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Applying the Competitive Model Perloff Chapter 9.

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Presentation on theme: "Applying the Competitive Model Perloff Chapter 9."— Presentation transcript:

1 Applying the Competitive Model Perloff Chapter 9

2 Consumer Welfare Measure how much consumers are affected by shocks which affect the equilibrium. Marginal Willingness to Pay –The maximum amount a consumer will pay for an extra unit. The monetary difference between what a consumer is willing to pay and what the good actually costs.

3 Consumer Surplus 5 4 3 2 1 543210 CS 2 = $1 1 = $2 E 1 = $3E 2 = $3E 3 = $3 Price = $3 a b c q, Magazines per week p, $ per magazine Demand

4 Consumer Surplus with Continuous Demand p 1 p, $ per trading card q 1 q, Trading cards per year DemandExpenditure,E Consumer surplus,CS Marginal willingness to pay for the last unit of output

5 Aggregate consumer surplus and the effect of a price change p,¢ per stem Q, Billion rose stems per year 57.8 32 30 1.1601.25 b a A = $149.64 million B = $23.2 million C = $0.9 million Demand Influenced by: Position of the demand curve (revenue) Elasticity of demand

6 Producer Welfare Difference between the amount that a good sells for and the minimum they have to be paid to produce (avoidable cost). VC: costs that change as output changes. MC: change in cost when output changes by one unit. VC n =MC 1 +MC 2 + … +MC n

7 Producer Surplus 4 3 2 1 43210 PS 2 = $2 3 = $1 1 = $3 MC 2 = $2 3 = $3 4 = $4 1 = $1 p Supply q, Units per week p, $ per unit

8 Producer Surplus in the Market p* p, Price per unit Q * Market supply curve Q, Units per year Market price Variable cost,VC Producer surplus,PS

9 Producer surplus and profit Producer surplus is revenue minus variable costs. In the long run: –all costs are variable –profit is zero –producer surplus is zero –Long run supply curve is horizontal In an increasing cost industry fixed factors earn a return equal to their opportunity cost, rent. –Producer surplus is rent in the long run.

10 Competition maximises welfare How should we measure societies welfare? –W = CS + PS –Weights both producers and consumers equally If output is either more or less than the competitive equilibrium, welfare is reduced.

11 The effect of reducing output on welfare p, $ per unit Q, Units per year Supply Demand p 2 MC 1 =p 1 Q 2 Q 1 e 1 2 e 2 C E B D A F

12 Explanation At competitive equilibrium P = MC Consumers are prepared to pay (value) the last unit produced at exactly what it costs to produce. P > MC consumers increase in satisfaction outweighs producers reduction as output expands. P < MC consumers reduction in satisfaction folowing a reduction in output is less than producers increase.

13 Effect of a restriction on the number of taxis p, $ per ride q 2 q 1 q, Rides per month E 1 D S 1 S 2 E 2 B A C AC 2 1 MC e 2 e 1 p 2 p 1 p 2 p 1 p, $ per ride n 2 q 1 Q 2 = n 2 q 2 Q 1 =n 1 1 Q, Rides per month q

14 Accounting for the effects of a tax Prices to consumers and producers change. PS and CS change. Government raises tax revenues which is spent to raise peoples welfare. W = PS + CS +T

15 Effects of a tax p, ¢ per stem Q, Billion rose stems per year 21 0 = 11 1.161.25 e 1 e 2 D Supply Demand C E B A F 32 30

16 Effects of a price floor p, $ per bushel Q d = 1.9 Q 1 = 2.1 G D Q s = 2.20 Q, Billion bushels of soybeans per year Q g = 0.3 p 1 = 4.59 3.60 Supply Demand Price support e F B MC A C E p = 5.00

17 Trade Policies (imports) Allow free trade (domestic price is the world price). Ban all imports. Set a non-zero import quota. Set a tariff on imported goods.

18 Free trade versus an import ban p, 1988 dollars per barrel 9.010.28.211.813.1 Q, Million barrels of oil per day Imports = 4.9 14.70 0 29.04 S a = S 2 S 1, World price e 2 e 1 D B A C Demand

19 Tariff or quota versus import ban p, 1988 dollars per barrel 9.08.211.813.1 Q, Million barrels of oil per day Imports = 2.8 0 14.70 19.70 29.04 S a = S 2 S 3 Demand S 1, World price e 2 e 3 e 1 = 5.00 F GH B A CE D


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