Lecture 4 - Input and Secondary markets

Levan Pavlenishvili

ISET

2022

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Table of Contents

Today’s reading: [BGVW] pp. 143-181 (Chapter 6, Chapter 7)

1 Valuing Costs in Efficient Input Markets

2 Valuing Costs in Distorted Input Markets
3 Primary Vs. Secondary Markets
4 Valuing Benefits and Costs in Efficient Secondary Markets
5 Valuing Benefits and Costs in Distorted Secondary Markets

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Valuing Costs in Efficient Markets
Perfectly Elastic Supply Curve

Suppose government decided to build a village road just 1 km of lengths

and it tries to buy some concrete. What will be the opportunity cost of
doing this project?

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Valuing Costs in Efficient Markets

Perfectly Inelastic Supply Curve

Suppose government is building a gas pipeline and has to expropriate land.

What will be the opportunity cost of removing this land from private
sector?

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Valuing Costs in Efficient Markets
Efficient market with noticeable price effects

Suppose government has decided to build Namakhvani HPP. What will

happen on the market for concrete?

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Valuing Costs in Efficient Markets

Efficient market with noticeable price effects

Suppose government has decided to build Namakhvani HPP. What will

happen on the market for concrete?

Large government purchase will shift the demand curve to the right
Consumer surplus will decrease due to increased prices and lower
demand (q2 )
Producer surplus will increased due to higher prices and increased
′
demand (q )
Government surplus will be effected with increased prices (P1 )

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Valuing Costs in Efficient Markets
Efficient market with noticeable price effects

Social surplus can be summarised with the social accounting ledger

Social opportunity cost of purchasing the resource can be approximated

′
with average of the new and old prices ( 12 (P1 + P0 )(q )) if demand and
supply are nonlinear
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Valuing Costs in Distorted Markets

1 Purchasing at below opportunity cost

2 Purchases when inputs are in fixed supply
3 Hiring unemployed labour
4 Purchase from monopoly

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Valuing Costs in Distorted Markets

Purchasing at below opportunity cost

Imagine government needs to establish more courts so that more cases can
be held with jury. What should be paid to jurors?

If we are paying jurors transportation costs does it mean we are

compensating with opportunity cost?
If we are paying jurors transportation costs and per Diem for lunch at
the court house does it mean we pay them the opportunity cost?
What can be a good measure for the opportunity cost in this case?

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Valuing Costs in Distorted Markets
Purchases when inputs are in fixed supply

Purchasing electricity to light up the military base, VS if it needs to light

up a nation wide highway. What will be the cost of electricity?

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Valuing Costs in Distorted Markets
Hiring Unemployed Labour

Government of Georgia decides to introduce a minimum wage. To cover

for unemployment growth it also introduces an employment scheme.

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Valuing Costs in Distorted Markets
Hiring Unemployed Labour
′
What could be the measure of social cost of hiring the L unemployed
workers?

1 Measure A: there is zero opportunity cost to hiring them - unlikely

that someone has 0 opportunity cost;
′
2 Measure B: the social cost of the project is Pm L , budgetary outlay
for labour - overestimates the true social cost
3 Measure C: opportunity cost of newly hired workers cdLd Lt - might
underestimate the social cost
4 Measure D: opportunity costs are distributed between Pr and Pm -
what is value of Pr ?
5 Measure E: opportunity cost is distributed between 0 and Pm on
average 21 Pm
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Valuing Costs in Distorted Markets

Purchases of an input from a Monopoly

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Valuing Costs in Distorted Markets

Purchases of an input from a Monopoly

Producer surplus increases:

1 Resulting from the higher price the monopolist now receives.
2 Resulting from the additional units that monopolist now sells

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Primary Vs. Secondary Markets

Primary markets: those that are directly affected (labour market through
minimum wages, concrete market from HPP construction)

Secondary markets: markets that are indirectly affected (market for taxis
through decreased employment levels, market for mining products for
production of concrete , pollution from some industrial activity)

Secondary effects are also called second-round, spillover, side, pecuniary,

or indirect affects

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Valuing Benefits and Costs in Efficient Secondary Markets

Complements and substitutes:

To identify secondary markets that are influenced it is important to

identify complements and substitutes of the specific good
Complements are goods that are needed to be consumed with the
product in question
Substitutes are goods that can be consumed instead of the product in
question

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Valuing Benefits and Costs in Efficient Secondary Markets

Efficient Secondary Markets without price changes:

Figure: Primary market: market for Figure: Secondary Market: market for
fishing days fishing equipment

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Valuing Benefits and Costs in Efficient Secondary Markets

Efficient Secondary Markets with price changes:

Figure: Primary market: market for Figure: Secondary Market: market for
fishing days golfing days

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Valuing Benefits and Costs in Efficient Secondary Markets

When should we count the impacts, or ignore them to avoid double

counting?

We can ignore changes in secondary markets if we do not have price

changes
If we have price changes in the secondary market benefits, or costs
can not be ignored
We should ignore effects in undistorted secondary markets, regardless
of whether there are price changes, if we are measuring benefits of the
primary market using empirically measured demand schedules that
were estimated without holding prices in secondary markets constant.

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Valuing Benefits and Costs in Distorted Secondary Markets
If secondary markets are distrorted (i.e. prices do not equal marginal
costs) effects on them can not be ignored keeping only primary market
analysis. For example:

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Valuing Benefits and Costs in Distorted Secondary Markets
Taxes can also distort secondary markets

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Valuing Benefits and Costs in Distorted Secondary Markets

Taxes can also distort secondary markets

These impacts can be summarised with the following social accounting

ledger

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In Summary

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In Summary

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