The Allocation Problem and Price Mechanism in Economics
The Allocation Problem
and the Price Mechanism
Economic Problems and Policy
Analysis
Helios Herrera
January 2014
Plan of the day
Today
•
Little refresh of Pareto Efficiency
•
Allocation problem and Price Mechanism
•
Exercises
The Allocation Problem:
•
Opportunity cost and marginal rate of substitution
•
Production possibilities frontier and resource
scarcity
•
Maximazion of well-being under resource
constraints
•
Impact of technological change
The Price Mechanism:
•
How demand curve reveals preferences
•
How the supply curve represents the marginal cost
of production
•
Consumers and producers surpluses
•
Discuss the roles of price mechanism
After this session
Maximizing Society’s Welfare
•
Let’s go back to last week’s lecture
–
In order to maximize a group’s welfare, it must
be impossible to increase someone’s welfare
without decreasing someone else’s welfare
–
In an efficient
allocation
of goods, no one can
be made better off without making someone
else worse off
Examples:
Classrooms, smoking, etc..
The CHUM proposes to rent its very
expensive scanner:
At a good price to private companies
Between 4pm and 9pm
Note: this is no working time for
CHUM
An example
Patients at
CHUM
R0
R2
R1
Satisfaction of
other patients
What is the most
plausible scenario?
1.
R0
R1
2.
R0
R2
3.
R2
R1
Let’s vote!
Renting out the scanner
Patients at
CHUM
R0
R2
R1
Satisfaction of
other patients
What is the most
plausible scenario?
1.
R0
R1
2.
R0
R2
3.
R2
R1
Let’s vote!
Renting out the scanner
C
h
r
i
s
C
h
r
i
s
t
i
e
A bridge too far?
A
s
c
a
n
d
a
l
t
h
r
e
a
t
e
n
s
t
h
e
N
e
w
J
e
r
s
e
y
g
o
v
e
r
n
o
r
’
s
n
i
c
e
-
t
h
u
g
i
m
a
g
e
In September the Port Authority closed two lanes of
traffic on a bridge that links New Jersey with
Manhattan for a so-called “traffic study”. The
weeklong traffic jam that resulted was hardest on
commuters in Fort Lee, a nearby suburb run by
Mark Sokolich, a Democrat who refused to endorse
Mr Christie in the election. Besides being a
nuisance, the gridlock also reportedly kept
ambulances from reaching an unconscious 91-year-
old woman, who later died. State Democrats cried
foul. On January 8th they found their smoking gun:
e-mails from Bridget Anne Kelly, a senior Christie
staffer, to the governor’s friends at the Port
Authority signalling the closures. “Time for some
traffic problems in Fort Lee,” she wrote.
Conditions to Maximize
Social Welfare
•
Let’s start with a practical example: vanilla
ice cream and chocolate ice cream.
•
In order to maximize consumers’ welfare, 3
conditions must be met:
Three
conditions
Make sure that:
1.
No resources are wasted and that as much ice
cream as possible is produced with available
ressources
2.
The flavor « mix » best corresponds to consumers’
preferences
3.
Each flavor goes to the consumers that like them
most
Discussion
Think about last week’s discussion
•
Is it possible to maximize welfare if one of
these conditions is transgressed ?
•
Is it possible to increase someone’s welfare
without decreasing someone else ?
Maximizing Society’s Welfare, 1
•
In talking about maximizing social welfare,
economists have in mind 3 different
optimality
concepts :
–
Efficiency in Production
–
Efficiency in Output
–
Efficiency in Exchange
Maximizing Society’s Welfare, 2
•
Efficiency in production
–
The only way to increase production of a good
is to decrease production of another
–
Conditions: using inputs efficiently in the
production process (isoquants, isocosts, MRTS)
•
Right combinations of inputs
•
All inputs (no wasting)
Maximizing Society’s Welfare, 3
Efficiency in output
–
Output (goods) must be produced in
combinations that match people’s preferences
–
The mix of outputs must be chosen so that any
other mix must reduce someone’s welfare
Maximizing Society’s Welfare, 4
•
Efficiency in exchange
Whatever the output, its distribution must be
efficient
Each good must be consumed by the person who
values it most !
Consumers must thus be able to complete all
mutually beneficial trades
Ex: hockey tickets
Efficiency in exchange
Difficult concept
Unrelated to value judgments about rich and
poor
If A is ready to pay $250 for a ticket and B is
ready to pay $100, A should get the ticket!
Explanation: voluntary exchanges can only
benefit both parties to the exchange
Exceptions: limited information
The Allocation Problem
All the preceding discussion turned around
the allocation problem
For most people, only distribution problems
exist
Ex: rent controls, minimum wage
Most economic changes have distributive and
allocative effects
Illustration of an
Allocation Problem
The
production possibility curve (PPC)
The basic problem of every society is that
resources are
rare
and needs are
unlimited
Choices must therefore be made:
Which goods to produce ?
Which wants to satisfy ?
The PPC
Society’s production possibility curve (or
Frontier)
Society’s budget curve
Full employment and the PPC
Production Possibility Curve (PPC)
Canons
Schools
C
A
B
E
F
.
.
PPC and Opportunity Costs
The production possibility frontier and
opportunity costs
O
pportunity costs
are the
sacrifice
society must make in
order to produce more of a good
Opportunity costs and costs of production
Opportunity costs and the PPC
On the PPC
Inside the PPC
Resource specialization and diminishing marginal
returns
Consequences on the shape of the PPC
Increasing marginal costs
PPC with specialized resources
Canons
Schools
A
X
A
X
A
+ 1
B
C
D
X
C
X
C
+ 1
A concave PPC
Compare the cost of production of one extra
unit of Coconuts
Increasing marginal costs
1.
The cost in E3 is
bigger than in E7
2.
The cost in E3 is
smaller than in E7
3.
The costs are
identical
Let’ s vote!
Compare the cost of production of one extra
unit of Coconuts
Increasing marginal costs
1.
The cost in E3 is
bigger than in E7
2.
The cost in E3 is
smaller than in E7
3.
The costs are
identical
Let’ s vote!
The effects of technological change on the PPC
The effects of an earthquake on the PPC
The effects of an increase in productivity on the
PPC
Change of slope and opportunity costs
Applications
Technological change in the production of canons
Canons
Schools
C
0
C
1
Consumers’ Preferences
Definition of social indifference curves
Compare the value of a extra unit of Coconuts if we are in E1 to
the value of one extra unit of Coconuts in we are in E2
1.
Value in E1 is
greater than E3
2.
Value in E1 is
smaller than E3
3.
Value in E1 is
the same as E3
Let’s Vote!
Hint: use the slopes
Compare the value of a extra unit of Coconuts if we are in E1 to
the value of one extra unit of Coconuts in we are in E2
1.
Value in E1 is
greater than E3
2.
Value in E1 is
smaller than E3
3.
Value in E1 is
the same as E3
Let’s Vote!
Hint: use the slopes
With the following preferences, we observe that…
1.
E4 gives less utility than
E2
2.
The value of coconuts
in E1 is greater than
than the value in E5
3.
E4 and E5 give the
same value
4.
2 and 3 are true
Let’s Vote!
With the following preferences, we observe that…
1.
E4 gives less utility than
E2
2.
The value of coconuts
in E1 is greater than
than the value in E5
3.
E4 and E5 give the
same value
4.
2 and 3 are true
Let’s Vote!
Pareto Efficiency
Definition: 3 necessary optimums
Applications
Problem: absence of unanimity
There exists no economic solution to the distribution
problem (meaning what is the « best » distribution of
revenues).
Why allocation E
*
maximizes social welfare ?
1.
It is on the highest
indifference curve
2.
The value of a
Coconuts is the same
as its production cost
3.
All resources are used
4.
1+2+3 are true
Let’s vote!
Why allocation E
*
maximizes social welfare ?
1.
It is on the highest
indifference curve
2.
The value of a
Coconuts is the same
as its production cost
3.
All resources are used
4.
1+2+3 are true
Let’s vote!
The dotted line shows technological progress in fishing. If workers are
not mobile between sectors, what can be said about the new equilibrium?
1.
Society’s welfare will
remain unchanged
2.
The new production will be
at point E2
3.
The new equilibrium will
be at point E1
4.
None of the above
Let’s vote!
The dotted line shows technological progress in fishing. If workers are
not mobile between sectors, what can be said about the new equilibrium?
1.
Society’s welfare will
remain unchanged
2.
The new production will be
at point E2
3.
The new equilibrium will
be at point E1
4.
None of the above
Let’s vote!
The Department of health has decided that hospital scanners
cannot be used by private clinics when not in use by
hospitals. Identify this situation in the graph.
Healthcare
Other
goods
A
B
C
1.
A
2.
B
3.
C
The Department of health has decided that hospital scanners
cannot be used by private clinics when not in use by
hospitals. Identify this situation in the graph.
Healthcare
Other
goods
A
B
C
1.
A
2.
B
3.
C
N
A
F
T
A
a
t
2
0
Ready to take off again?
T
w
o
d
e
c
a
d
e
s
a
g
o
t
h
e
N
o
r
t
h
A
m
e
r
i
c
a
n
F
r
e
e
-
T
r
a
d
e
A
g
r
e
e
m
e
n
t
g
o
t
o
f
f
t
o
a
f
l
y
i
n
g
s
t
a
r
t
.
T
h
e
n
i
t
s
t
a
l
l
e
d
PASS through the gates of the Bombardier plant in
Querétaro and you leave the Mexico of potholed roads and
blaring horns behind: welcome to a strangely serene place
called North America.
With the exception of the wings, which are made in
Northern Ireland, the Learjet 85 is a North American story.
Bombardier, a Canadian firm based in Montreal, took over
Learjet, an American firm, in 1990. When the Mexico-
made carcass reaches Learjet’s headquarters in Wichita,
Kansas, for kitting out, it is married to engines built in
Canada, but designed by America’s Pratt & Whitney. It is
fitting that the 85’s maiden flight will, all things being
equal, come within a few weeks of the 20th anniversary of
the North American Free-Trade Agreement coming into
force on January 1st 1994. Without NAFTA, a trinational
endeavour like the new Learjet would be unthinkable.
Epilogue
We must get the most out of our resources
(the problem of scarcity)
Choices entail costs
We must make sure that what we produce is
in line with peoples’ preferences
More of a little desired good and less of a highly
desired good = decrease in welfare
As we will see, unless failures arise,
decentralized decisions in markets are
efficient
The Price Mechanism
Welfare in Partial Equilibrium
Partial Eq.: « Market per market » vision
Tool: surplus
Study plan:
Surplus and interpretation
Market efficiency
The roles of prices
Inefficient cases
Consumers’ Surplus
Let’s suppose a few copies of Elvis’ last
album are put on sale
Four buyers seem interested:
John is willing to pay 100$
Paul is willing to pay 80$
George is willing to pay 70$
Ringo is willing to pay 50$
Consumers all pay the same price, but do not
value goods the same way
Qty
Price
4
100
80
70
50
John’s willingness to pay
Paul’s willingness to pay
Georges
Ringo
3
2
1
Demand
Definitions
Willingness to pay: maximum amount a
buyer is ready to pay to obtain a good =
measure of the value of good to the buyer
Voluntary exchange
Consumer surplus: difference between the
willingness to pay and the price really paid for
the good
Qty
Price
4
100
80
70
50
John’s consumer surplus ($20)
Paul
Georges
Ringo
3
2
1
Price = $80
Qty
Price
4
100
80
70
50
John’s consumer surplus ($30)
Paul’s consumer surplus (10$)
Georges
Ringo
3
2
1
Price = $70
Total CS = $40
Qty
Price
P
1
Q
1
D
Consumer
Surplus
Continuous Case
The lower the price, the higher the consumer
surplus
P
2
Q
2
Consumer surplus:
measure of welfare
•
CS = (willingness to pay – price paid)
•
CS measures, from the buyer’s point of
view, the surplus benefit received when
buying a good
•
CS is a good measure of the welfare
consumers get when consuming a good
Producer Surplus
Let’s suppose you want a few of your houses
repainted
Four people are interested to paint them
Here are the minimum prices they are willing
to accept :
Mary is willing to paint one for 900 $/house
Louise is willing to paint one for 800 $
Georgia is willing to paint one for 600 $
Grandma is willing to paint one for 500 $
Qty
Price
4
900
800
600
500
Louise
Cost for Georgia
Cost for Grandma
3
2
1
Supply = MC
Mary
Definitions
Cost: minimum amount a producer will
accept to produce a good
Opportunity cost (we will get back to this topic in
a few slides) = MC
Producer surplus: difference between the
good’s price and production cost
Qty
Price
4
900
800
600
500
Louise
Georgia
Grandma’s producer surplus (100$)
3
2
1
Mary
Price = 600$
Qty
Price
4
900
800
600
500
Louise
Georgia’s PS (200$)
Grandma’s producer surplus (300$)
3
2
1
Mary
Price = 800$
Total PS= 500$
Qty
Price
P
2
Q
1
S
Continuous Case
The higher the price, the higher the
producer surplus
Producer
surplus
P
1
Q
2
Markets and efficiency
•
Does the market maximize society’s
welfare?
•
We can answer this question with the help
of consumer and producer surplus
Social welfare
•
T
otal
S
urplus (or social welfare) = sum of
all groups’ surpluses = (CS + PS)
•
TS = (Value to consumers - P
paid
) + (P
reçeived
- MC)
•
TS = Value to consumers - MC
•
When total surplus is at a maximum,
resource allocation is efficient
Qty
Price
P
e
Q
e
Producer
surplus
Consumer
surplus
D
S
Total Surplus = CS + PS
The competitive market
•
At equilibrium, every unit produced brings
to consumers a
value
equal to the
cost of
production
.
•
The difference between them is the
gain
society receives from the production and
exchange of a good
•
By maximizing total surplus, the
competitive market is a source of efficiency
Qty
Price
P
e
Q
e
D
S
Efficiency
Willingness
to pay
Cost to
producers
Up to Q
e
, consumers’ willingness
to pay exceeds costs for producers
The price mechanism
•
Conveys information
•
Conveys incentives
•
Coordinates
•
Rations
•
Induces responsible behaviour
•
Creates value
Qty
Price
2.50
2.00
1.50
4
7
10
•
Prices convey information:
Prices convey information:
•
About value (through demand)
About value (through demand)
Qty
Price
S = MC
2.00
2.50
4
7
10
1.50
•
Prices convey information:
Prices convey information:
•
About costs of production (through supply)
About costs of production (through supply)
Prices reflect scarcity
Prices reflect
relative
scarcity (through
market prices)
Example:
If value increases,
relative
scarcity increases, and
so does the price
If production costs increase,
relative
scarcity
increases as well, and so does the price
Qty
Price
S
D
5 $
120
Demand for wood in North Carolina
before and after a hurricane warning
6 $
140
D’
A
s
p
r
i
c
e
s
i
n
c
r
e
a
s
e
,
n
e
w
t
e
c
h
n
o
l
o
g
i
e
s
e
m
e
r
g
e
W
h
y
$
3
G
a
s
i
s
G
o
o
d
f
o
r
A
m
e
r
i
c
a
,
W
i
r
e
d
,
D
e
c
e
m
b
e
r
2
0
0
5
P
r
i
c
e
s
(
p
e
r
b
a
r
r
e
l
o
f
o
i
l
)
(
$
U
S
)
30$
70$
100$
Deep sea wells
Liquified gas
Tar sands
Natural gas
Liquified coal
Biodiesels
Methane
Hydrogen
Quantities
Incentives
Prices convey
incentives
Right prices compel people to take scarcity
into account when consuming
If prices cannot adjust, people will use
bad
incentives
Example : free water in Montreal
Quantity
Price
MC
D
P*
P
Demand for drinking
water with a price = 0
Q*
Prices induce responsible
behaviour
•
The price mechanism makes consumers pay for
their decisions
•
If prices cannot adjust, society (usually tax payers)
must pay for the individual decisions of
consumers.
•
Irresponsible behaviour comes from not having to
suffer from the consequences of one’s own
decisions
•
Example: watering of lawns
Rationing
through
prices
•
To ration is necessary (lotteries, queues,…)
•
Price rationing
•
They make sure that resources go to those
who value them most
•
Market prices lead to
exchange efficiency
(available goods go to those who value
them most)
•
Examples
The creation of value
•
The price mechanism
creates value
•
It makes sure resources are transformed in
something of higher value
Quantity
Price
Q
e
D
MC
The creation of value
Value
received
Foregone
value
Up to Q
e
, value obtained
by consumers exceeds the
value foregone by society
Value > Cost
Value < Cost
Free goods
If there are no prices (or prices cannot
adjust), this can lead to inefficiencies
Example
Controlled prices in education
Available quantity
Price
MC
D
P*
P ’
Controlled tuition prices
MC
value
Social welfare
•
The price mechanism maximizes society’s
welfare
•
At market equilibrium (quantity Q
*
) all the
units produced bring consumers a
value
higher than
opportunity cost
.
Maximizing welfare
Market equilibrium
maximizes
social welfare
Conditions:
Competitive markets
Supply and demand reflect the true costs and
value of a good to society
Otherwise: market failures
Price
Qty
D
MC
P
e
Q
e
P
c
P
p
Q
t
Social welfare if less than Q
e
is produced
A
B
D
F
C
E
TS = A + B + D + F
Deadweight loss = C + E
Price
Qty
D
Cm
P
e
Q
e
P
c
P
p
Q
t
Social welfare if more than Q
e
is produced
A
B
D
F
C
E
TS = A + B + C + D + E + F - G
Deadweight loss = G
Q
x
G
Pareto efficient allocation
•
The difference between maximum social
welfare and the amount attained is called
deadweight loss
or
welfare loss
•
The quantity corresponding to competitive
market equilibrium
is Pareto efficient
•
Graphical interpretation
P
Q
D
MC
Q
Other good
Q
*
P
*
Q
*
Q
k
P
k
Q
k
End
•
For Next Week:
•
First Class Assignment: download and read the
scenario, download the excel
•
Bring the laptop to do Class Assignment
•
Do the exercises
•
Finish Ch. 5
•
Read the appendix of Chapter 4
Delve into the concepts of the allocation problem and price mechanism in economics through a series of exercises and discussions, exploring topics like Pareto efficiency, opportunity cost, supply and demand curves, and societal welfare maximization. An engaging example involving the rental of a scanner at a hospital highlights the complexity of decision-making in resource allocation scenarios. Additionally, a real-life scandal involving traffic manipulation sheds light on the consequences of misallocated resources.
Download Presentation
Please find below an Image/Link to download the presentation.
The content on the website is provided AS IS for your information and personal use only. It may not be sold, licensed, or shared on other websites without obtaining consent from the author. Download presentation by click this link. If you encounter any issues during the download, it is possible that the publisher has removed the file from their server.
E N D
Presentation Transcript
The Allocation Problem and the Price Mechanism Economic Problems and Policy Analysis Helios Herrera January 2014
Plan of the day Today Little refresh of Pareto Efficiency Allocation problem and Price Mechanism Exercises
After this session The Allocation Problem: Opportunity cost and marginal rate of substitution Production possibilities frontier and resource scarcity Maximazion of well-being under resource constraints Impact of technological change The Price Mechanism: How demand curve reveals preferences How the supply curve represents the marginal cost of production Consumers and producers surpluses Discuss the roles of price mechanism
Maximizing Societys Welfare Let s go back to last week s lecture In order to maximize a group s welfare, it must be impossible to increase someone s welfare without decreasing someone else s welfare In an efficient allocation of goods, no one can be made better off without making someone else worse off Examples: Classrooms, smoking, etc..
An example The CHUM proposes to rent its very expensive scanner: At a good price to private companies Between 4pm and 9pm Note: this is no working time for CHUM
Renting out the scanner Patients at CHUM R2 R0 R1 What is the most plausible scenario? 1. R0 R1 2. R0 R2 3. R2 R1 Let s vote! Satisfaction of other patients
Renting out the scanner Patients at CHUM R2 R0 R1 What is the most plausible scenario? 1. R0 R1 2. R0 R2 3. R2 R1 Let s vote! Satisfaction of other patients
Chris Christie A bridge too far? A scandal threatens the New Jersey governor s nice-thug image In September the Port Authority closed two lanes of traffic on a bridge that links New Jersey with Manhattan for a so-called traffic study . The weeklong traffic jam that resulted was hardest on commuters in Fort Lee, a nearby suburb run by Mark Sokolich, a Democrat who refused to endorse Mr Christie in the election. Besides being a nuisance, the gridlock also reportedly kept ambulances from reaching an unconscious 91-year- old woman, who later died. State Democrats cried foul. On January 8th they found their smoking gun: e-mails from Bridget Anne Kelly, a senior Christie staffer, to the governor s friends at the Port Authority signalling the closures. Time for some traffic problems in Fort Lee, she wrote.
Conditions to Maximize Social Welfare Let s start with a practical example: vanilla ice cream and chocolate ice cream. In order to maximize consumers welfare, 3 conditions must be met:
Three conditions Make sure that: 1. No resources are wasted and that as much ice cream as possible is produced with available ressources 2. The flavor mix best corresponds to consumers preferences 3. Each flavor goes to the consumers that like them most
Discussion Think about last week s discussion Is it possible to maximize welfare if one of these conditions is transgressed ? Is it possible to increase someone s welfare without decreasing someone else ?
Maximizing Societys Welfare, 1 In talking about maximizing social welfare, economists have in mind 3 different optimality concepts : Efficiency in Production Efficiency in Output Efficiency in Exchange
Maximizing Societys Welfare, 2 Efficiency in production The only way to increase production of a good is to decrease production of another Conditions: using inputs efficiently in the production process (isoquants, isocosts, MRTS) Right combinations of inputs All inputs (no wasting)
Maximizing Societys Welfare, 3 Efficiency in output Output (goods) must be produced in combinations that match people s preferences The mix of outputs must be chosen so that any other mix must reduce someone s welfare
Maximizing Societys Welfare, 4 Efficiency in exchange Whatever the output, its distribution must be efficient Each good must be consumed by the person who values it most ! Consumers must thus be able to complete all mutually beneficial trades Ex: hockey tickets
Efficiency in exchange Difficult concept Unrelated to value judgments about rich and poor If A is ready to pay $250 for a ticket and B is ready to pay $100, A should get the ticket! Explanation: voluntary exchanges can only benefit both parties to the exchange Exceptions: limited information
The Allocation Problem All the preceding discussion turned around the allocation problem For most people, only distribution problems exist Ex: rent controls, minimum wage Most economic changes have distributive and allocative effects
Illustration of an Allocation Problem The production possibility curve (PPC) The basic problem of every society is that resources are rare and needs are unlimited Choices must therefore be made: Which goods to produce ? Which wants to satisfy ?
The PPC Society s production possibility curve (or Frontier) Society s budget curve Full employment and the PPC
Production Possibility Curve (PPC) A Canons F.. C E B Schools
PPC and Opportunity Costs The production possibility frontier and opportunity costs Opportunity costs are the sacrifice society must make in order to produce more of a good Opportunity costs and costs of production Opportunity costs and the PPC On the PPC Inside the PPC
Increasing marginal costs Resource specialization and diminishing marginal returns Consequences on the shape of the PPC
PPC with specialized resources A Canons B A concave PPC C D XA+ 1 XA Schools XC XC+ 1
Increasing marginal costs Compare the cost of production of one extra unit of Coconuts 1. The cost in E3 is bigger than in E7 The cost in E3 is smaller than in E7 The costs are identical Let s vote! 2. 3.
Increasing marginal costs Compare the cost of production of one extra unit of Coconuts 1. The cost in E3 is bigger than in E7 The cost in E3 is smaller than in E7 The costs are identical Let s vote! 2. 3.
Applications The effects of technological change on the PPC The effects of an earthquake on the PPC The effects of an increase in productivity on the PPC Change of slope and opportunity costs
Technological change in the production of canons C1 Canons C0 Schools
Consumers Preferences Definition of social indifference curves
Compare the value of a extra unit of Coconuts if we are in E1 to the value of one extra unit of Coconuts in we are in E2 1. Value in E1 is greater than E3 Value in E1 is smaller than E3 Value in E1 is the same as E3 2. 3. Let s Vote! Hint: use the slopes
Compare the value of a extra unit of Coconuts if we are in E1 to the value of one extra unit of Coconuts in we are in E2 1. Value in E1 is greater than E3 Value in E1 is smaller than E3 Value in E1 is the same as E3 2. 3. Let s Vote! Hint: use the slopes
With the following preferences, we observe that 1. E4 gives less utility than E2 The value of coconuts in E1 is greater than than the value in E5 E4 and E5 give the same value 2 and 3 are true 2. 3. 4. Let s Vote!
With the following preferences, we observe that 1. E4 gives less utility than E2 The value of coconuts in E1 is greater than than the value in E5 E4 and E5 give the same value 2 and 3 are true 2. 3. 4. Let s Vote!
Pareto Efficiency Definition: 3 necessary optimums Applications Problem: absence of unanimity There exists no economic solution to the distribution problem (meaning what is the best distribution of revenues).
Why allocation E*maximizes social welfare ? 1. It is on the highest indifference curve The value of a Coconuts is the same as its production cost All resources are used 1+2+3 are true 2. 3. 4. Let s vote!
Why allocation E*maximizes social welfare ? 1. It is on the highest indifference curve The value of a Coconuts is the same as its production cost All resources are used 1+2+3 are true 2. 3. 4. Let s vote!
The dotted line shows technological progress in fishing. If workers are not mobile between sectors, what can be said about the new equilibrium? 1. Society s welfare will remain unchanged The new production will be at point E2 The new equilibrium will be at point E1 None of the above 2. 3. 4. Let s vote!
The dotted line shows technological progress in fishing. If workers are not mobile between sectors, what can be said about the new equilibrium? 1. Society s welfare will remain unchanged The new production will be at point E2 The new equilibrium will be at point E1 None of the above 2. 3. 4. Let s vote!
The Department of health has decided that hospital scanners cannot be used by private clinics when not in use by hospitals. Identify this situation in the graph. 1. A 2. B 3. C Other goods A B C Healthcare
The Department of health has decided that hospital scanners cannot be used by private clinics when not in use by hospitals. Identify this situation in the graph. 1. A 2. B 3. C Other goods A B C Healthcare
NAFTA at 20 Ready to take off again? Two decades ago the North American Free-Trade Agreement got off to a flying start. Then it stalled PASS through the gates of the Bombardier plant in Quer taro and you leave the Mexico of potholed roads and blaring horns behind: welcome to a strangely serene place called North America. With the exception of the wings, which are made in Northern Ireland, the Learjet 85 is a North American story. Bombardier, a Canadian firm based in Montreal, took over Learjet, an American firm, in 1990. When the Mexico- made carcass reaches Learjet s headquarters in Wichita, Kansas, for kitting out, it is married to engines built in Canada, but designed by America s Pratt & Whitney. It is fitting that the 85 s maiden flight will, all things being equal, come within a few weeks of the 20th anniversary of the North American Free-Trade Agreement coming into force on January 1st 1994. Without NAFTA, a trinational endeavour like the new Learjet would be unthinkable.
Epilogue We must get the most out of our resources (the problem of scarcity) Choices entail costs We must make sure that what we produce is in line with peoples preferences More of a little desired good and less of a highly desired good = decrease in welfare As we will see, unless failures arise, decentralized decisions in markets are efficient
Welfare in Partial Equilibrium Partial Eq.: Market per market vision Tool: surplus Study plan: Surplus and interpretation Market efficiency The roles of prices Inefficient cases
Consumers Surplus Let s suppose a few copies of Elvis last album are put on sale Four buyers seem interested: John is willing to pay 100$ Paul is willing to pay 80$ George is willing to pay 70$ Ringo is willing to pay 50$ Consumers all pay the same price, but do not value goods the same way
Price John s willingness to pay 100 Paul s willingness to pay 80 Georges 70 Ringo 50 Demand 1 2 3 4 Qty
Definitions Willingness to pay: maximum amount a buyer is ready to pay to obtain a good = measure of the value of good to the buyer Voluntary exchange Consumer surplus: difference between the willingness to pay and the price really paid for the good
Price Price = $80 100 John s consumer surplus ($20) Paul 80 Georges 70 Ringo 50 1 2 3 4 Qty
Price Price = $70 100 John s consumer surplus ($30) 80 Paul s consumer surplus (10$) Georges 70 Ringo 50 Total CS = $40 1 2 3 4 Qty
Continuous Case Price Consumer Surplus The lower the price, the higher the consumer surplus P1 P2 D Q2 Q1 Qty
Consumer surplus: measure of welfare CS = (willingness to pay price paid) CS measures, from the buyer s point of view, the surplus benefit received when buying a good CS is a good measure of the welfare consumers get when consuming a good
