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Microeconomic Tools
© Copyright Allen C. Goodman, 2006
Supply and Demand
• In microeconomics, we typically have suppliers reacting positively to price, and demanders reacting negatively.
• The two of them combine to provide an equilibrium, that indicates the market quantity and the market price.
100 200 300 400 500
2.50
5.00
7.50
10.00
Price
Apples
Demand for Apples
What affects demand?
• Price of the good
• Prices of other goods
• Consumer income
• Tastes
100 200 300 400 500
2.50
5.00
7.50
10.00
Price
Apples
Demand with higher income
Demand for Apples
Supply of Apples
100 200 300 400 500
2.50
5.00
7.50
10.00
Apples
What affects supply?
• Technological change
• Input prices
• Prices of Production-Related Goods
• Size of the Industry
• Weather
Supply of Apples
100 200 300 400 500
2.50
5.00
7.50
10.00
Apples
Improved technology
Poor weather
Equilibrium of Demand and Supply
100 200 300 400 500
2.50
5.00
7.50
10.00
Apples
SupplyDemand
Equilibrium of Demand and Supply
100 200 300 400 500
2.50
5.00
7.50
10.00
Apples
SupplyDemand
Total Revenue,Total Expenditures
Equilibrium of Demand and Supply
100 200 300 400 500
2.50
5.00
7.50
10.00
Apples
SupplyDemand
Shift in Demand
Equilibrium of Demand and Supply
100 200 300 400 500
2.50
5.00
7.50
10.00
Apples
SupplyDemand Shift in Supply
Equilibrium of Demand and Supply
100 200 300 400 500
2.50
5.00
7.50
10.00
Apples
SupplyDemand Shift in SupplyShift in Demand
What Does Consumer Surplus Measure?
• Consumer surplus, the amount that buyers are willing to pay for a good minus the amount they actually pay for it, measures the benefit that buyers receive from a good as the buyers themselves perceive it.
How the Price Affects Consumer Surplus
Copyright©2003 Southwestern/Thomson Learning
Initialconsumer
surplus
Quantity
(b) Consumer Surplus at Price P
Price
0
Demand
A
BC
D EF
P1
Q1
P2
Q2
Consumer surplusto new consumers
Additional consumersurplus to initial consumers
PRODUCER SURPLUS
• Producer surplus is the amount a seller is paid for a good minus the seller’s cost.
• It measures the benefit to sellers participating in a market.
• Just as consumer surplus is related to the demand curve, producer surplus is closely related to the supply curve.
How the Price Affects Producer Surplus
Copyright©2003 Southwestern/Thomson Learning
Quantity
(b) Producer Surplus at Price P
Price
0
P1B
C
Supply
A
Initialproducersurplus
Q1
P2
Q2
Producer surplusto new producers
Additional producersurplus to initialproducers
D EF
MARKET EFFICIENCY
• Consumer surplus and producer surplus may be used to address the following question:
– Is the allocation of resources determined by free markets in any way desirable?
MARKET EFFICIENCY
Consumer Surplus
= Value to buyers – Amount paid by buyers
and
Producer Surplus
= Amount received by sellers – Cost to sellers
MARKET EFFICIENCY
Total surplus
= Consumer surplus + Producer surplus
or
Total surplus
= Value to buyers – Cost to sellers
EFFICIENCY and EQUITY
• Efficiency is the property of a resource allocation of maximizing the total surplus received by all members of society.
• In addition to market efficiency, a social planner might also care about equity – the fairness of the distribution of well-being among the various buyers and sellers.
MARKET EFFICIENCY
• In addition to market efficiency, a social planner might also care about equity – the fairness of the distribution of well-being among the various buyers and sellers.
Consumer and Producer Surplus in the Market Equilibrium
Copyright©2003 Southwestern/Thomson Learning
Producersurplus
Consumersurplus
Price
0 Quantity
Equilibriumprice
Equilibriumquantity
Supply
Demand
A
C
B
D
E
MARKET EFFICIENCY
• Three Insights Concerning Market Outcomes– Free markets allocate the supply of goods to the
buyers who value them most highly, as measured by their willingness to pay.
– Free markets allocate the demand for goods to the sellers who can produce them at least cost.
– Free markets produce the quantity of goods that maximizes the sum of consumer and producer surplus.
The Efficiency of the Equilibrium Quantity
Copyright©2003 Southwestern/Thomson Learning
Quantity
Price
0
Supply
Demand
Costto
sellers
Costto
sellers
Valueto
buyers
Valueto
buyers
Value to buyers is greaterthan cost to sellers.
Value to buyers is lessthan cost to sellers.
Equilibriumquantity
Consumersurplus
Producer
surplus
Efficiency is all about quantity!
Efficiency is all about quantity!
Utility Analysis?
• In principles courses we often measure utility -- sometimes use “utils” ...
• which is dorky (most of the time).
• For several analyses in urban, we’ll want to use more modern analysis ...
• Ordinal utility
Indifference Curves
Pounds of Spam
Sq. F
eet o
f ho
usin
g
20 40 60 80 100
500
1000
1500
2000
Indifference Curves
Pounds of Spam
Sq. F
eet o
f ho
usin
g
20 40 60 80 100
500
1000
1500
2000 Higher level of utility
How much is bought?
Pounds of Spam
Sq. F
eet o
f ho
usin
g
20 40 60 80 100
500
1000
1500
2000In a monthHousing = $1.00/sq.footSpam = $10/poundIncome = $1500
If price of Spam doubles?
Putting them together
Pounds of Spam
Sq. F
eet o
f ho
usin
g
20 40 60 80 100
500
1000
1500
2000In a monthHousing = $1.00/sq.footSpam = $10/poundIncome = $1500
Putting them together
Pounds of Spam
Sq. F
eet o
f ho
usin
g
20 40 60 80 100
500
1000
1500
2000In a monthHousing = $1.00/sq.footSpam = $10/poundIncome = $1500
U1
U2
Putting them together
Pounds of Spam
Sq. F
eet o
f ho
usin
g
20 40 60 80 100
500
1000
1500
2000In a monthHousing = $0.75/sq.footSpam = $10/poundIncome = $1500
U increases
More housing
More Spam
Why?
A close look at the tangency
Pounds of Spam
Sq. F
eet o
f ho
usin
g
20 40 60 80 100
500
1000
1500
2000
In a monthHousing = $1.00/sq.footSpam = $10/poundIncome = $1500
U2
-U/h = - Mgl. utility of housing
U/s =Mgl. utilityof Spam
-phh
+pss
A close look at the tangency
Pounds of Spam
Sq. F
eet o
f ho
usin
g
20 40 60 80 100
500
1000
1500
2000
U2
-U/h = - Mgl. utility of housing
U/s =Mgl. utilityof Spam
phh
+pss
phh + pss = 0
h/s = -ps/ph
Now, for utility
-MUh/Mus = (U/h)/(U/s)
= h/s
-ps/ph = h/s = -MUs/Muh
or
Muh /ph = MUs/ ps
In a monthHousing = $1.00/sq.footSpam = $10/poundIncome = $1500
MU/p = Utility/$ = Bang for the Buck!
MU/p = Utility/$ = Bang for the Buck!