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ECON Week 7 Notes

by: jared.stein Notetaker

ECON Week 7 Notes ECON 2010

jared.stein Notetaker


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These are my notes for Week 7 (lectures 17&18) for ECON 2010 with Charles Bartholome
Principles of Microeconomics
Dr. Charles A M de Bartolome
Class Notes
Microeconomic, Economics, finance
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This 10 page Class Notes was uploaded by jared.stein Notetaker on Sunday October 9, 2016. The Class Notes belongs to ECON 2010 at University of Colorado at Boulder taught by Dr. Charles A M de Bartolome in Fall 2016. Since its upload, it has received 3 views. For similar materials see Principles of Microeconomics in Microeconomics at University of Colorado at Boulder.


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Date Created: 10/09/16
10/05/16 Lecture 17: I. Firm Decision Making and Societal Gains A. Determining Society’s MC Gain 1. Society MC and Market S curves are same lines a. Firm S and MC Curves b. Society S curve is formed by stacking individual firm S curves: c. To draw S curve  At price .5 $/can  Tasty produces until MC  = $.5 (Produces 20 cans)  Healthy produces until MC Hea = $.5 (Produce 25 cans)  Campbell produces until MC Camp = $.5 (Produces 30 cans)  When price = $.5 Q S m = 75 and every firm has MC = .5  d. To draw MC  curveiety  When Q S m = 75, every firm has MC = $.5/can  If extra can produced   By tasty MC = .5  By healthy MC = .5  By Campbell MC =.5  MC  = .5ety   If total output is 75 and every fir, has MC = .5, MC  = .5 society 2.  To draw S curve a. At price $1/can  Tasy produces until MC  = 1 40m cans produced  Healthy produces until MC Hea = 1 35m cans produced  Campbell produces until MC Cam = 1 50m cans produced b. When Price = 1, Q S M = 125 and every firm has MC = 1 c. To draw MC  curve:ety  When Q=125, every firm has MC=$1/can  If extra can produced  By Tasty, MC = 1  By Healthy, MC = 1  By Campbell, MC = 1  MC  = 1ciety society  (If total output is 125 and every firm has MC  = 1  S  and MC Soc curves have different interpretations, but the lines  are the same! B. Total (Operating) Profit of All Firms When Price is $1/can 1.  a. Interpret Smaras MC  curveety  Total Profit = profit from + profit from + …+ price from 1st can 2nd can    125th can       = p­MC   +    p ­ MC +   …   +   p­MC        of 1st can     of 2nd can       of 125th can       = area of ABC       = ½(.8) 125 = 50 (M$/week) II. Do Households Benefit from Profits Made by Firms A. Firms 1. Firms are owned by individuals (shareholders)  Profits paid out by shareholders 2. Well­being of each shareholder of Trusty increased by the $ it receives  Tasty Soup’s profit: 16 (m$/week)  Well being of all shareholders of Trusy’s  16 (m$/week) 3. Well­being of each shareholder of soup firm increased by $ it received  All firms in soup market have combined profits:  50 (m$/week)  Well­being of all shareholders of soup­market firms increased: 50  (m$/week) B. Evaluating the Market Outcome  1. Market Model 2. Each household affected because of soup market in 2 ways a. As consumer: net benefit from buying and eating soup b. As shareholder: profits paid by firm to individuals 3. Total well being / total net benefit / total surplus created is sum of well­being/    Net benefits/surplus created by each route 4. For soup market a. Total Net Benefit = Net benefit from buying + Net benefit from profit b. Total Surplus = Consumer Surplus + Producer Surplus C. Total Benefit to Individuals from Soup Market 1. Two Choices a. Determine net benefit from buying and profits separately, then sum  Total = net benefit from buying + net benefit from profit         = MB soc­p  +  MB soc­p  +  p ­ MC soc + …+ p ­ MC society from buying  of 500th can    of 1st can             of 500th can         = ABE + BCE = ½(3)500 + ½(.8)500 = 950 (m$/week) OR b. Look at the big picture: benefit of each unit is benefit of unit minus cost of unit.  Total net benefit = MB soc­ MC so + MB soc ­ MC soc + ….+  Of 1st can                of 2nd can MB  ­ MC  ty society    Of 2nd can = sum of rectangles = Area of traingle = ½(3.5)500­950 (m$/week) 10/07/16 Lecture 18 I. Social Evaluation of the Market Outcome A. Normative: What do we want to happen? 1. The market is just a “social system” which determines what output is produced  and how it is distributed among households. 2. There are other social systems by determine what output is produced and how it is distributed. a. Socialist system: each household gets certain level of goods “free”   Paid for by taxes b. Communist system: everybody gets told what goods they get and where they work 3. Suppose, using different systems, net benefit is created as: a. Which system is best  This is a value­judgement  Course’s value­judgement “The best outcome is outcome in which society gets the highest  well­being or highest net benefit.” 4. Understanding that all systems are likely to have their problems, instead of  looking at all possible systems, look at best possible outcome. a. In a perfect world, outcome which gives the greatest possible well­ being/net benefit is called the Pareto ­ efficient outcome 5. Then compare the greatest possible NB with NB achieved using the Market  System. a. Calculate how much NB is lost because we use Market System instead  of being able to use the “perfect” system. b. Repeat for each system c. Choose the system which gives the lowest NB loss B. Determining the Efficient Outcome: The Planner 1. To determine how much an efficient outcome looks, personalize the decision­ making: 2. Consider what would happen if an individual makes the decisions: “The  planner” a. We are going to pretend that she knows everything ­ the perfect world  She organize production and consumption to create as much NB as possible b. To do this, she can command people and firms  John consumes 10 soup cans  Southwest Airlines manufactures 1000 flights  Susan takes an air flight to Dallas at Thanksgiving c. She chooses  The quantity produced of each product  How hard each household is to work  How much of each product is consumed by each individual d. She is commanding. Goods allocated  By the command of the planner  Not by the individuals voluntarily interacting through markets 3. How would planner choose output to achieve efficiency  a. Decision­making ­ use marginal analysis to make plan b. Margin is line which divides soup cans made from soup cans not made c. If planner sets production and consumption target of 300 cans:  Planner evaluates plan by considering effect of moving margin to  produce 1 extra can  To make extra soup can, must use resources which could make  “other things”  Net­benefit gained   MB ­ well being given up from “other things” not made  MB­MC  3 ­ .5  The plan (to make 300 cans) is not the best plan. I create more NB  by producing extra cans  If MB > MC, planner creates more well being by increasing the  target. Planner continues to increase target if MB > MC or until  MB = MC 4. If target is 600 cans: a. Planner evaluates plan by considering effect of moving margin to  produce 1 less can.  Loose benefit MB = .4  Gain benefit of “other things” = 2  Well­being increases  b. If MB < MC, planner creates more well­being by decreasing the target.  Planner continues to decrease target if MB < MC of until MB = MC c. Maximum possible well­being from soup  When MB = MC  When Quantity = 500 (m cans/week)  Well being = ½(3.8)500 = 950 (m$/week) 5. Planner’s task a.  Seeks information on MBs and MCs  Runs computer program  Sends production and shipping plan to firms  Tells firms which goods to send which goods to which households.  Is there an easier way to do it? How bad is the market outcome? C. Market Outcome 1. Pareto ­ efficient outcome at intersection of MB and MC curves a. Market outcome is at intersection of MB and MC curves  D curve is same line as MB curve  S curve is same line as MC curve  When market mechanism sets Q  = Q, it sets MB = MC ad  produces 500 units b. Competitive markets ensure the max well being (950 m$/week) gained  by people.  Partly through goods consumed  Partly through profits received by shareholders  First Fundamental Welfare Theorem c. Using the market, society gets outcome which maximizes net benefit  without any commands.   Total Net  = NB from buying   +   NB from profits   Benefit       (People organize(Firm managers buying to make organize production this as big as  to make this as  possible) big as possible) d. Why does this work?  Planner: when deciding whether to produce more, planner  compares MB with MC. Wants more to be produced if MB > MC  Individual: When deciding whether to buy more, individual  compares MB with price, buys more if MB > p  But competition ensures firms choose output such that MC = price, so individual is comparing MB and MC, and is buying more if MB > MC. (makes same decisions as planner) II. Revisiting Adam Smith A. 1776: “An inquiry into the nature and causes of the wealth of nations” 1. “Every individual necessarily labors to render the annual revenue [net benefit]  of society as great as he can. He can generally indeed neither intends to promote  the public interest, nor knows how much he is promoting it...He intends only his  own gain, and he is in this, as in many other cases, led by an invisible hand to  promote an end which was no part of his intention... By pursuing his own interest  he frequently promotes that of society more effectually than when he intends to  promote it. I have never known much good by those who affected to trade for the  public purpose.” a. Invisible hand = price 2. Market creates as much well­being/net benefit possible a. As much as planner in perfect world b. Real planner can never create more, usually creates less. B. Food Facts example 1. 1941: Japanese farmers produced enough rice to give everyone in population  336 grams of rice a day War causes government to requisition farms 2. 1945 Rice output dropped to 234 grams a day C. Development plans example 1. Development “Guru”:   “Turkey isn’t making enough tractors.”  “If Turkey made more tractors, farmers could grow more food,  households would get more bread, and everybody would gain.” 2. Me: “excuse me. Markets ensure that well­being is maximized. Not possible to  make everybody better off. In particular, opp cost: to make the tractors, fewer cars will be made, and people benefit more  from the cars than the bread.


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