Economics 2: Spring 2014 J. Bradford DeLong ; Maria Constanza Ballesteros ; Connie Min

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Economics 2: Spring 2014 J. Bradford DeLong ; Maria Constanza Ballesteros ; Connie Min http://delong.typepad.com/sdj/econ-2-spring-2014/

Economics 2: Spring 2014: Supply and Demand Algebra: Price Ceilings http://delong.typepad.com/sdj/econ-1-spring-2014/ February 5, 2014, 4-5:30 101 Barker, U.C. Berkeley

Consider a Market in Equilibrium…

Demand: – P = 100-(5/3)Q d Supply: – P = 15Q s Equilibrium: – Q = (100-0)/(15+(5/3) – P=(15/(15+(5/3)))100+ ((5/3)/(15+(5/3)))0 – P = 90, Q = 6

Consider a Market in Equilibrium… Demand: – P = 100-(5/3)Q d Supply: – P = 15Q s Equilibrium: – P = 90, Q = 6 Surplus: – Demanders pay 6x90=540; average value=95; consumer surplus=95x6- 540=30

Consider a Market in Equilibrium… Demand: – P = 100-(5/3)Q d Supply: – P = 15Q s Equilibrium: – P = 90, Q = 6 Surplus: – Consumer surplus = 95x6-540=30 – Suppliers earn 6x90=540; averge cost=45; producer surplus=540-45x6=270

Consider a Market in Equilibrium… Demand: – P = 100-(5/3)Q d Supply: – P = 15Q s Equilibrium: – P = 90, Q = 6 Surplus: – Consumer surplus = 30 – Producer surplus = 270

The Government Says: This Isnt Fair! The situation: – Demand: P = 100- (5/3)Q d – Supply: P = 15Q s – Equilibrium: P = 90, Q = 6 – Surplus: Consumer = 30; Producer = 270 Why should suppliers get nine times as much surplus? The Westerosi Army needs to buy other things as well! They will have to face the ice zombies!

The Government Imposes a Price Ceiling on What You Can Charge: 60 The situation: – Demand: P = 100- (5/3)Q d – Supply: P = 15Q s – Equilibrium: P = 90, Q = 6 – Surplus: Consumer = 30; Producer = 270 Why should suppliers get nine times as much surplus? The Westerosi Army needs to buy other things as well! They will have to face the ice zombies!

What Happens? The situation: – Demand: P = 100- (5/3)Q d – Supply: P = 15Q s – Equilibrium: P = 90, Q = 6 – Surplus: Consumer = 30; Producer = 270 Why should suppliers get nine times as much surplus? The government imposes a price ceiling of 60

Ladies and Gentlemen, to Your i>Clickers! The situation: Demand: P = 100- (5/3)Q d Supply: P = 15Q s Equilibrium: P = 90, Q = 6 Surplus: Consumer = 30; Producer = 270 A PRICE CEILING OF 60 How many dragon-training flights will be flown with the price ceiling? A. 6 B. 4 C. 24 D. 14 E. None of the above

Ladies and Gentlemen, to Your i>Clickers! The situation: Demand: P = 100-(5/3)Q d Supply: P = 15Q s Equilibrium: P = 90, Q = 6 Surplus: Consumer = 30; Producer = 270 A PRICE CEILING OF 6 How many dragon-training flights will be flown with the price ceiling? A. 6. B. 4. C. 24. D. 14. E. None of the above

Ladies and Gentlemen, to Your i>Clickers! The situation: Demand: P = 100- (5/3)Q d Supply: P = 15Q s Equilibrium: P = 90, Q = 6 Surplus: Consumer = 30; Producer = 270 A PRICE CEILING OF 6 How many dragon-training flights will be flown with the price ceiling? A. 6. [B. 4.] C. 24. D. 14. E. None of the above Why 4? Because only 4 potential riders think its worth showing up at the dragonstrip if you are only going to be paid £60 But then what is the 24 number? Thats how many people show up with plans for training missions…

Is This New Situation a Better Equilibrium? The situation: – Demand: P = 100- (5/3)Q d Supply: P = 15Q s – Price ceiling = 60 Equilibrium: P = 60, Q = 4

Lets Calculate the Surplus… The situation: – Demand: P = 100- (5/3)Q d Supply: P = 15Q s – Price ceiling = 60 Equilibrium: P = 60, Q = 4 Producer Surplus: – 4 missions flown – Whats the average cost?

Ladies, Gentlemen, and Large Intelligent Fire-Breathing Reptiles, to Your i>Clickers… The situation: – Demand: P = 100-(5/3)Q d Supply: P = 15Q s – Price ceiling = 60 Equilibrium: P = 60, Q = 4 Whats the average cost to producers of the four dragon-training missions flown? A. 45 B. 60 C. 30 D. 15 E. None of the above

Ladies, Gentlemen, and Large Intelligent Fire-Breathing Reptiles, to Your i>Clickers… The situation: – Demand: P = 100- (5/3)Q d Supply: P = 15Q s – Price ceiling = 60 Equilibrium: P = 60, Q = 4 Whats the average cost to producers of the four dragon-training missions flown? A. 45. B. 60. C. 30. D. 15. E. None of the above

Ladies, Gentlemen, and Large Intelligent Fire-Breathing Reptiles, to Your i>Clickers… The situation: – Demand: P = 100-(5/3)Q d Supply: P = 15Q s – Price ceiling = 60 Equilibrium: P = 60, Q = 4 Whats the average cost to producers of the four dragon-training missions flown? A. 45. B. 60. [C. 30.] D. 15. E. None of the above Yes: the first mission costs a little more than 0, the last a little less than 60, the average costs 30

Ladies, Gentlemen, and Large Intelligent Fire-Breathing Reptiles, to Your i>Clickers… The situation: – Demand: P = 100-(5/3)Q d Supply: P = 15Q s – Price ceiling = 60 Equilibrium: P = 60, Q = 4 Average cost: 30 Whats the producer surplus? A. 120 B. 180 C. 270 D. 60 E. None of the above…

Ladies, Gentlemen, and Large Intelligent Fire-Breathing Reptiles, to Your i>Clickers… The situation: – Demand: P = 100- (5/3)Q d Supply: P = 15Q s – Price ceiling = 60 Equilibrium: P = 60, Q = 4 Average cost: 30 Whats the producer surplus? A. 120. B. 180. C. 270. D. 60. E. None of the above…

Ladies, Gentlemen, and Large Intelligent Fire-Breathing Reptiles, to Your i>Clickers… The situation: – Demand: P = 100-(5/3)Q d Supply: P = 15Q s – Price ceiling = 60 Equilibrium: P = 60, Q = 4 Average cost: 30 Whats the producer surplus? [A. 120.] B. 180. C. 270. D. 60. E. None of the above… Producer surplus = (price – average cost)x(units) Producer surpus = (60 – 30) x 4 = 120

Is This New Situation a Better Equilibrium? The old situation: – Demand: P = 100- (5/3)Q d – Supply: P = 15Q s – Equilibrium: P = 90, Q = 6 – Surplus: Consumer = 30; Producer = 270 Impose a price ceiling of 60 – New equilibrium: P = 60, Q = 4 – Reduce producer surplus from 270 to 120

Is This New Situation a Better Equilibrium? The situation: – Demand: P = 100- (5/3)Q d Supply: P = 15Q s – Equilibrium: P = 90, Q = 6 – Surplus: Consumer = 30; Producer = 270 Impose a price ceiling of 60: – New equilibrium: P = 60, Q = 4. Reduce producer surplus from 270 to 120 What happens to consumer surplus?

Calculating Consumer Surplus The situation: – Demand: P = 100-(5/3)Q d Supply: P = 15Q s – Equilibrium: P = 90, Q = 6 – Surplus: Consumer = 30; Producer = 270 Impose a price ceiling of 60: – New equilibrium: P = 60, Q = 4. Reduce producer surplus from 270 to 120 What happens to consumer surplus? Only four of the 24 consumers actually get to fly their planned training mission… How do you select the four?

Calculating Consumer Surplus The situation: – Demand: P = 100-(5/3)Q d Supply: P = 15Q s – Equilibrium: P = 90, Q = 6 – Surplus: Consumer = 30; Producer = 270 Impose a price ceiling of 60: – New equilibrium: P = 60, Q = 4. Reduce producer surplus from 270 to 120 What happens to consumer surplus? Only four of the 24 consumers actually get to fly their planned training mission… How do you select the four? The government asks everybody to raise their hand if they are those who have the four highest willingnesses-to-pay…

Calculating Consumer Surplus The situation: – Demand: P = 100-(5/3)Q d Supply: P = 15Q s – Equilibrium: P = 90, Q = 6. Surplus: Consumer = 30; Producer = 270 Impose a price ceiling of 60: – New equilibrium: P = 60, Q = 4. Reduce producer surplus from 270 to 120 What happens to consumer surplus? Only four of the 24 consumers actually get to fly their planned training mission… How do you select the four? – The government asks everybody to raise their hand if they are those who have the four highest willingnesses-to-pay… Yeah, right, thats really going to work

Some Bureaucratic Process Selects Missions Randomly… The situation: – Demand: P = 100-(5/3)Q d Supply: P = 15Q s – Equilibrium: P = 90, Q = 6. Surplus: Consumer = 30; Producer = 270 Impose a price ceiling of 60: – New equilibrium: P = 60, Q = 4. Reduce producer surplus from 270 to 120 What happens to consumer surplus? Only four of the 24 consumers actually get to fly their planned training mission… How do you select the four? – The government asks everybody to raise their hand if they are those who have the four highest willingnesses-to- pay… Yeah, right, thats really going to work What is the average willingness to pay of the four selected missions going to be?

Gentlebeings, to Your i>Clickers… The situation: – Demand: P = 100-(5/3)Q d Supply: P = 15Q s – Equilibrium: P = 90, Q = 6. Surplus: Consumer = 30; Producer = 270 Impose a price ceiling of 60: – New equilibrium: P = 60, Q = 4. Reduce producer surplus from 270 to 120 Only four of the 24 consumers actually get to fly their planned training mission. Some bureaucrat selects the four randomly… What is the average willingness-to-pay of the four selected missions going to be? A. 95 B. 80 C. 96 2/3 D. 60 E. None of the above

Gentlebeings, to Your i>Clickers… The situation: – Demand: P = 100-(5/3)Q d Supply: P = 15Q s – Equilibrium: P = 90, Q = 6. Surplus: Consumer = 30; Producer = 270 Impose a price ceiling of 60: – New equilibrium: P = 60, Q = 4. Reduce producer surplus from 270 to 120 Only four of the 24 consumers actually get to fly their planned training mission. Some bureaucrat selects the four randomly… What is the average willingness-to-pay of the four selected missions going to be? A. 95. B. 80. C. 96 2/3. D. 60. E. None of the above

Gentlebeings, to Your i>Clickers… The situation: – Demand: P = 100-(5/3)Q d Supply: P = 15Q s – Equilibrium: P = 90, Q = 6. Surplus: Consumer = 30; Producer = 270 Impose a price ceiling of 60: – New equilibrium: P = 60, Q = 4. Reduce producer surplus from 270 to 120 Only four of the 24 consumers actually get to fly their planned training mission. Some bureaucrat selects the four randomly… What is the average willingness-to-pay of the four selected missions going to be? A. 95. [B. 80.] C. 96 2/3. D. 60. E. None of the above The mission planner with the highest willingness-to-pay is just shy of 100. The mission planner with the lowest willingness-to-pay is just more than 60. The average is 80. Why is it kosher to calculate the average of the whole distribution by just adding up the biggest and the smallest and dividing by 2, anyway?

Gentlebeings, to Your i>Clickers… The situation: – Demand: P = 100-(5/3)Q d Supply: P = 15Q s – Equilibrium: P = 90, Q = 6. Surplus: Consumer = 30; Producer = 270 Impose a price ceiling of 60: – New equilibrium: P = 60, Q = 4. Reduce producer surplus from 270 to 120 Only four of the 24 consumers actually get to fly their planned training mission. Some bureaucrat selects the four randomly… What is the average willingness-to-pay of the four selected missions going to be? A. 95. [B. 80.] C. 96 2/3. D. 60. E. None of the above The mission planner with the highest willingness-to-pay is just shy of 100. The mission planner with the lowest willingness-to-pay is just more than 60. The average is 80. Why is it kosher to calculate the average of the whole distribution by just adding up the biggest and the smallest and dividing by 2, anyway? Anybody?

Gentlebeings, to Your i>Clickers… The situation: – Demand: P = 100-(5/3)Q d Supply: P = 15Q s – Equilibrium: P = 90, Q = 6. Surplus: Consumer = 30; Producer = 270 Impose a price ceiling of 60: – New equilibrium: P = 60, Q = 4. Reduce producer surplus from 270 to 120 Only four of the 24 consumers actually get to fly their planned training mission. Some bureaucrat selects the four randomly… Average willingness-to-pay: 80 What is the consumer surplus here?

Gentlebeings, to Your i>Clickers… The situation: – Demand: P = 100-(5/3)Q d Supply: P = 15Q s – Equilibrium: P = 90, Q = 6. Surplus: Consumer = 30; Producer = 270 Impose a price ceiling of 60: – New equilibrium: P = 60, Q = 4. Reduce producer surplus from 270 to 120 Only four of the 24 consumers actually get to fly their planned training mission. Some bureaucrat selects the four randomly… Average willingness-to-pay: 80 What is the consumer surplus here? A. 80 B. 30 C. 160 D. 120 E. None of the above…

Gentlebeings, to Your i>Clickers… The situation: – Demand: P = 100-(5/3)Q d Supply: P = 15Q s – Equilibrium: P = 90, Q = 6. Surplus: Consumer = 30; Producer = 270 Impose a price ceiling of 60: – New equilibrium: P = 60, Q = 4. Reduce producer surplus from 270 to 120 Only four of the 24 consumers actually get to fly their planned training mission. Some bureaucrat selects the four randomly… Average willingness-to-pay: 80 What is the consumer surplus here? A. 80. B. 30. C. 160. D. 120. E. None of the above…

Gentlebeings, to Your i>Clickers… The situation: – Demand: P = 100-(5/3)Q d Supply: P = 15Q s – Equilibrium: P = 90, Q = 6. Surplus: Consumer = 30; Producer = 270 Impose a price ceiling of 60: – New equilibrium: P = 60, Q = 4. Reduce producer surplus from 270 to 120 Only four of the 24 consumers actually get to fly their planned training mission. Some bureaucrat selects the four randomly… Average willingness-to-pay: 80 What is the consumer surplus here? [A. 80.] B. 30. C. 160. D. 120. E. None of the above… Consumer surplus = (avg w-t-p – price) x quantity Avg w-t-p = 80 Price = 60 Quantity = 4 Consumer surplus = 80

Is This New Situation a Better Equilibrium? The old situation: – Demand: P = 100- (5/3)Q d Supply: P = 15Q s – Equilibrium: P = 90, Q = 6. Surplus: Consumer = 30; Producer = 270 Impose a price ceiling of 60: – New equilibrium: P = 60, Q = 4. Reduce producer surplus from 270 to 120 Increase consumer surplus from 30 to 80

Is This New Situation a Better Equilibrium? The old situation: – Demand: P = 100- (5/3)Q d Supply: P = 15Q s – Equilibrium: P = 90, Q = 6. Surplus: Consumer = 30; Producer = 270 Impose a price ceiling of 60: New equilibrium: P = 60, Q = 4. Reduce producer surplus from 270 to 120 Increase consumer surplus from 30 to 80 Reduced total surplus from 300 to 200

Is This New Situation a Better Equilibrium? The old situation: – Demand: P = 100-(5/3)Q d Supply: P = 15Q s – Equilibrium: P = 90, Q = 6. Surplus: Consumer = 30; Producer = 270 Impose a price ceiling of 60: New equilibrium: P = 60, Q = 4. Reduce producer surplus from 270 to 120 Increase consumer surplus from 30 to 80 Reduced total surplus from 300 to 200 Huh!? Where did the extra £100 of surplus go!?!?!?

Huh?! Where Did the Extra £100 of Surplus Go!?!?!? In the old situation: – We matched 6 suppliers with an average cost of 45 to 6 missions with an average willingness-to-pay of 95 – Generated 6 x 50 = 300 of surplus

Huh?! Where Did the Extra £100 of Surplus Go!?!?!? In the old situation: – We matched 6 suppliers with an average cost of 45 – to 6 missions with an average willingness-to-pay of 95 – Generated 6 x 50 = 300 of surplus With the price ceiling: – We match 4 suppliers with an average cost of 30 – To 4 missions with an average willingness-to-pay of 80 – Generate 4 x 50 = 200 of surplus

Huh?! Where Did the Extra £100 of Surplus Go!?!?!? In the old situation: – We matched 6 suppliers with an average cost of 45 – to 6 missions with an average willingness-to- pay of 95 – Generated 6 x 50 = 300 of surplus With the price ceiling: – We match 4 suppliers with an average cost of 30 – To 4 missions with an average willingness-to- pay of 80 – Generate 4 x 50 = 200 of surplus We have made 4 matches instead of 6 We havent improved the average quality of the matches – We have degraded the average willingness-to-pay of demanders – We have improved the cost of suppliers: if we are only going to fly four missions, these are the four who should be flying those missions

An Anti-Krugman and Wells Rant! Here is their analysis of a price ceilingand their equivalent of the -100 loss in surplus that we have calculatedthis yellow triangle. How large is this yellow triangle?

An Anti-Krugman and Wells Rant! How large is this yellow surplus loss Harberger triangle? Well, its base is from 60 to 100; its height is from 4 to 6… Its area is: 2 x 40 x ½ = 40 But we found that the surplus loss was 100…

What Is Going on? Why Do We Find a Surplus Loss of 100 When KW Only Find a Surplus Loss of 20? Their Harberger triangle is 40… But we found that the surplus loss was 100… They assume the high willingness-to-pay demanders get to purchase when there is excess supply …

What Is Going on? Why Do We Find a Surplus Loss of 100 When KW Only Find a Surplus Loss of 20? Their Harberger triangle is 40… But we found that the surplus loss was 100… They assume the high willingness-to-pay demanders get to purchase when there is excess supply … Sometimes that may happen (secondary markets, scalping)… Sometimes that may not happen…

What Is Going on? Why Do We Find a Surplus Loss of 100 When KW Only Find a Surplus Loss of 20? Their Harberger triangle is 40… But we found that the surplus loss was 100… They assume the high willingness-to-pay demanders get to purchase when there is excess supply … Sometimes that may happen (secondary markets, scalping)… Sometimes that may not happen… You need to talk about it, not just to assume it…

So I Think KW Get This Really Wrong! But I havent found anything else in KW that I think is equally really wrong…