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DEMAND Substitute slices of pizza for bottles. MARKET DEMAND Substitute slices of pizza for bottles. SUPPLY Substitute slices of pizza for bottles. MARKET SUPPLY Substitute slices of pizza for bottles. MARKET EQUILIBRIUM Substitute slices of pizza for bottles. Q demanded = Q supplied. - PowerPoint PPT Presentation
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DEMANDSubstitute slices of pizza for bottles
MARKET DEMANDSubstitute slices of pizza for bottles
SUPPLY Substitute slices of pizza for bottles
MARKET SUPPLY Substitute slices of pizza for bottles
MARKET EQUILIBRIUM Substitute slices of pizza for bottles
Qdemanded = Qsupplied
“Economic Efficiency”How demonstrate this?
Welfare Economics
Two ways to look @ Demand Curve
Quantity
Price
Quantity
Price
“Willingness to Pay”
“Willingness to Purchase”
$2
3 3
$2
D D
“Willingness to Pay”
Quantity
PricePrice willing to pay is a measure of the benefit received
Because we are examining the last coke purchased, we are measuring the “Marginal Benefit” received from the last coke
MARGINAL BENEFIT
Quantity
Price
$1
D = MB
S
Consumer Surplus
Quantity
Price Total of all marginal Benefits = Total Consumer Benefit
$1
CONSUMER SURPLUS
D = MB
Producer Surplus
Quantity
Price
$1
Producer Surplus
Quantity
Price
$1
PRODUCER SURPLUS
S = MC
Quantity
Price
$1
PRODUCER SURPLUS
S = MC
Total Social Surplus
Quantity
Price
$1
PRODUCER SURPLUS
CONSUMER SURPLUS
TOTAL SOCIAL SURPLUS
Proving “Efficiency” of Markets
Quantity
Price
$1
PRODUCER SURPLUS
CONSUMER SURPLUS
$2 Reduction in Total Social Surplus
Proving “Efficiency” of Markets
Quantity
Price
$1PRODUCER SURPLUS
CONSUMER SURPLUS
D = MB
S = MC MC > MB
Reduces total Social Benefit
Maximum Social Benefit@ Market Equilibrium
Quantity
Price
$1PRODUCER SURPLUS
CONSUMER SURPLUS
D = MB
S = MC
“Efficiency of Markets”
What Have We Proven?
Given 1. Society’s Demand
• reflection (measurement) of how it values things
• ie, how “willing to pay”
2. Costs of Producing
Then can not achieve
Social Benefit, or happiness by
Or quantity producedQuantity
Price
$1PRODUCER SURPLUS
CONSUMER SURPLUS
D = MB
S = MC
Maximum Social Benefit@ Market Equilibrium
Quantity
Price
$1PRODUCER SURPLUS
CONSUMER SURPLUS
D = MB
S = MC
“Efficiency of Markets”
But,
What is Missing in this picture?
Other Costs? Supply curve based on Production Costs– Labor, materials,
depreciation– “write a check”
“Internal” Costs
BUT also
Environmental CostsPollution of air & water, loss of
wetlands, soil damage from Irrigation
“External” to firm producing
But, “Real” costs to societyQuantity
Price
$1
S = MC
ATCMC
EXTERNAL COSTS
How Value ?– Chpt 6– Assume we have their
value
Add to Firm’s Existing Costs
New EquilibriumHigher Price
Lower Quantity
Quantity
Price
p1
S = MC
S’ = MSC
D
q1
P2
q2
How Achieve Lower Quantity?
Need Mechanism to Internalize “external” costs
1.Tax “market” based
solution
Quantity
Price
p1
S = MC
S’ = MC + tax = MSC
q1
P2
q2
How Achieve Lower Quantity?
2. Government Regulation
Both 1 & 2 are mechanisms to internalize “external” costs
Quantity
Price
p1
S = MC
S’ = MSC
q1q2
Market Equilibrium & “Efficiency”
Quantity
Price
$1PRODUCER SURPLUS
CONSUMER SURPLUS
D = MB
S = MC
Marginal “private” benefits
Accruing to owner or buyer
Other Benefits?Third Party Benefits(people not involved in
market transaction)
• People living around– airports– universities– parks
“Social Benefits”
EXTERNAL BENEFITS(external to the market)
How value?Chpt 6
How Achieve larger Q?Quantity
Price
$1PRODUCER SURPLUS
CONSUMER SURPLUS
D = MPBMarginal private benefits
S = MC
q1 q2
D’ = MSB
Market Equilibrium & “Efficiency”
How Achieve larger Q?Need Mechanism
to Internalize “external” benefits
Cost to Supply the
good:Tax breaksSubsidies
airportsland preservesparks
Quantity
Price
P1PRODUCER SURPLUS
CONSUMER SURPLUS
D = MB
S = MC
P2
q1 q2
Figure 3-1: Automobile Market with External Costs
Figure 3-2: Automobile Market with Pollution Tax
Figure 3-3: A Positive Externality
Figure 3-4: A Subsidy for Open and Rural Land Use
Figure 3-6: Welfare
Analysis of the
Automobile Market with
Pollution Costs
“Efficiency” with Externalities
Quantity
Price
D = MpB
S = MpC
the case of “Optimal” pollution
S’ w/ external social costs
p0
q0q1
Up to q1 pollution permitted
Social benefits of driving
> combined costs of production & pollution
Implication of demand for cars? “optimal pollution
permitted.
Ironic conclusion of Traditional Environmental Econ based on Neoclass market economics
We’ve used econ theory to prove pollution OK!
Quantity
Price
D = MpB
S = MpC
S’ w/ external social costs
p0
q0q1
D’
Lecture 4 Discussion Question
Should our goal be to reduce pollution by 50%, 75%, or 100% ??
Explain your answer.
Quantity
Price
$1PRODUCER SURPLUS
CONSUMER SURPLUS
D = MB
S = MC
Quantity
Price Total of all marginal Benefits = Total Consumer Benefit
ATCMC
Figure 3-5: Welfare
Analysis of the
Automobile Market