REVIEW Economic Concepts and Analysis

Benjamin Franklin, London, September 19, 1772 In the affair of so much importance to you, wherein you ask my advice, I cannot, for want of sufficient premises, advise you what to determine, but if you please I will tell you how. When those difficult cases occur, they are difficult, chiefly because while we have them under consideration, all the reasons pro an d con are not present to the mind at the same time; but sometimes one set present themselves, and at other times another, the first being out of sight. Hence the various purposes or inclinations that alternately prevail, and the uncertainty that perplexes us. To get over this, my way is to divide half a sheet of paper by a line into two columns; writing over the one Pro, and over the other Con. Then, during three or four days consideration, I put down under the different heads short hints of the different motives, that at different times occur to me, for or against the measure. When I have thus got them all together in one view, I endeavor to estimate their respective weights; and where I find two, one on each side, that seem equal, I strike them both out. If I find a reason pro equal to some two reasons cons, I strike out three. If I judge some two reasons con, equal to some three reasons pro, I strike out five; and thus proceeding I find at length where the balance lies; and if, after a day or two of further consideration, nothing new that is of importance occurs on either side, I come to a determination accordingly. And, though the weight of reasons cannot be taken with the precision of algebraic quantities, yet when each is thus considered, separately and comparatively, and the whole lies before me, I think I can judge better, and am less liable to take a rash step, and in fact I have found great advantage from this kind of equation, in what may be called moral or prudential algebra.

CONCEPTUALLY BCA IS SIMPLE 1.Decide whose benefits and costs count (standing). 2.Select the portfolio of alternative projects. 3.Catalogue potential (physical) consequences and select measurement indicators. 4. Predict quantitative consequences over the life of the project. 5.Monetize (attach dollar values to) all consequences. 6.Discount for time to find present values. 7.Sum: Add up the benefits and costs. 8.Perform sensitivity analysis. 9.Recommend the alternative with the largest net benefit

THE REALITIES OF DOING BCA Decide whose benefits and costs count. Contentious whether global, national, state, or local perspective is appropriate. Select the portfolio of alternative projects. Potentially infinite, the analyst must select a reasonable subset. Catalogue potential (physical) consequences and select measurement indicators. Difficult to identify specific consequences where unresolved scientific or biological processes are involved. True consequences may be unobservable.

THE REALITIES OF DOING BCA Predict quantitative consequences over the life of the project. Prediction is difficult, especially over long periods for complex systems. Monetize (attach dollar values to) all consequences (W2P). Where there are no appropriate market values, one needs “catalogues” that rarely exist. Often the most important benefits are the most difficult to measure. Discount for time to find present values. Different theories suggest different social discount rates.

THE REALITIES OF DOING BCA Sum: Add up the benefits and costs. Perform sensitivity analysis. Potentially infinite—analyst has to choose a reasonable subset. Recommend the alternative with the largest net social benefits. This is usually easy! It normally does not present any practical analytical difficulties, just political ones. The one exception is where sensitivity analysis shows that NPV estimates are very uncertain.

Linear function

Nonlinear function

●Law of Demand: the inverse relationship between the price of a good and the quantity consumers are willing to purchase. ●As price of a good rises, consumers buy less. ●The availability of substitutes (goods with similar functions) explains this negative relationship. ●Law of Demand: the inverse relationship between the price of a good and the quantity consumers are willing to purchase. ●As price of a good rises, consumers buy less. ●The availability of substitutes (goods with similar functions) explains this negative relationship. Law of Demand

Demand Cell phone service price (monthly bill) Cell phone subscribers (millions) $ $ $ $ Market Demand Schedule $ $ Price (monthly bill) Quantity (millions of subscribers)

Market Demand Schedule Price (monthly bill) Quantity (millions of subscribers) Demand Notice how the law of demand is reflected by the shape of the demand curve. As the price of a good rises … consumers buy less.

Market Demand Schedule Price (monthly bill) Quantity (millions of subscribers) Demand The height of the demand curve at any quantity shows the maximum price that consumers are willing to pay for that additional unit. Here, for the 16th unit … consumers are only willing to pay up to $73 for it. While they would be willing to pay up to $92 for the 7.6 (millionth) unit.

Consider the market for cellular phones service again. This time we will assume that the demand for cell service is more linear and that the market price is $ Demand If the market price is $100, then the 30th unit will not sell because those who demand it are only willing to pay $60 for cellular phone service. At $100, the 17th unit will sell because those who demand it are willing to pay up to $100 for cellular phone service. At $100, the 5th unit will sell because those who demand it are willing to pay up to $133 for cellular phone service. Market price = $100 Market Demand Schedule Price (monthly bill) Quantity (millions of subscribers) 30

Demand Market price = $100 Market Demand Schedule Price (monthly bill) Quantity (millions of subscribers) 30 For all those goods under 17 units, people are willing to pay more than $100 for service. The area, represented by the distance above the actual price paid and below the demand curve, is called consumer surplus. This area represents the net gains to buyers from market exchange. Consumer surplus

Summing Demand for a Private Good

Q a = 20 – P Q b = 25 – P Q c = 15 –.5P Summed Q a + Q b + Q c = 60 – 2.5P

When the market price for gasoline rises from $1.25 to $2.00 a gallon, the quantity demanded in the market falls insignificantly from 8 to 7 million units per week. In contrast, when the market price for tacos rises from $1.25 to $2.00, quantity demanded in the market falls significantly from 8 to 4 million units per week. As taco demand is highly sensitive to price changes, taco demand is described as elastic; as petrol demand is relatively insensitive to price changes, gasoline demand is described as inelastic. Elastic and Inelastic Demand $2.00 $1.25 D Taco market $1.00 Gasoline market D $2.00 $1.25 $1.00 Quantity (tacos) Quantity (gasoline) Price

Elasticity

Various Kinds of Demand Schedules

Demand for Stuff

●Law of Supply: there is a positive relationship between the price of a product and the amount of it that will be supplied. ●As the price of a product rises, producers will be willing to supply a larger quantity. ●Law of Supply: there is a positive relationship between the price of a product and the amount of it that will be supplied. ●As the price of a product rises, producers will be willing to supply a larger quantity. The Law of Supply

Supply Cell phone service supplied to market (millions) $ $ $ $ $ $ Price (monthly bill) Quantity (millions of subscribers) Market Supply Schedule Cell phone service price (monthly bill)

Price (monthly bill) Quantity (millions of subscribers) Supply Notice how the law of supply is reflected by the shape of the supply curve. As the price of a good rises … producers supply more. Market Supply Schedule

Market Supply Schedule Price (monthly bill) Quantity (millions of subscribers) The height of the supply curve at any quantity shows the minimum price necessary to induce producers to supply that next unit to market. Here, for the 11th unit … producers require $73 to induce them to supply it. While they would require $91 to supply the 18.2 (millionth) unit. Supply The height of the supply curve at any quantity also shows the opportunity cost of producing that next unit of the good.

Consider the market for cellular phones service again. This time we will assume that the supply for cell phones is more linear and that the market price is $ If the market price is $100, then the 30th unit will not be produced because the cost of supplying it exceeds the market price of $140. At $100, the 17th unit will be produced because those who supply it are willing to do so for at least $100. At $100, the 5th unit will be produced because those who supply it are willing to do so for at least $60. Market price = $100 Price (monthly bill) Quantity (millions of subscribers) 30 Market Supply Schedule Supply

Market price = $100 Price (monthly bill) Quantity (millions of subscribers) 30 For market outputs of less then 17 units, producers are willing to supply the good for $100. The area represented by the distance above the supply curve but below the actual sales price is called producer surplus. This area is the difference between the minimum amount required to induce producers to supply a good and the amount they actually receive. Producer surplus Supply Market Supply Schedule

When the market price for soft drinks increases from $1.00 to $1.50 a six-pack, the quantity supplied to the market rises from 100 to 200 million units per week. When the market price for physician services rises from $100 to $150 an office visit, the quantity supplied rises from 10 to 12 million visits per week. As soft drink supply is very sensitive to price changes, soft drink supply is described as elastic; as physician services supply is relatively insensitive to price changes, physician services supply is described as inelastic. Elastic and Inelastic Supply $200 $150 S Physician Services market 100 $100 Soft drink market S $2.00 $1.50 $1.00 Quantity (million visits) Quantity (million 6-packs) Price

quantity supplied of 600 … Excess supply Downward This table & graph indicate demand and supply conditions of the market for pocket calculators. Equilibrium will occur where the quantity demanded equals the quantity supplied. If the price in the market differs from the equilibrium level, market forces will guide it to equilibrium. A price of $12 in this market will result in a quantity demanded of 450 … resulting in an excess supply. With an excess supply present, there will be downward pressure on price to clear the market. Quantity demanded = 450 Quantity supplied = 600 Market Equilibrium Price (dollars) Quantity supplied (per day) Quantity demanded (per day) Condition in the market Direction of pressure on price > Price ($) Quantity D S

and quantity demanded of 650 … resulting in excess demand Excess supply Downward A price of $8 in this market will result in quantity supplied of 500 … With an excess demand present, there will be upward pressure on price to clear the market. D S Quantity demanded = 650 Quantity supplied = 500 Market Equilibrium Price (dollars) Quantity supplied (per day) Quantity demanded (per day) Condition in the market Direction of pressure on price > Price ($) Quantity < Excess demand Upward

and quantity demanded of 550 … resulting in market balance. A price of $10 in this market results in a quantity supplied of 550 … Excess supply Downward With market balance present, there will be an equilibrium present and the market will clear. D S Market Equilibrium Price (dollars) Quantity supplied (per day) Quantity demanded (per day) Condition in the market Direction of pressure on price > Price ($) Quantity < Excess demand Upward = Balance Equilibrium Quantity demanded = 550 Quantity supplied = 550

Excess supply Excess demand Excess supply Downward At every price below market equilibrium there is excess demand and there will be upward pressure on the price level. D S Market Equilibrium Price (dollars) Quantity supplied (per day) Quantity demanded (per day) Condition in the market Direction of pressure on price > Price ($) Quantity < Excess demand Upward = Balance Equilibrium At every price above market equilibrium there is excess supply and there will be downward pressure on the price level. It is at equilibrium that prices will rest. Equilibrium price

Market price = $100 Net Gains to Buyers and Sellers Price (monthly bill) Quantity (millions of subscribers) 30 Supply Demand Equilibrium Return again to the market for cell phone service. When the market is in equilibrium – where supply just equals demand – price equals $100. If the area above the market price and below the demand curve is called consumer surplus … and the area above the supply curve but below the market price is called producer surplus … then the combined area is the net gains to buyers and sellers. It is here that all potential gains from production and exchange are realized. Net gains to buyers and sellers

Natural Monopoly I

Natural Monopoly II

Monopoly Revenue

Natural Monopoly III

Benefits from a Subway

Private Good Q = P

Public Good I

Summing Demand for a Public Good Q a = 20 – P, P a = 20 – Q Q b = 25 – P, P b = 25 – Q Q c = 15 –.5P, P c = 30 – 2Q Summed P a + P b + P c = Q

Public Good II P = Q

Public Good III

What Is a FAIR Tax/Price? IF THE LIGHTHOUSE COST $12000? ●Equal share? ●Equal net benefit? ●Equal ratio of MC to MB IF THE LIGHTHOUSE COST $12000? ●Equal share? ●Equal net benefit? ●Equal ratio of MC to MB IF THE LIGHTHOUSE COST $12000 & A + B EACH HAD A BENEFIT LEVEL OF $2000 AND C’s BENFIT WAS $2750?