
ECON 1000
Professor
Avi Cohen

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▪ Welfare Economics ▪ Recall, the allocation of resources refers to: • how much of each good is produced • which producers produce it • which consumers consume it ▪ Welfare economics: the study of 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? ▪ WTP and the Demand Curve Derive the demand schedule: ▪ WTP and the Demand Curve ▪ About the Staircase Shape… This D curve looks like a staircase with 4 steps – one per buyer. ▪ WTP and the Demand Curve At any Q, the height of the D curve is the WTP of the marginal buyer, the buyer who would leave the market if P were any higher. ▪ Consumer Surplus (CS) Consumer surplus is the amount a buyer is willing to pay minus the buyer actually pays: CS = WTP – P ▪ CS and the Demand Curve ▪ CS and the Demand Curve ▪ CS and the Demand Curve ▪ CS with Lots of Buyers & a Smooth D Curve At Q = 5 (thousand), the marginal buyer is willing to pay $50 for pair of shoes. Suppose P = $30. Then his consumer surplus = $20. ▪ CS with Lots of Buyers & a Smooth D Curve CS is the area b/w P and the D curve, from 0 to Q. Recall: area of a triangle equals ½ x base x height Height of this triangle is $60 – 30 = $30. So, CS = ½ x 15 x $30 = $225. ▪ How a Higher Price Reduces CS If P rises to $40, CS = ½ x 10 x $20 = $100. Two reasons for the fall in CS. ▪ Consumer surplus A. Find marginal buyer’s WTP at Q = 10. B. Find CS for P = $30. ▪ Answers A. At Q = 10, marginal buyer’s WTP is $30. B. CS = ½ x 10 x $10 = $50 ▪ 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. ▪ Cost and the Supply Curve ▪ Cost and the Supply Curve ▪ Cost and the Supply Curve ▪ Producer Surplus ▪ Producer Surplus and the S Curve ▪ PS with Lots of Sellers & a Smooth S Curve Suppose P = $40. At Q = 15(thousand), the marginal seller’s cost is $30, and her producer surplus is $10. ▪ PS with Lots of Sellers & a Smooth S Curve PS is the area b/w P and the S curve, from 0 to Q. The height of this triangle is $40 – 15 = $25. So, PS = ½ x b x h = ½ x 25 x $25 = $312.5 ▪ How a Lower Price Reduces PS If P falls to $30, PS = ½ x 15 x $15 = $112.5 Two reasons for the fall in PS. ▪ Producer Surplus A. Find marginal seller’s cost at Q = 10. B. Find PS for P = $20. ▪ Answers A. At Q = 10, marginal cost = $20 B. PS = ½ x 10 x $20 = $100 ▪ What Do CS, PS, and Total Surplus Measure? CS = (value to buyers) – (amount paid by buyers) CS measures the benefit buyers receive from participating in the market. PS = (amount received by sellers) – (cost to sellers) PS measures the benefit sellers receive from participating in the market. Total surplus = CS + PS TS measures the total gains from trade in a market. ▪ 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. ▪ Measuring Society’s Well-Being Total surplus = CS + PS = (value to buyers) – (amount paid by buyers) + (amount received by sellers) – (cost to sellers) = (value to buyers) – (cost to sellers) ▪ Market Efficiency An allocation of resources is efficient if it maximizes total surplus. Efficiency means: • Raising or lowering the quantity of a good would not increase total surplus. • The goods are being produced by the producers with lowest cost. • The goods are being consumed by the buyers who value them most highly. ▪ Market Efficiency ▪ Efficiency means making the pie as big as possible. ▪ In contrast, equity refers to whether the pie is divided fairly. ▪ What’s “fair” is subjective, harder to evaluate. ▪ Hence, we focus on efficiency as the goal, even though policymakers in the real world usually care about equity, too. ▪ Evaluating the Market Equilibrium Market eq’m: P = $30 Q = 15,000 Total surplus = CS + PS Is t
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