Presentation on theme: "Applying the Competitive Model"— Presentation transcript:
1 Applying the Competitive Model Perloff Chapter 9
2 Consumer WelfareMeasure how much consumers are affected by shocks which affect the equilibrium.Marginal Willingness to PayThe 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 p , $ per magazine a 5 b 4 CS = $ 2 CS = $ 1 c 3 Price=$32E=$3E=$3E=$3Demand123112345q, Magazines per week
4 Consumer Surplus with Continuous Demand , $ pertrading cardConsumersurplus,CSp1Expenditure,EDemandMarginal willingness topay for the last unit of outputqq, Trading cards per year1
5 Aggregate consumer surplus and the effect of a price change ,per stem57.8Influenced by:Position of the demand curve (revenue)Elasticity of demandA= $ millionbC= $0.9 million32B= $23.2 milliona30Demand1.161.25Q, Billion rose stems per year
6 Producer WelfareDifference 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.VCn=MC1+MC2+ … +MCn
7 Producer Surplus p , $ per unit Supply 4 p PS = $ 3 PS = $ 2 PS = $ 1 MC=$1MC=$2MC=$3MC=$412341234q, Units per week
8 Producer Surplus in the Market , Price per unitMarket supply curveMarket pricep*Producer surplus,PSVariable cost,VCQ*Q, Units per year
9 Producer surplus and profit Producer surplus is revenue minus variable costs.In the long run:all costs are variableprofit is zeroproducer surplus is zeroLong run supply curve is horizontalIn 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 + PSWeights both producers and consumers equallyIf output is either more or less than the competitive equilibrium, welfare is reduced.
11 The effect of reducing output on welfare , $ per unitASupplye2pe21BCMC=p11EDemandDMC2FQQQ, Units per year21
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 ridep, $ per rideAC2AC1MCS2AppE2e222pBCS1pp1e11E1DqqnqQ=nqQ=nq1221222111Unrestricted market gives a horizontal LRS curve, a shift in demand is met by more taxi firms entering the market.Restrict number of firms to n2, these firms can be persuaded to supply more rides by shifting up the MC curve. Aggregating this together gives S2 as the industry supply curve.Note rent causes AC1 to go to AC2.q, Rides per monthQ, Rides per month
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 Supply A e 32 e B C 30 t = 11 E Demand 21F1.161.25Q, Billion rose stems per year
16 Effects of a price floor , $ per bushelSupplyAp= 5.00Price supportDBCep= 4.591DemandEFG3.60MCQ===d1.9Q12.1Qs2.2Qg=0.3Q, Billion bushels of soybeans per year
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 , 1988 dollarsSa=S2Demandper barrelAe29.042BCe114.70S1, World priceD8.29.010.211.813.1Imports = 4.9Q, Million barrels of oil per day
19 Tariff or quota versus import ban , 1988 dollarsSa=S2per barrelAe29.042e319.70S3t= 5.00BDCEe114.70S1, World priceFGHDemand8.29.011.813.1Imports = 2.8Q, Million barrels of oil per dayWith a quota, the internal price must be at a level sufficient to ensure that the domestic supply plus the quota is enough to meet demand. If there is a shortfall the market price will be competed upwards.