CDAE 272 International Economic Development Spring 2008

Class 10 Feb. 14 Last class 3.Economic concepts and methods Today: 3.Economic concepts and methods Next class: 3. Economic concepts and methods Quiz 3 (sections 3.1 – 3.6) Reading: Supply and demand ( download from the class website ) Important date: Problem set 2 ( download from the class website Feb. 15 ): due Tuesday, Feb. 26

3. Economic concepts and methods 3.1. An overview of an economic system -- How does it work? 3.2. Demand and supply 3.3. Market equilibrium and price determination 3.4. Excess supply and excess demand 3.5. Consumer and producer surplus 3.6. Impacts of market interventions 3.7. International trade & price determination

Class exercise 2 (Tuesday, Feb. 12) Demand: Q d = P Supply: Qs = P (1) Draw the supply and demand curves on the same graph (2) Derive the equilibrium price (P*) & quantity (Q*) (3) Derive the excess supply (ES) and excess demand (ED) functions: ED = ES = (4) What is the quantity of ED or ES when P = 5?

3.5. Consumer surplus & producer surplus Consumer surplus (CS): -- Class experiments: (a) CS of one consumer = willingness to pay – actual expenditure (b) Total CS in a market = sum of willingness to pay – total expenditure (c) How about more than one product? -- Definition and interpretation (see reading) -- A graphical analysis

3.5. Consumer surplus & producer surplus Consumer surplus (CS): -- How to calculate CS at a particular price level? For example: for Q d = 50 – 0.5 P, what is the CS when P = 60

3.5. Consumer surplus & producer surplus Consumer surplus (CS): -- Change in CS due to a change in price -- A graphical analysis -- How to calculate the change in CS? -- Two-step method: -- One-step method:

Class exercise 3 (Thursday, Feb. 14) Demand: Q d = P (1) Calculate consumer surplus (CS) when P = 10 (2) Calculate the CHANGE IN CS when P increased from $10 per unit to $12 per unit

3.5. Consumer surplus & producer surplus Producer surplus (PS): -- A class experiment -- Definition and interpretation (see reading) -- A graphical analysis -- How to calculate PS at a particular price level? For example: for Q s = P, what is the PS when P = 80?

3.5. Consumer surplus & producer surplus Producer surplus (PS): -- Change in PS due to a change in price -- A graphical analysis -- How to calculate the change in PS due to a change in price? -- Two-step procedure -- One-step procedure

3.5. Consumer surplus & producer surplus Measurement of total welfare or economic efficiency -- The sum of CS and PS can be used to measure the total welfare -- The sum of CS and PS is at the maximum level when the market is at equilibrium

3.6. Market interventions Major market interventions: -- Floor price -- Ceiling price -- Sales tax -- Price subsidy

3.6. Market interventions Impacts of a floor (minimum) price (P F ) -- No effect when P F < P* ( note that P* is the market equilibrium price ) -- Many effects when P F > P* -- Increase in market price -- A surplus in the market -- Consumers: worse off due to a higher price (a decrease in CS) -- Producers: -- Better off or worse off ( PS may increase or decrease ) -- Even if producers as a group are better off, not every producer is directly better off -- Examples:

3.6. Market interventions Impacts of a ceiling (maximum) price (P C ) -- No effect when P C > P* ( note that P* is the market equilibrium price ) -- Many effects when P C < P* -- decrease in market price -- A shortage in the market -- Producers: worse off due to a lower price (a decrease in PS) -- Consumers: -- Better off or worse off ( CS may increase or decrease ) -- Even if consumers as a group are better off, not every consumer is directly better off -- Examples: