Consumer’s surplus and market
Varian: Intermediate Microeconomics, 8e, chapters 14, 15 and 16
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In this lecture you will learn
• how to measure consumers’ welfare
• how to evaluate the impact of a tax reform
• how to derive a market demand
• what the connection between MR and elasticity of demand is
• what properties has market equilibrium
• how president Obama solved a problem with paparazzi
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Consumer’s surplus
How do we measure consumer’s welfare?
Until now you probably used consumer’s surplus (the area between below
the demand curve and above the price price).
Now we learn two more general methods for measuring welfare:
• compensating variation (CV)
• equivalent variation (EV)
Consumer’s surplus is only a special case of CV and EV.
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Compensating variation (CV)
How much extra money would you need after a price change to be as well
off as you were before the price change?
An alternative definition: What is our net revenue if we compensate a
consumer for a change in price that happened in the past.
Example:
A Czech firm sends an employee to a more expensive country (USA).
• CV: By how much the employee’s salary has to be raised so that she
has the same utility as at the original salary in the CR.
• CV alternatively: What is the firm’s cost of the income compensation
at which the employee has the same utility as with the original salary
in the CR.
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Equivalent variation (EV)
How much extra money would you need before a price change to be just
as well off as you were before the price change?
An alternative definition: What change in welfare would be equivalent to a
change in price from the point of view of the consumer.
Example:
A Czech firm sends an employee to a more expensive country (USA).
• EV: By how much money the employee’s salary has to be reduced so
that she has the same utility as with the original salary in the US?
• EV alternatively: What salary reduction in the CR is equivalent to
the employee working with the Czech salary in the US.
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Example – Cobb-Douglas preferences
Utility function: u(x1, x2) = x
1
3
1 x
2
3
2
Income: m = 90
Price of good 2: p2 = 1
Price of good 1 increases from p∗
1 = 1 to ˆp1 = 2
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Example – Cobb-Douglas preferences
Utility function: u(x1, x2) = x
1
3
1 x
2
3
2
Income: m = 90
Price of good 2: p2 = 1
Price of good 1 increases from p∗
1 = 1 to ˆp1 = 2
What is CV and EV?
The optimal bundle at p∗
1 = 1:
(x∗
1 , x∗
2 ) =
m
3p∗
1
,
2m
3p2
= (30, 60)
The optimal bundle at ˆp1 = 2:
(ˆx1, ˆx2) =
m
3p∗
1
,
2m
3p2
= (15, 60)
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Example – Cobb-Douglas preferences (CV)
How much extra money would the consumer need at (ˆp1, p2) = (2, 1)
to be just as well of as with the bundle (x∗
1 , x∗
2 ) = (30, 60)?
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Example – Cobb-Douglas preferences (CV)
How much extra money would the consumer need at (ˆp1, p2) = (2, 1)
to be just as well of as with the bundle (x∗
1 , x∗
2 ) = (30, 60)?
What income m∗ would bring her
the original utility u(30, 60)?
m∗
6
1
3 2m∗
3
2
3
= 30
1
3 60
2
3
m∗
≈ 113
Compensating variation:
CV = m∗
− m = 113 − 90 = 23
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Example – Cobb-Douglas preferences (CV)
How much extra money would the consumer need at (ˆp1, p2) = (2, 1)
to be just as well of as with the bundle (x∗
1 , x∗
2 ) = (30, 60)?
What income m∗ would bring her
the original utility u(30, 60)?
m∗
6
1
3 2m∗
3
2
3
= 30
1
3 60
2
3
m∗
≈ 113
Compensating variation:
CV = m∗
− m = 113 − 90 = 23
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Example – Cobb-Douglas preferences (CV)
How much extra money would the consumer need at (ˆp1, p2) = (2, 1)
to be just as well of as with the bundle (x∗
1 , x∗
2 ) = (30, 60)?
What income m∗ would bring her
the original utility u(30, 60)?
m∗
6
1
3 2m∗
3
2
3
= 30
1
3 60
2
3
m∗
≈ 113
Compensating variation:
CV = m∗
− m = 113 − 90 = 23
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Example – Cobb-Douglas preferences (EV)
How much extra money would the consumer need at (p∗
1, p2) = (1, 1),
to be just as well of as with the bundle (ˆx1, ˆx2) = (15, 60)?
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Example – Cobb-Douglas preferences (EV)
How much extra money would the consumer need at (p∗
1, p2) = (1, 1),
to be just as well of as with the bundle (ˆx1, ˆx2) = (15, 60)?
What income ˆm would bring her
the original utility u(15, 60)?
ˆm
3
1
3 2 ˆm
3
2
3
= 15
1
3 60
2
3
ˆm ≈ 71
Equivalent variation:
EV = m − ˆm = 90 − 71 = 19
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Example – Cobb-Douglas preferences (EV)
How much extra money would the consumer need at (p∗
1, p2) = (1, 1),
to be just as well of as with the bundle (ˆx1, ˆx2) = (15, 60)?
What income ˆm would bring her
the original utility u(15, 60)?
ˆm
3
1
3 2 ˆm
3
2
3
= 15
1
3 60
2
3
ˆm ≈ 71
Equivalent variation:
EV = m − ˆm = 90 − 71 = 19
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Example – Cobb-Douglas preferences (EV)
How much extra money would the consumer need at (p∗
1, p2) = (1, 1),
to be just as well of as with the bundle (ˆx1, ˆx2) = (15, 60)?
What income ˆm would bring her
the original utility u(15, 60)?
ˆm
3
1
3 2 ˆm
3
2
3
= 15
1
3 60
2
3
ˆm ≈ 71
Equivalent variation:
EV = m − ˆm = 90 − 71 = 19
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Compensating vs. equivalent variation
CV and EV = two ways of measuring the vertical distance between the ICs
=⇒ usually CV = EV (e.g. in the previous example).
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Compensating vs. equivalent variation
CV and EV = two ways of measuring the vertical distance between the ICs
=⇒ usually CV = EV (e.g. in the previous example).
Exception: quasilinear preferences – the vertical distance among ICs is the
same for all relative prices =⇒ CV = EV (see the graph below).
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Consumer’s surplus – quasilinear preferences
Consumer buys a discrete good 1 and a composite good 2 and has
a quasilinear utility function u(x1, x2) = v(x1) + x2, where v(x1) = 0.
We can use reservation prices to derive the demand:
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Consumer’s surplus – quasilinear preferences (cont’d)
For each x1 holds: corresponding reservation price = MU1(x1)
Example:
At p = r1 the consumer is indifferent between u(x1, x2) for x1 = 0 and 1:
u(0, m) = u(1, m − r1)
v(0) + m = v(1) + m − r1
r1 = v(1)
At p = r2 the consumer is indifferent between u(x1, x2) for x1 = 1 and 2:
u(1, m − r2) = u(2, m − 2r2)
v(1) + m − r2 = v(2) + m − 2r2
r2 = v(2) − v(1)
The utility from n units of good 1 = r1 + r2 + · · · + rn = v(n).
Example: Utility from n = 2 is r1 + r2 = v(1) + v(2) − v(1) = v(2).
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Consumer’s surplus – quasilinear preferences (cont’d)
Gross surplus GCS = v(n) is the utility from n units of good 1.
Net surplus CS = v(n) − pn is the utility minus the expenditure
on n units of good 1.
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Approximating a continuous demand – quasilinear pref.
Consumer’s surplus associated with a continuous demand can be
approximated by a discrete demand with small changes in quantity.
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A change in consumer’s surplus – quasilinear preferences
Let us assume that the price of a good increases from p to p .
The change in consumer’s surplus ∆CS has a shape of a trapezoid.
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Example – GCS for quasilinear preferences
Consumer buys good 1 and composite good 2
Utility function: u = v(x1) + x2, where v(x1) = 10x1 − x2
1 /2
Budget line: m = p1x1 + x2
What is the gross consumer surplus at p1 = 8?
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Example – GCS for quasilinear preferences
Consumer buys good 1 and composite good 2
Utility function: u = v(x1) + x2, where v(x1) = 10x1 − x2
1 /2
Budget line: m = p1x1 + x2
What is the gross consumer surplus at p1 = 8?
I substitute the BL x2 = m − p1x1 into the utility u: v(x1) + m − p1x1
Looking for x1 that maximizes utility:
MU1(x1) − p1 = 0
p1 = MU1(x1) = 10 − x1
Price of good 1 measures marginal utilities for given quantities x1.
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Example – GCS for quasilinear preferences
Consumer buys good 1 and composite good 2
Utility function: u = v(x1) + x2, where v(x1) = 10x1 − x2
1 /2
Budget line: m = p1x1 + x2
What is the gross consumer surplus at p1 = 8?
I substitute the BL x2 = m − p1x1 into the utility u: v(x1) + m − p1x1
Looking for x1 that maximizes utility:
MU1(x1) − p1 = 0
p1 = MU1(x1) = 10 − x1
Price of good 1 measures marginal utilities for given quantities x1.
GCS – area under the inverse demand for x1 ∈ (0, 2):
• CS (area of the triangle) +p1x1 = 2×2
2 + 8 × 2 = 18
•
2
0 (10 − x1) dx1 = 10x1 − x2
1 /2 = 18
GCS equals to the utility from x1 = 2: v(x1) = 10x1 − x2
1 /2 = 18.
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Example – ∆CS pro quasilinear preferences
Inverse demand of a consumer: p = 10 − x
The price of good decreases from p = 8 to p = 7
What is the change in the net consumer’s surplus (∆CS)?
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Example – ∆CS pro quasilinear preferences
Inverse demand of a consumer: p = 10 − x
The price of good decreases from p = 8 to p = 7
What is the change in the net consumer’s surplus (∆CS)?
The original consumer’s surplus:
Quantity demanded: x = 10 − p = 2
Consumer’s surplus: CS = (10−p )x
2 = (10−8)×2
2 = 2
New consumer’s surplus:
Quantity demanded: x = 10 − p = 3
Consumer’s surplus: CS = (10−p )x
2 = (10−7)×3
2 = 4.5
The change in consumer’s surplus: ∆CS = CS − CS = 2.5
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∆CS, CV and EV for quasilinear preferences
Utility function:u(x1, x2) = v(x1) + x2, price increase from p1 to p1
A change in consumer’s surplus
∆CS = (v(x1) − p1x1) − (v(x1 ) − p1 x1 )
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∆CS, CV and EV for quasilinear preferences
Utility function:u(x1, x2) = v(x1) + x2, price increase from p1 to p1
A change in consumer’s surplus
∆CS = (v(x1) − p1x1) − (v(x1 ) − p1 x1 )
CV: How much to give the consumer at the price p1 to keep her at the
same utility as with the price p1: u(x1 , x2 ) + CV = u(x1, x2)
v(x1 ) + m − p1 x1 + CV = v(x1) + m − p1x1
CV = (v(x1) − p1x1) − (v(x1 ) − p1 x1 ) = ∆CS
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∆CS, CV and EV for quasilinear preferences
Utility function:u(x1, x2) = v(x1) + x2, price increase from p1 to p1
A change in consumer’s surplus
∆CS = (v(x1) − p1x1) − (v(x1 ) − p1 x1 )
CV: How much to give the consumer at the price p1 to keep her at the
same utility as with the price p1: u(x1 , x2 ) + CV = u(x1, x2)
v(x1 ) + m − p1 x1 + CV = v(x1) + m − p1x1
CV = (v(x1) − p1x1) − (v(x1 ) − p1 x1 ) = ∆CS
EV: How much to take from the consumer at the price p1 to keep her at
the same utility as with the price p1 : u(x1, x2) − EV = u(x1 , x2 )
v(x1) + m − p1x1 − EV = v(x1 ) + m − p1 x1
EV = (v(x1) − p1x1) − (v(x1 ) − p1 x1 ) = ∆CS
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SUPPLEMENT: ∆CS, CV and EV for other preferences
Quasilinear preferences (IE = 0), where good 2 is composite:
• Prices = reservation prices = marginal utilities measured in money
• Utility from n units = area below the demand curve for x1 ∈ (0, n)
• ∆CS measures the changes in utility in money units correctly
For quasilinear preferences holds:
∆CS = CV = EV
Other preferences with IE = 0:
• If price of good 1 decreases, I become richer.
• Normal good (IE < 0): demand additional unit for price > MU
(Inferior good (IE > 0): demand additional unit for price < MU)
• Utility from n units = area below the demand curve for x1 ∈ (0, n)
• ∆CS doesn’t measure the changes in utility correctly.
For other preferences with IE = 0 holds:
∆CS = CV = EV
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APPLICATION: Evaluating social policies
If we know the market demand function we can calculate ∆CS.
This approach suffers from two defects:
1 ∆CS = change in welfare only for quasilinear preferences.
2 ∆CS we get an estimate of cost across the population. Important to
know more about the distribution of costs.
King (J Publ Econ, 1983) uses a method similar to EV to evaluate a
proposed reform of tax treatment of housing in Britain.
Results:
• 4 888 out of 5 895 studied households are better off.
• Worse of are especially for very poor households.
This information is crucial for a correct setup of the reform.
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Producer’s surplus PS
Producer’s surplus (PS) = the difference between the revenue from x∗
and the minimal amount at which the producer is willing to sell x∗.
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Producer’s surplus PS
Producer’s surplus (PS) = the difference between the revenue from x∗
and the minimal amount at which the producer is willing to sell x∗.
A rise in price from p to p reduces producer’s surplus by ∆PS.
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Market demand
Market demand = sum of individual demand curves
Example:
Individual demand curves:
• D1(p) = max{20 − p, 0}
• D2(p) = max{2.5 − p/2, 0}
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Market demand
Market demand = sum of individual demand curves
Example:
Individual demand curves:
• D1(p) = max{20 − p, 0}
• D2(p) = max{2.5 − p/2, 0}
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Market demand
Market demand = sum of individual demand curves
Example:
Individual demand curves:
• D1(p) = max{20 − p, 0}
• D2(p) = max{2.5 − p/2, 0}
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Market demand
Market demand = sum of individual demand curves
Example:
Individual demand curves:
• D1(p) = max{20 − p, 0}
• D2(p) = max{2.5 − p/2, 0}
Market demand: D(p) = D1(p) + D2(p) = max{22.5 − 1.5p, 20 − p, 0}
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Price elasticity of demand
Price elasticity of demand measures sensitivity of demand to price.
Two ways of calculating:
1) Percentage change in quantity/percentage change in price:
=
∆q
q
/
∆p
p
=
∆q
∆p
p
q
2) Point elasticity (small changes):
=
dq
dp
p
q
Elasticity often shown in absolute value:
• | | < 1 – inelastic demand
• | | = 1 – unit elastic demand
• | | > 1 – elastic demand
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Example – linear demand function
Linear demand q = a − bp:
=
dq
dp
p
q
= −b
p
q
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Example – linear demand function
Linear demand q = a − bp:
=
dq
dp
p
q
= −b
p
q
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Example – linear demand function
Linear demand q = 100 − p:
=
dq
dp
p
q
=
−p
100 − p
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Example – constant elasticity demand
Demand function q = Ap :
=
dq
dp
p
q
= Ap −1 p
q
=
Ap
Ap
=
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Example – constant elasticity demand
Demand function q = Ap :
=
dq
dp
p
q
= Ap −1 p
q
=
Ap
Ap
=
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Example – constant elasticity demand
Demand function q = 5/p:
=
dq
dp
p
q
= −
5
p2
p
q
= −
5
p2
p2
5
= −1
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Elasticity and marginal revenue
Marginal revenue MR – what is the change in total revenue
if quantity increases by 1 unit:
MR(q) =
dR(q)
dq
=
d(pq)
dq
= p +
dp
dq
q (1)
By expanding (1) by p/p we get the relationship between MR a :
MR(q) = p +
dp
dq
q
p
p
= p 1 +
dp
dq
q
p
= p 1 +
1
= p 1 −
1
| |
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Elasticity and marginal revenue
Marginal revenue MR – what is the change in total revenue
if quantity increases by 1 unit:
MR(q) =
dR(q)
dq
=
d(pq)
dq
= p +
dp
dq
q (1)
By expanding (1) by p/p we get the relationship between MR a :
MR(q) = p +
dp
dq
q
p
p
= p 1 +
dp
dq
q
p
= p 1 +
1
= p 1 −
1
| |
Control questions:
• A monopoly charges a price p = 10 at which | | = 4.
What is monopoly’s marginal revenue?
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Elasticity and marginal revenue
Marginal revenue MR – what is the change in total revenue
if quantity increases by 1 unit:
MR(q) =
dR(q)
dq
=
d(pq)
dq
= p +
dp
dq
q (1)
By expanding (1) by p/p we get the relationship between MR a :
MR(q) = p +
dp
dq
q
p
p
= p 1 +
dp
dq
q
p
= p 1 +
1
= p 1 −
1
| |
Control questions:
• A monopoly charges a price p = 10 at which | | = 4.
What is monopoly’s marginal revenue? MR = 10 × (1 − 1/4) = 7.5
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Elasticity and marginal revenue
Marginal revenue MR – what is the change in total revenue
if quantity increases by 1 unit:
MR(q) =
dR(q)
dq
=
d(pq)
dq
= p +
dp
dq
q (1)
By expanding (1) by p/p we get the relationship between MR a :
MR(q) = p +
dp
dq
q
p
p
= p 1 +
dp
dq
q
p
= p 1 +
1
= p 1 −
1
| |
Control questions:
• A monopoly charges a price p = 10 at which | | = 4.
What is monopoly’s marginal revenue? MR = 10 × (1 − 1/4) = 7.5
• Can a profit-maximizing monopoly choose a price at which | | < 1?
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Elasticity and marginal revenue
Marginal revenue MR – what is the change in total revenue
if quantity increases by 1 unit:
MR(q) =
dR(q)
dq
=
d(pq)
dq
= p +
dp
dq
q (1)
By expanding (1) by p/p we get the relationship between MR a :
MR(q) = p +
dp
dq
q
p
p
= p 1 +
dp
dq
q
p
= p 1 +
1
= p 1 −
1
| |
Control questions:
• A monopoly charges a price p = 10 at which | | = 4.
What is monopoly’s marginal revenue? MR = 10 × (1 − 1/4) = 7.5
• Can a profit-maximizing monopoly choose a price at which | | < 1?
No (It would be Yes only if MC < 0).
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Example of MR – linear demand
Marginal revenue for a linear inverse demand curve p(q) = a − bq:
MR(q) = (R(q)) = ((a − bq) × q) = (aq − bq2
) = a − 2bq
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Example of MR – linear demand
Marginal revenue for a linear inverse demand curve p(q) = a − bq:
MR(q) = (R(q)) = ((a − bq) × q) = (aq − bq2
) = a − 2bq
The marginal revenue curve has the
same vertical intercept as the
demand curve, but has twice the
slope.
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Example of MR – constant elasticity demand
Marginal revenue for a demand with constant elasticity q(p) = Ap :
MR(q) = p 1 +
dp(q)
dq
q
p
= p 1 +
1
= p 1 −
1
| |
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Example of MR – constant elasticity demand
Marginal revenue for a demand with constant elasticity q(p) = Ap :
MR(q) = p 1 +
dp(q)
dq
q
p
= p 1 +
1
= p 1 −
1
| |
Relationship between and MR:
• | | < 1 =⇒ MR < 0
• | | = 1 =⇒ MR = 0
• | | > 1 =⇒ MR > 0
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CASE: Strikes and Profits
In 1979 the United Farm Workers called for a strike against lettuce growers
in California.
Result of the strike:
• production was cut in half
• price of lettuce rose 4x
• profits of farmers doubled
Producers eventually settled the strike. Why?
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CASE: Strikes and Profits
In 1979 the United Farm Workers called for a strike against lettuce growers
in California.
Result of the strike:
• production was cut in half
• price of lettuce rose 4x
• profits of farmers doubled
Producers eventually settled the strike. Why?
They were afraid of the long-run supply
response. Most of the lettuce consumed in
U.S. in winter is grown in California. If the
strike had held for several seasons, lettuce
could be planted in other regions.
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Equilibrium – assumptions
Market demand D(p) = sum of individual
demands of consumers
Market supply S(p) = sum of individual
supplies of firms
Competitive market – each agent takes
prices as outside of her control. The market
price is independent of any one agent’s
actions, but determined by the actions of
all the agents together.
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Equilibrium
At the equilibrium price quantities supplied and demanded are equal:
D(p∗
) = S(p∗
) = q∗
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Example – equilibrium in the market with linear curves
Demand curve: D(p) = a − bp
Supply curve: S(p) = c + dp
What is the equilibrium price and quantity?
In equilibrium supply equals to demand:
D(p) = a − bp∗
= c + dp∗
= S(p)
Equilibrium price:
p∗
=
a − c
b + d
Substituting the price into D(p) or S(p) we get equilibrium quantity:
q∗
=
ad + bc
b + d
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Example – equilibrium in the market with linear curves
Demand curve: D(p) = 100 − 2p
Supply curve: S(p) = 40 + p
What is the equilibrium price and quantity?
In equilibrium supply equals to demand:
D(p) = 100 − 2p∗
= 40 + p∗
= S(p)
Equilibrium price:
p∗
= 20
Substituting the price into D(p) or S(p) we get equilibrium quantity::
q∗
= 40
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Taxes
When a tax is present in a market, there are two prices of interest:
• Demand price pD – the price the demander pays.
• Supply price pS – the price the supplier gets.
The prices differ by the amount of the tax
Quantity tax: pD = pS + t.
Value tax: pD = (1 + τ)pS .
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Example – quantity tax
Equilibrium with quantity tax: q∗ = D(pD) = S(pS ) and pS = pD − t
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Example – quantity tax
Equilibrium with quantity tax: q∗ = D(pD) = S(pS ) and pS = pD − t
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Example – quantity tax with linear curves
Quantity tax: t > 0
Demand curve: D(p) = a − bp
Supply curve: S(p) = c + dp
What determines the division of the tax between demand and supply?
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Example – quantity tax with linear curves
Quantity tax: t > 0
Demand curve: D(p) = a − bp
Supply curve: S(p) = c + dp
What determines the division of the tax between demand and supply?
Equilibrium conditions with quantity tax:
a − bp∗
D = c + dp∗
S and p∗
D = p∗
S + t
Solution – supply a demand prices:
p∗
S =
a − c − bt
b + d
and p∗
D =
a − c + dt
b + d
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Example – quantity tax with linear curves
Quantity tax: t > 0
Demand curve: D(p) = a − bp
Supply curve: S(p) = c + dp
What determines the division of the tax between demand and supply?
Equilibrium conditions with quantity tax:
a − bp∗
D = c + dp∗
S and p∗
D = p∗
S + t
Solution – supply a demand prices:
p∗
S =
a − c − bt
b + d
and p∗
D =
a − c + dt
b + d
Difference between the equilibrium price p∗ = (a − c)/(b + d) and
• supply price p∗
S is bt/(b + d),
• demand price p∗
D is −dt/(b + d).
The division of the tax depends on slopes of supply and demand.
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Passing along a tax
Horizontal supply (d = ∞)
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Passing along a tax
Horizontal supply (d = ∞) – demanders pay the entire tax:
p∗
S = p∗ a p∗
D = p∗ + t.
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Passing along a tax
Horizontal supply (d = ∞) – demanders pay the entire tax:
p∗
S = p∗ a p∗
D = p∗ + t.
Vertical supply (d = 0)
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Passing along a tax
Horizontal supply (d = ∞) – demanders pay the entire tax:
p∗
S = p∗ a p∗
D = p∗ + t.
Vertical supply (d = 0) – suppliers pay the entire tax:
p∗
S = p∗ − t a p∗
D = p∗.
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Passing along a tax
A flat supply – much of the tax can be passed along to demanders.
A steep supply – very little of the tax can be passed along.
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Deadweight loss
Deadweight loss of a tax – net loss in consumer’s and producer’s surplus
due to a reduction in quantity (areas B + D in the graph).
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Pareto efficiency
An economic situation is Pareto efficient if there is no way to make any
person better off without hurting anybody else.
Perfectly competitive market is Pareto efficient at the quantity q∗.
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APPLICATION: Waiting in line
Will waiting in line lead to a Pareto efficient allocation?
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APPLICATION: Waiting in line
Will waiting in line lead to a Pareto efficient allocation?
Is it possible that someone who waited for a ticket might be willing to sell
it to someone who didn’t wait in line?
Yes. Willingness to wait and to pay differ across the population.
Plus waiting in line is a form of deadweight loss—the people who wait in
line pay a “price” but no one receives any benefits from the price they pay.
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APPLICATION: President Obama and paparazzi
President Obama had a problem: paparazzi pursued his daughters.
Paparazzi were motivated by a high price (high demand in the media).
What would be your advice for him?
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APPLICATION: President Obama and paparazzi
President Obama had a problem: paparazzi pursued his daughters.
Paparazzi were motivated by a high price (high demand in the media).
What would be your advice for him?
Reduce demand – the White house offers photographs of the presidential
family for free.
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What should you know?
• The effect of a change in price on welfare
can be measured using CV, EV, or ∆CS.
• CV: What amount compensates the
consumer for a completed change in price.
• EV: What amount is equivalent to the
effect of a planned change in price.
• CS: The difference between the area
below demand and the revenues.
• CV = EV = ∆CS for quasilinear
preferences because they don’t have IE.
Not equal for other preferences.
• PS: The difference between the revenues
and the area below supply.
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What should you know? (cont’d)
• Market demand is a sum of individual
demand curves.
• The more elastic the demand, the higher
the MR at a given price.
• Unregulated market equilibrium is Pareto
efficient – no way to make anyone better
off without hurting anyone else.
• Tax is the difference between the demand
and supply price.
• If a tax affects the quantity, the result is
not Pareto efficient – there is DWL.
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