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EEP101 Lecture 2
EEP101 Lecture 2
EEP101 Lecture 2
Lecture 2
Basic Definitions
Competitive Economy: An economy comprised of many
small economic units, each with no market power. Pareto Optimal: A resource allocation such that you cannot improve any individuals welfare without hurting at least one other individual. Socially efficient allocation. The Main Theorem of Welfare Economics: A competitive economy will achieve Pareto optimal resource allocation when: - Full information exists - No externalities exist - There are no increasing returns to scale in technology
Manage externalities
Externalities: when activities of one agent affect preferences/technologies of other agents.
Production Externalities: when productivity of an individual is affected by activities of others (smokestack laundry, irrigation - fishery). Consumption Externalities: when welfare of some individuals is affected by the consumption activities of other individuals (loud music, smoking).
Negative externalities reduce utility or productivity (pollution). Positive Externalities increase utility or productivity (orchard and apiary - trees and bees).
Examples
-Knowledge from education and public research -National Security -Legal system, treaties -Infrastructure, such as roads, bridges, etc. -Environmental amenities, such as clean air
Producers
Behavior/Incentives
Consumers
Willingness to Pay
(Taste, Wealth)
Price
150
Paul
50
V and W
Tickets
Equilibrium
Equilibrium Price = $100 Peter, Paul and Mary buy tickets from Professors V, W and X. If they all trade at the equilibrium price, does it matter who buys from whom? No Gains: Peter Paul Mary V W X Total Gain: $250
Price
Consumer Surplus
200 Peter Z
150
Paul
= = = = = =
$100 = $100 $100 = $50 $100 = $0 $50 = $50 $50 = $50 $100 = $0
50
V and W
Producer Surplus
Tickets
Po
What is paid
D = Willingness to Pay
Qo
Quantity
Quantity
Po
Producer Surplus
D
Qo
Quantity
Price Increase
Price
Remaining Consumer Surplus PH Po New Producer Surplus Lost Producer Surplus: Deadweight Lost Consumer Surplus: Transfer Lost Consumer Surplus: Deadweight
D
QL Qo
Quantity
Monopoly
P
Pm
C
Pc
B MR
Monopoly produces too little and charges too much. Welfare loss under monopoly is DABC .
D
Q
Qm
Qc
P c = a -
P c =
ad + bc . b+d
a-c QM = 2b + d
b(a - c ) P M = a 2b + d a( b + d ) + bc = 2b + d
Pc
Pmn
Qmn
Qc
Calculation of monopsony
B(Q) - QMC (Q) Maximization equation: Maximize Q Q Area: B(Q) = P( z)dz = area under demand.
0
Optimality condition:
B MC =Q + MC(Q) Q Q
Pmmb
C E
Pmms MR Qmm
Qmm=middlemen output Pmms=price paid by middlemen to supplier Pmmb=price paid to middlemen by buyer
D Q
Pmmb
Profits PmmbCEPmms
Pmms
E
MR Qmm D Q