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

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

5. Aggregate consumer surplus and the effect of a price change,
per stem
57.8
Influenced by:
Position of the demand curve (revenue)
Elasticity of demand A
= $ million b C
= $0.9 million 32 B
= $23.2 million a 30
Demand
1.16
1.25 Q
, Billion rose stems per year

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.
VCn=MC1+MC2+ … +MCn

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

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

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
, $ per unit A
Supply e 2 p e 2 1 B C MC = p 1 1 E
Demand D MC 2 F Q Q Q
, Units per year 2 1

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 taxisp
, $ per ride p
, $ per ride AC 2 AC 1 M C S 2 A p p E 2 e 2 2 2 p B C S 1 p p 1 e 1 1 E 1 D q q n q Q = n q Q = n q 1 2 2 1 2 2 2 1 1 1
Unrestricted 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 month Q
, 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 Demand21 F
1.16
1.25 Q
, Billion rose stems per year

16. Effects of a price floor
, $ per bushel
Supply A p
= 5.00
Price support D B C e p
= 4.59 1
Demand E F G
3.60 MC Q = = = d
1.9 Q 1
2.1 Q s
2.2 Q g =
0.3 Q
, 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 dollars S a = S 2
Demand
per barrel A e
29.04 2 B C e 1
14.70 S 1
, World price D
8.2
9.0
10.2
11.8
13.1
Imports = 4.9 Q
, Million barrels of oil per day

19. Tariff or quota versus import ban
, 1988 dollars S a = S 2
per barrel A e
29.04 2 e 3
19.70 S 3 t
= 5.00 B D C E e 1
14.70 S 1
, World price F G H
Demand
8.2
9.0
11.8
13.1
Imports = 2.8 Q
, Million barrels of oil per day
With 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.