1. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-1 Chapter 3 Supply and demand: an introduction

2. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-2 Supply and demand: an introduction How do consumers get the goods and services they want in the right quantities and qualities? –Some goods and services are allocated by the market forces of supply and demand. Why do some goods and services have shortages or surpluses and others do not? –Some goods and services are regulated by government.

3. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-3 What, how and for whom? Central planning versus the market Three problems all economic systems must address –What should be produced? –How should it be produced? –For whom will it be produced?

4. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-4 What, how and for whom? Central planning versus the market Centralised economic organisations –Agrarian society –Former Soviet Union –Cuba –North Korea –China –Bureaucracy

5. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-5 What, how and for whom? Central planning versus the market Central planning means a small number of individuals address –What  Establish production targets for factories and farms. –How  Plan how to achieve the goals. –For whom  Distribute the goods and services produced.

6. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-6 What, how and for whom? Central planning versus the market Free-market or capitalist economic systems –Individual choices determine:  Which careers to pursue  Which products to produce or buy  When to start and shut down a business  Who gets what, which is decided by individual preferences and purchasing power

7. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-7 Buyers and sellers in markets The market for any good or service consists of all the buyers and sellers of that good or service. –In the market for pizza:  sellers comprise the individuals and firms that sell pizza,  buyers include all individuals who buy, or might buy pizza.

8. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-8 Buyers and sellers in markets The demand curve –A representation of the relationship between the amount of a particular good or service that buyers want to purchase and the price of the good or service.

9. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-9 Buyers and sellers in markets –A property of demand is that as the price of a good or service goes down, the quantity consumers wish to buy will increase. Therefore, the demand curve is downward sloping. –Determinants of a downward-sloping demand curve  Substitution effect  Income effect  Buyer’s reservation price

10. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-10 The daily demand curve for pizza in Perth Price ($ per slice) Quantity (1000s of slices per day) 4 2 3 81216 Demand

11. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-11 Buyers and sellers in markets The substitution effect –The change in the quantity demanded of a good or service caused by a change in price, which results because the good or service becomes more or less expensive relative to other goods and services. The income effect –The change in the quantity demanded of a good or service caused by a change in price, which results because of a change in purchasing power of a buyer’s income.

12. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-12 Buyers and sellers in markets The income effect –The change in the quantity demanded of a good that results because a change in the price of a good changes the buyer’s purchasing power.

13. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-13 Buyers and sellers in markets The reservation price –Based on the cost-benefit principle, if the reservation price (benefit) exceeds the market price (cost) the consumer will purchase the good. –At higher prices, benefit will exceed cost for a smaller quantity than at lower prices. –When the good sells for a high price, it will satisfy the cost- benefit test for fewer buyers than when it sells for a lower price.

14. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-14 Buyers and sellers in markets Price ($ per slice) Quantity (1000s of slices per day) Demand 81216 The buyer’s reservation price: The largest dollar amount the buyer would be willing to pay for a good. 4 2 3

15. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-15 Buyers and sellers in markets Horizontal interpretation Price determines quantity demanded. Price ($ per slice) 4 2 3 81216 Demand Quantity (1000s of slices per day)

16. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-16 Buyers and sellers in markets Vertical interpretation Quantity measures the marginal buyer’s reservation price. Price ($ per slice) 4 2 3 81216 Demand Quantity (1000s of slices per day)

17. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-17 Buyers and sellers in markets The supply curve –A representation of the relationship between the amount of a particular good or service that sellers want to supply and the price of the good or service.

18. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-18 Buyers and sellers in markets Will the opportunity cost of producing additional units of pizza increase or decrease? (Hint: low-hanging- fruit principle) –Sellers must receive a higher price to produce additional units of a product to cover the higher opportunity costs of each additional unit. –Seller’s reservation price: The smallest dollar amount for which a seller would be willing to sell an additional unit, generally equal to marginal cost.

19. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-19 The daily supply curve for pizza in Perth Price ($ per slice) Quantity (1000s of slices per day) 4 2 3 81216 Supply

20. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-20 The daily supply curve for pizza in Chicago Price ($ per slice) Quantity (1000s of slices per day) 4 2 3 81216 Supply Horizontal interpretation Shows the quantity produced for each price.

21. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-21 The daily supply curve for pizza in Chicago Price ($ per slice) Quantity (1000s of slices per day) 4 2 3 81216 Supply Vertical interpretation Shows the marginal cost (reservation price) for producing each additional unit.

22. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-22 Market equilibrium Equilibrium –Any situation in which a system is at rest, for example where neither price nor quantity of a good or service is changing. Market equilibrium –Occurs in a market when all buyers and sellers are satisfied with their respective quantities at the market price. Equilibrium price and equilibrium quantity –The values of price and quantity for which quantity supplied and quantity demanded are equal.

23. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-23 The equilibrium price and quantity of pizza in Perth Price ($ per slice) Quantity (1000s of slices per day) 4 2 3 81216 Supply Demand Equilibrium at $3 Quantity demanded = Quantity supplied

24. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-24 Market equilibrium What would happen if the price of pizza were $4 per slice in the pizza example? What would happen if the price of pizza were $2 per slice in the pizza example?

25. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-25 Excess supply Price ($ per slice) Quantity (1000s of slices per day) 4 2 3 81216 Supply Demand Excess supply = 8000 slices per day

26. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-26 Excess demand Price ($ per slice) Quantity (1000s of slices per day) 4 2 3 816 Excess demand = 8000 slices per day Supply Demand

27. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-27 Points along the demand and supply curves of a pizza market Demand for pizzaSupply of pizza Price ($/slice) Quantity demanded (1000s of slices/day) Price ($/slice) Quantity supplied (1000s of slices/day) 1812 2624 3436 4248

28. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-28 Graphing supply and demand and finding the equilibrium price and quantity Price ($ per slice) Quantity (1000s of slices per day) 5 2 3 4 1 4 102 Demand 0 68 Supply 2.50 5 The equilibrium price = $2.50 The equilibrium quantity = 5

29. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-29 Market equilibrium What do you think? –Is the market equilibrium always an ideal outcome for all market participants?

30. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-30 An unregulated housing market Monthly rent ($/apartment) Quantity (1000s of apartment/ month) 1600 2 Supply Demand What do you think? Is $1600 more than some people can afford?

31. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-31 Rent controls (price ceiling) Monthly rent ($/apartment) 1600 2 Supply Demand 2400 Controlled rent = 800 1 3 0 Excess demand = 200 000 apartments/ month Quantity (1000s of apartment/ month)

32. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-32 Market equilibrium Rent controls reconsidered –Other consequences of rent controls  Maintenance will decline and housing quality will fall  Illegal payments  Creation of co-ops and conversion to condominiums  Reduction in household mobility  Discrimination

33. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-33 Market equilibrium Price ceiling –A maximum allowable price, specified by law. Price floor –A minimum allowable price, specified by law.

34. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-34 Price controls (price floor) Price of sugar ($/kg) Quantity (100 kg of sugar/day) $1.50 2 Supply Demand $2 1 3 0 Excess supply $1.70

35. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-35 Market equilibrium Sugar price controls? –Market responses to a sugar price floor  Stockpiles  Government purchase schemes  Production quotas  Producer buyout schemes

36. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-36 Predicting and explaining changes in prices and quantities Distinguishing between –A change in the quantity demanded  A movement along the demand curve that occurs in response to a change in price. –A change in demand  A shift of the entire demand curve.

37. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-37 An increase in quantity demanded vs. An increase in demand Price ($/can) Quantity (1000s of cans/day) 5 2 3 4 1 4 122 6 0 D D Increase in quantity demanded

38. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-38 An increase in quantity demanded vs. An increase in demand Price ($/can) Quantity (1000s of cans/day) 5 2 3 1 4 12 6 0 Increase in demand D D D’

39. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-39 Shifts in the demand curve Direction of the shifts –Complements: Two goods are complements in consumption if an increase (decrease) in the price of one causes a fall (rise) in demand for the other, as shown by a leftward (rightward) shift in the demand curve for the other. –Substitutes: Two goods are substitutes in consumption if an increase (decrease) in the price of one causes a fall (rise) in demand for the other, as shown by a rightward (leftward) shift in the demand curve for the other.

40. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-40 The effect on the market for tennis balls of a decline in court rental fees Price ($/ball) Quantity (1000s of balls /month) 1.00 S D 40 D’ 1.40 58

41. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-41 Effect on the market for overnight letter delivery of a decline in the price of Internet access Price ($/letter) Quantity (letters/month) P’ P Q’Q S D D’

42. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-42 Predicting and explaining changes in prices and quantities Thinking as an economist –As average income rises why does the price of premium bottled wine go up?

43. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-43 Price ($/bottle) Quantity (bottles/month) D P Q S P’ Q’ D’ Predicting and explaining changes in prices and quantities Wine is a normal good.

44. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-44 Predicting and explaining changes in prices and quantities A change in income –Normal good  One whose demand increases (decreases) when the incomes of buyers increase (decrease). –Inferior good  One whose demand decreases (increases) when the incomes of buyers increase (decrease).

45. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-45 Predicting and explaining changes in prices and quantities Change in the quantity supplied –A movement along the supply curve that occurs in response to a change in price. Change in supply –A shift of the entire supply curve.

46. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-46 The effect on the plastic kayak market of an increase in the price of plastic Price ($/kayak) Quantity (kayaks/month) 1200 100 S D 1600 80 S’

47. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-47 Predicting and explaining changes in prices and quantities What do you think? –Does the increase in the cost of plastic have any effect on the demand curve for kayaks?

48. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-48 The effect on the market for new houses of a decline in carpenters’ wage rates Price ($1000/house) Quantity (houses/month) 220 40 D S 190 50 S’

49. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-49 Why do students’ major assignments go through so many more revisions today than in the 1970s? Price ($/revision) Quantity (millions of revisions per year) 55 12 D S 7.50 36 S’

50. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-50 Predicting and explaining changes in prices and quantities Other determinants of supply –Weather –Expectations –Number of sellers

51. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-51 Price Quantity P P’ QQ’ S D’ D An increase in demand will lead to an increase in both the equilibrium price and quantity. Four simple rules of the effects of supply and demand shifts: I

52. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-52 Price Quantity P’ P Q’Q S D D’ A decrease in demand will lead to a decrease in both the equilibrium price and quantity. Four simple rules of the effects of supply and demand shifts: II

53. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-53 P’ P QQ’ S’ D S Price Quantity An increase in supply will lead to a decrease in the equilibrium price and an increase in the equilibrium quantity. Four simple rules of the effects of supply and demand shifts: III

54. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-54 P P’ Q’Q S D S’ Price Quantity An decrease in supply will lead to an increase in the equilibrium price and a decrease in the equilibrium quantity. Four simple rules of the effects of supply and demand shifts: IV

55. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-55 The effects of simultaneous shifts in supply and demand (a) Price ($/bottle) Millions of bottles/month P Q S D P’ Q’ D’ S’ S’ after the price of bottles falls. D’ after the disclosure that bottled water is no more pure than ordinary tap water. The market for bottled water

56. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-56 The effects of simultaneous shifts in supply and demand (b) Price ($/bottles) Millions of bottles per month P Q S D P’ Q’ D’ S’ The market for bottles S’ after the price of bottles falls. D’ after the disclosure that bottled water is no more pure than ordinary tap water.

57. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-57 The effects of simultaneous shifts in supply and demand Observations: –(a) When demand falls and supply increases, the equilibrium price falls and the equilibrium quantity falls if the demand curve shifts more than the supply curve. –(b) When demand falls and supply increases, the equilibrium price falls and the equilibrium quantity rises if the demand curve shifts less than the supply curve.

58. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-58 Predicting and explaining changes in prices and demand Thinking as an economist –Why do the prices of some goods, like airline tickets to Fiji, go up during the months of heaviest consumption, while other goods, such as cherries, go down?

59. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-59 Seasonal variation in air travel and cherry markets Price ($/ticket) 1000s of tickets/day S DwDw DsDs QsQs QwQw PsPs PwPw High consumption due to high demand

60. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-60 Seasonal variation in air travel and cherry markets Price ($/kg) 100s of kg/ day SWSW D QWQW QSQS PsPs PwPw S High consumption due to high supply

61. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-61 Markets and social welfare What do you think? –When are the prices and quantities determined in market equilibrium socially optimal, in the sense of maximising total economic surplus?

62. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-62 Markets and social welfare Cash on the table –Assume  All exchange is purely voluntary. –If so  The buyer’s reservation price exceeds the seller’s reservation price and both the buyer and seller receive an economic surplus.

63. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-63 Markets and social welfare Cash on the table –Buyer’s surplus  The difference between the buyer’s reservation price and the price she or he actually pays. –Seller’s surplus  The difference between the price received by the seller and his or her reservation price. –Total surplus  The difference between the buyer’s reservation price and the seller’s reservation price.

64. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-64 Price controls in the pizza market Price ($ per slice) Quantity (1000s of slices per day) S D 3 12 4 2 816 Assume Buyer’s reservation P = $4 Seller’s reservation P = $2 Pizza sells for $3 Buyer’s surplus: $4 - $3 = $1 Seller’s surplus: $3 - $2 = $1 Total surplus: $4 - $2 = $2

65. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-65 Price controls in the pizza market Price ($ per slice) Quantity (1000s of slices per day) Excess demand = $8000 slices/day D 4 2 3 81216 Assume price controls = $2 Quantity supplied falls to 8000. Buyer’s reservation price ($4) is greater than seller’s ($2). Both would benefit from additional production. There is CASH ON THE TABLE. S

66. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-66 Markets and social welfare Cash on the table –Economic metaphor for unexploited gains from exchange.

67. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-67 Markets and social welfare Smart for one, dumb for all –Socially optimal quantity: The quantity of a good that results in the maximum possible economic surplus from producing and consuming the good. –The socially optimal quantity occurs when MC = MB. –Economic efficiency occurs when all goods and services are produced and consumed at their respective socially optimal levels.

68. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-68 Markets and social welfare –Achieving economic efficiency  Maximises the economic surplus.  Increases the economic pie. –When is the market equilibrium efficient?  When all costs of producing the good or service are borne directly by the seller.  When all benefits from the good or service accrue directly to buyers.

69. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-69 Markets and social welfare –Inefficient market equilibrium  When some costs of production fall on people other than those who sell the good or service.  When some benefits from the good or service accrue to people who did not buy the good or service.

70. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-70 Markets and social welfare –Example: Pollution  The market is in equilibrium: MC = MB  MC however underestimates the cost to society of producing the good.  Therefore, the market produces more than the efficient amount and there is no incentive for producers and consumers to alter their behaviour.

71. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-71 Markets and social welfare Example: Vaccinations  The market is in equilibrium: MC = MB.  MB underestimates the benefits to society of consuming the vaccinations.  The market produces less than the efficient amount of vaccinations and there is no incentive for producers and consumers to alter their behaviour.

72. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 3-72 Markets and social welfare Smart for one, dumb for all –In these markets  Buyers and sellers are behaving rationally.  Market equilibrium exists.  There are no unexploited opportunities for individuals.  Economic surplus is not maximised.