1. Microeconomics Lecture 2 Gains from exchange

2. Attention! I am giving each of you a piece of paper. On it is written information useful to you and private. Do NOT show it to anyone else!!!

3. An Imaginary Market Buyers and Sellers. Each Buyer wants to buy one unit. Each Seller wants to sell one unit. Each Buyer has a reservation price for the one unit – this is the maximum that he or she will pay for that one unit. Each Seller has a reservation price for the one unit – this is the minimum that he or she will accept for that one unit.

4. Profit/Surplus The profit/surplus of a buyer is the difference between the reservation price and the price paid. The profit/surplus of a seller is the difference between the price received and the reservation price. Both want to maximise their surplus.

5. A Particular Market Mechanism Bilateral Trades Buyers and Sellers negotiate individually and see if they can agree on a price. Pretend that this is a real experiment and I will pay you your surpluses: So for the buyers I will pay the difference between the reservation price and the price paid; and for the buyers I will pay the difference between the price recieved and the reservation price.

6. Are you ready? You should find someone who will trade with you and you should agree on the price. OK: GO!!! If you agree a trade with someone, come to me and we will write the details on the computer here.

7. BuyerReservation price of buyer SellerReservation price of seller Price agreed Profit of buyer Profit of seller

8. Information not normally available Imagine that there are 10 buyers with a reservation price of £10 10 buyers with a reservation price of £20... 10 buyers with a reservation price of £100 10 sellers with a reservation price of £10 10 sellers with a reservation price of £20... 10 sellers with a reservation price of £100

9. We have studied a particular mechanism What do you think of it? Is it efficient? Is it fair? Let us now study another mechanism – a competitive market – in which a price is chosen such that the demand equals the supply. What are the properties of this mechanism?

10. Properties of Competitive Market Mechanism Total surplus is maximised. With any other single price (not a competive equilibrium price) the total surplus is less. So this mechanism maximises the total surplus extracted from the market. Note however that it says nothing about the distribution of the surplus or whether it is a fair mechanism.

11. Goodbye!! See you tomorrow.