ECON 200 Week 4 Notes
ECON 200 Week 4 Notes ECON 200
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This 5 page Class Notes was uploaded by Rachel Pollard on Thursday January 28, 2016. The Class Notes belongs to ECON 200 at University of Washington taught by Haideh Salehi-Esfahani in Winter2015. Since its upload, it has received 92 views.
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Date Created: 01/28/16
Session 7 Tuesday, January 26, 2016 10:23 AM Supply in pure exchange: supply without production Exchange takes place until all the mutual gains are exhausted The source of mutual gains from exchange and derivation of the supply behavior in pure exchange An Example: • Trevor doesn't have any shirts and would like buy one! He values a shirt at $20 (MV=$ 20). • Sunil ahs received an accumulated a lot of shirt. He values a shirt at $0 (MV=$0) • Trevor would be happy to buy a shirt from Sunil for anything less than $20 and Sunil would be happy to get anything from Trevor. • If P=$10, Trevor gains $10 and Sunil gains $10 • If P= $12, Trevor gains $8 and Sunil gains $12 • If P= $5, Trevor gains $15 and Sunil gains $5 • What common attribute do all these calculations have in common? o The sum of the gains is always $20. • What is the sum of their gains from trade? o $20, no matter what the price is • The source of mutual benefit is the differences between marginal evaluations of a good by different people • Mutual gains from trade: o Trade takes place until all the mutual gains from trade are exhausted • A table of MVs for A and B for shirts • We assume that A has no shirts at all. B has 11 shirts Quantity MV ($) for A MV ($) for B 1 12 20 2 10 18 3 8 16 4 6 14 5 4 12 6 2 10 7 0 8 8 0 6 9 0 4 10 0 2 11 0 0 • For Q=1, A is willing to forego $12, and B is willing to forego $20 • Trade takes place until there are no more gains • An exchange that has the biggest difference between marginal values o At Q 1, A's MV=$12, At Q11, B's MV=$0 o $12 o For the 1st item that B gives up, A would be willing to pay $12. So the difference in MVS is $12 and the maximum amount of mutual gains from this trade is $12. o The next item is valued by B at $2, If B is offered $3 for the shirt, will she give it up and sell it to A? o Yes, A values the 2nd shirt at $1 -. The maximum mutual gains from this trade is $8. o For the 3rd shirt, there's a $4 gain. o For the 4th shirt, there's a break point, the MVs are the same. • Either three units or four units are traded. o The total gains from trade are $12+$8+$4+$0=$24 • We conclude that trade takes place until all the gains from trade are exhausted. Clicker Question • The price they agree upon may change the distribution of the gains between the buyer and the seller, but the total gains will be $24 for nay set of mutually agreed prices. • Two major insights about trade: o Some trade is better than none o More trade is not necessarily preferred by all (to less trade) as some groups may lose when trade expands. Evidence of mutual gains from trade: • Banning trade in certain goods o Countries sometimes ban imports of certain goods. o These goods can still be found in those countries through smuggling: it is dangerous and costly, but there are sufficiently high mutual gains that it does take place • The Khunjerab Pass between China and Pakistan on the Ancient Silk Road • When a country desires to punish another without going to war with them. Deriving the supply behavior from the MV schedule in pure exchange. • Let's consider Meena with an endowment of 8 comic books. We can think of a scenario where she will voluntarily offer a quantity of her books for sale, given a market price for comic books. Marginal Value ($) Quantity of Comic Books 14 1 12 2 10 3 8 4 6 5 4 6 2 7 0 8 • We derive the supply behavior for Meena from her marginal value (demand) behavior for comic books. • This table shows that at the market price of $14 per book, she will demand a quantity such that her MV=market price. Therefore at the market price of $14, Meena will demand 1 book. • Since she has 8, how many will she offer for sale? o 7 o She only "values" the second book at $12 of other goods and services given up, not $14. • Suppose now the market price is $1 2 per book. How many books does she demand? o She keeps 2 and keeps 6 Market Price per Book Meena’s Quantity Meena’s quantity of books ($) Demanded supplied 14 1 7 12 2 6 10 3 5 8 4 4 6 5 3 4 6 2 2 7 1 0 8 0 • This table is Deriving Meena's Supply Schedule • The first and third column above show the supply schedule for Meena. • Suppose the market price is $8 per book. She will sell 4 • Her total revenue is price times quantity so 8*4=$32 • The supply graph is upward sloping • Revenues-Cost=Sellers Surplus • Does a seller have a Seller's Surplus? • To give up her first book, Meena requires to be paid $2. • As a seller, she values her first book to sell at $2. • When she gives up something that she valu es, at $2, she incurs a cost. • This is called the marginal cost of the first book = $2 • She values her second book at $4 • So the marginal cost of the second book is $4. • The MC of the 3rd = $6. • The MC of the 4th = $8 • The total cost of selling 4 books at the pr ice of $8 is 2+4+6+8=20 • $20 is the total cost • The total revenue is price times quantity ---> $8*4=$32 • Her surplus is $12. • If the market price is P=$8, the seller supplies a quantity such that P=MC. • In the graph of the supply curve: o The area below the price and above the supply curve pertains to producer surplus, or seller's rent. o The area below the supply curve up to the quantity offered for sale is seller's total cost of selling o The whole square is the total revenue Session 8 Thursday, January 28, 2016 10:30 AM Meena's Supply behavior • If the market price is P=$8, the seller supplies a Quantity such that P=MC. • Rent=seller's surplus Derivation of the Market Supply Curve • Adding the quantities on the x -axis, add the quantities across th e suppliers Market Equilibrium and Economic Efficiency: • Putting the market supply and market demand together. • For the 1st unit, the marginal cost is $6 and the marginal value of the buyer is $14 so the trade will take place. • For the 2nd unit, the marginal cost is $8 and the marginal value is $12 so the trade will take place. • As long as MVs are different, exchange will be mutually beneficial. • Trade will stop where the marginal cost of the seller is equal to the marginal value of the buyer. So at Qe, trade w ill not take place. • At Pe, the market is in a Pareto Optimal or efficient situation. Here, the gains from exchange are maximized. These gains are the CS and seller's rents together the triangle to the left of Qe units. • Quantity demanded=Quantity supplied = Quantity equilibrium Important features of the organized markets: • In a modern economy with organized markets, there is a single price for most goods. • Image two adjacent markets for apples. One market price is $1 per pound and the other price is $2 per pound. o Everyone would purchase apples from the lower price store Haggling • Suppose you value a good at $12 and the price is $10. However, since this is a "haggling" market, you entertain the ide a of haggling to reduce the price, like other consumers. • What is the cost of haggling for 15 minutes if your job pays $20 hour? • Will you haggle? No • Haggling is costly. (negotiate) Clicker Question: In explaining how the equilibrium price and quantity are reached, we can reason that if the starting price is too high, a surplus develops and the sellers will compete with each other thus reducing the price. Transactions costs are characteristics or attributes that exist in some markets where mutually beneficial trade is difficult to achieve. Transaction costs include: • Information cost about the buyer/seller is (where the goods are) • Costs of establishing the salient features/properties of goods traded • Cost of reaching an agreement over the price of the good o r service to be traded (haggling) • Cost of establishing and enforcing property rights over the goods and services traded.
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