ECO 2023 Week 5 - Day 1 Lecture Notes
ECO 2023 Week 5 - Day 1 Lecture Notes Eco 2023
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This 7 page Class Notes was uploaded by Erika Huber on Wednesday September 21, 2016. The Class Notes belongs to Eco 2023 at University of Florida taught by Mark Rush in Fall 2016. Since its upload, it has received 12 views. For similar materials see Principles of Economics: Microeconomics in Economics at University of Florida.
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Date Created: 09/21/16
9/19/16 ECO 2023 Week 5 – Day 1 Lecture Notes Chapter 5: Allocative Efficiency What’s most desirable point from a social prospective? Supply and demand tells what is most efficient point and Chapter 5 tells what is the most desirable point. Marginal Analysis Important decision making tool Market pays off for quantitative skills o EX: highest paying jobs are major in finance and economics How we decide the amount to produce that is the best from a social perspective If the marginal benefit of an action is greater than the marginal cost of the action, then do the action. If the marginal benefit of an action is less than the marginal cost of the action, then do not do the action. What do I mean by “Marginal benefit?” And what about “Marginal cost?” Marginal in economics means additional o What is the cost of just one more unit of an item? Marginal Benefit Measuring marginal benefit The consumer is the person that benefits from the product Price Slices of Pizza a) Maximum price the consumer is willing to pay: $8 b) Value to the consumer: $8 $8 c) Marginal benefit to the consumer (MB): $8 d) Marginal social benefit (MSB): $8 $5 Demand = MSB Quantity 2 million 7 million MB = MSB Total benefit is different from marginal benefit. As Quantity increases, the MSB decreases. As Quantity decreases, the MSB increases. $8 is the maximum price the consumer is willing to pay for the 2 millionth slice of pizza. Marginal Cost Measuring marginal cost Slices of Pizza a) Minimum price the producer Price is willing to accept: $3 S = MSC a. What determines minimum price? They are trying to make a $7 profit so making that additional slice of pizza has to cover costs of making pizza and giving them a little bit of profit b) Marginal cost to the producer (MC): $3 $3 c) Marginal social cost (MSC): $3 Quantity 4 million 9 million MC = MSC As Quantity increases, MSC increases. As Quantity decreases, MSC decreases. $3 is the minimum price the supplier is willing to accept to produce the 4 millionth slice of pizza. Now we’re going to put these curves together… Allocative Efficiency Put the MSB and the MSC curves together 1. Start at 1 and proceed unit by unit… 2. By producing where MSB=MSC, ALL the units with a surplus of benefit over cost have been produced. 3. By producing where MSB=MSC, NONE of the units with a loss of cost over benefit have been produced. 4. The total surplus… Price S (MSC) $13 $12 The orange triangle is the total surplus area. QEFF (MSB=MSC) $2 $1 D (MSB) Quantity 1 2 When you produce at QEFF When you produce at QEFF (Efficient quantity), you (Efficient quantity), you produce all of this area. produce none of this area. MSB > MSC MSB > MSC = DO action MSB<MSC = DO NOT do action QEFF = Allocative efficient quantity = social benefit QEQ = Equilibrium quantity = individual benefit QEFF = QEQ At QEFF (QEQ), MSB = MSC QEQ: D = S QEFF: MSB = MSC We look at two different things: 1. Surplus benefit over cost of each individual unit 2. Surplus benefit over cost of all the units First Unit Second Unit Surplus benefit over $12 $10 coast of each individual unit Surplus benefit over $12 $22 cost of all the units Want to get the maximum total surplus benefit possible; you want to get all of the benefits where the MSB exceeds the MSC; you want to produce everywhere that MSB exceeds MSC. So we ideally want to produce at the QEFF point because MSB = MSC. Why produce at QEFF if at QEFF, MSB=MSC and it doesn’t add anything to your surplus benefit? Why not? If producing at that point is not subtracting anything from your total surplus, then why not produce there. If not producing there, then where else to produce? If you produce below QEFF then you lose some surplus benefit that you could have and you don’t have a maximum total surplus. Invisible Hand An amazing result! The equilibrium quantity is the same as the allocative efficient quantity. Paraphrasing Adam Smith (The Wealth of Nations) o “People, pursuing only their own self-interest are nonetheless led, as if by an invisible hand, to advance the social interest.” MB = MSB, because individual benefit ends up also benefitting society. o There are instances where this doesn’t work and we will look at the later, but this works with many instances. Division of the Surplus Consumer Surplus: The difference between the maximum price a consumer is willing to pay (MB=MSB) minus the price actually paid, summed over the quantity consumed. Producer Surplus: The difference between the price actually received minus the minimum price a producer is willing to accept (=MC=MSC), summed over the quantity produced. Total surplus = Consumer Surplus + Producer Surplus Consumer surplus & producer surplus aren’t always equal. They can be equally divided and sometimes, they are not equally divided. Price S = MSC $10 $9 PMax The blue triangle is the Consumer surplus. $5 PEQ The green triangle is the Producer surplus. $2 PMin D = MSB Quantity 15 million PMax = the maximum price that demanders are willing to pay PEQ = the equilibrium price PMin = the minimum price that suppliers are willing to accept There is a consumer surplus of $4: o Consumers are willing to pay $9 but they only pay $5. There is a producer surplus of $3: o Producers are willing to accept $2 but they receive $5. The area of the consumer surplus (blue triangle): o Area = ½ * B * H o Area = ½ * 15 million * $5 o Area = $37.5 million Deadweight Loss What happens if less than the efficient quantity is produced? Deadweight Loss from Underproduction Price S = MSC The red triangle is the area of deadweight loss. If you produce at Q under, then you produce none of the area between Q under and QEFF. D = MSB None Quantity Q under QEFF Deadweight Loss from Overproduction Price S = MSC The red triangle is the area of deadweight loss. All D = MSB Quantity QEFF Q over If you produce at Q over, then you produce all of the area between QEFF and Q over.
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