Introduction To Microeconomics
Introduction To Microeconomics
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Date Created: 04/23/14
Lecture Notes April 22nd 2014 CHAPTER 4 Example 2 would like to buy a shirt He values a shirt at 20 MV ofthe rst shirt what he is willing to give up of other goods to acquire this shirt Sunil has received and on his various birthdays He values a shirt at 0 MV 0 because there is no more variety for Sunil the marginal value decreases Trevor would be ha to bu a shirt from Sunil for an thin less than 20 and Sunil would be ha to et an hing from Trevor If P 10 Trevor gains 10 and Sunil gains 10 mutual gains from exchange If P 12 Trevor gains 8 and Sunil gains 12 If P 5 Trevor gains and Sunil gains I Price Trevor Gains Sunil Gains 5 15 5 Trevor Gains More 10 10 10 Equal Gain 12 8 12 Sunil Gains More What common attribute do all these calculation have in common Mutual gains is the difference between the Marginal Value of the consumer and the marginal value of the POTENTIAL seller What is the sum of their gains from trade 20 each price divides the Trevors Marginal Value of 20 into equal or unequal gains so the mutual gains will always equal the marginal value of the consumer The source of mutual benefit from exchange is the difference between the marginal evaluations of a good by different people for this to happen the person who sells it must value it less than the person who wants to buy it Example 39 at a grocery store both you and the store gains since they value the good that you buy less than your marginal value for that good 39 We see this type of mutual gain everyday in our lives Mutual Gains from Trade Trade takes place until all the mutual gains from trade are exhausted Let s look at the table of MVs for A and B for shirts We assume that at all B has this situation creates room for a potential seller and trade this is because person A has none of a good that person B has a lot of so person A is willing to buy off person B Quantity MV S forA MV S for B 20 18 16 14 12 10 4 OO0lO U39lhaQlJ O 1 2 For B the 11 item has a MV of O For this item A would be willing to pay 12 So the difference in MVs is 12 and maximum amount of mutual gains from this trade is 12 differences between the marginal values 2The next item is valued by B at 2 B is willing to give up 2 of other goods to have this unit If B is offered 3 for the shirt will she give it up and sell it to A Yes because if she doesn39t sell it she wouldve gorgon 3 of goods and services when she39s only willing to give up S2 A values the 2nd shirt at 10 The maximum mutual gains from this trade is S 8 difference between marginal evaluations KThe next 3rd item is valued by B at 4 and by A at 8 so the maximum mutual gains from this trade is S 4 3The 4 item is valued by B at 6 and by A at 6 so the gains from trade from this exchange are S 0 breaking point but is included in the continuous manner of where there marginal values are the same and the exchange would take place In our approach in chapter 2 we included the last unit of the good where 2 among purchases a consumer makes we can do the same here However to be consistent with our textbook Ch 4 page 106 explanation of Table 41 I In any case whether or not we include the 4 item as traded between the seller and the buyer The 5 shirt is valued by B at 8 and by A at 4 Will this trade take place No because the marginal value is higher for the seller than the buyer so therefore the seller would receive no benefit if it was sold at 4 and the buyer would receive no benefit if it was sold at 8 so there is no way for them to both gain from this trade and therefore it wont take place Therefore 4 shirts are to be purchased by A from B The total gains from trade are 1284 24 We conclude that trade takes place until all the gains from trade are exhausted 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 any set of mutually agreed prices Clicker Question peter has allocated one chocolate bar and one package of chips to each child Betty and Sue The children39s mv for the second of each is half of the first Is there room for a mutually beneficial trade between betty and sue What we are given Betty 100 chocolate bar 20 chips Sue 30 chocolate bar 100 chips HOW TO SOLVE Chocolate Bar Chips Betty 1st 100 020 Betty 2nd 050 010 Sue 1st 030 1 00 Sue 2nd 015 050 Highest Marginal Value for first Chocolate Bar 1 00 from Betty Highest Marginal Value for second Chocolate Bar O50 from Betty Highest Marginal Value for first Chip bag 100 from Sue Highest Marginal Value for second chip bag 050 from sue Since each child bar has one chocolate bar and one bag of chips they are viable for a trade The trade will happen because Betty values the second chocolate bar higher than sue values her first chocolate bar and Sue values her second bag of chips higher than Betty value s her first bag of chips Therefore since both children value their favorite treat more than the option of variety a trade can be made Official Answer yes sue should give betty the chocolate bar and receive the potato chips rom betty Two major insights about trade 1 Some trade is better than none 2 More trade is not necessarily preferred by all to less trade as some groups may lose when trade expands If there is a seller and a buyer and another seller comes in the original seller would loose out on this new mutual bene t which is an example of how trade may not be preferred when expanded In Other Words Trade is mutually bene cial 39 More trade is not necessarily preferred by all to less trade as some groups may lose For example some groups lose from expansion of domestic trade to intemational trade The gains to millions of consumers outweigh the losses to some groups Evidence of mutual gains from trade 1 Banning trade in certain goods Countries sometimes ban imports of certain goods cars consumer appliances alcoholic beverages etc Does this imply you will not nd the banned goods in those countries Countries would Want to be able to manufacture them themselves this still happens through smuggling which is a testament to how strong trade really is Smuggling is dangerous and costly bu there are sufficiently high mutual gains that it does take place Deriving the supply behavior in pure exchange Let s consider Meena with an endowment of 8 comic books We can think of a scenario where Meena will voluntarily offer a quantity of her books for sale given a market price for comic books In other Words she will supply some of her books for sale We derive the supply behavior for Meena from her marginal value demand behavior for comic books Table 2 Meena s MV Schedule Marginal Value S Quantity of Comic Books 14 1 12 2 10 3 8 4 6 5 4 6 2 7 O 8 This table shows that at the market price of 14 per book Meena will demand a quantity such that her 2 Therefore at the market price of 14 Meena will demand 1 book ALWAYS THINK OF YOURSELF AS CONSUMER FIRST Since she has 8 how many will she offer for sale 7 since the price is 14 and her MV for 1 book is 14 she will demand quantity of that one book and sell the rest she sells the rest because she will be gaining more by selling at a price of 14 because her MV for keeping those books drops At a market price of 14 per book Why does she not keep two books and sell the rest The answer lies in the MV table she only values the second book at 12 of other goods and services given up not 14 For a market price of 14 per book if she keeps the second book she would have to give up 14 Worth of other goods and services Since she only values the second book at 12 the second book is too expensive for her to keep and so she offers it for sale Why would she not keep the third book She values the 3rd book at 10 If she keeps it when she can get 14 for it in sale she would have given up 14 worth of other goods While she is only willing to give up 10 Clearly the 3 book is too expensive for her to keep so she offers it for sale Therefore at a market price of 14 she keeps ie demands 1 book and offers 7 for sale One important point of this exercise is to appreciate that Example Suppose now the market price of comic books drops to 12 per book At a price of 12 how many books does Meena demand in this case keep She demands 2 books She will offer the rest that is 6 books for sale Why does she not keep the 3 book She only values the 3rd book at 10 while if she sells it she can get 12 for it How about the 4 book She values that at 8 while she can get 12 for it By the same reasoning she puts up a total of 6 books up for sale Now suppose the market price changes again Now the market price is 10 per book How many books does she demand ie keep She keeps 3 How many books does she offer for sale She sells 5 From our analysis above we can build the supply schedule for books Meena offers for sale columns 1 and 3 Table 3 below Table 3 Deriving Meena s Supply Schedule Market Price per Book S 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 O 8 O The rst and the third column of the table above show the supply schedule for Meena Therefore if the market price for a comic book is 14 she offers 7 books for sale At a market price of 12 she offers 6 books for sale and so on The supply curve in continuous form on a graph P As P rises Meena is willing to sell more books Since she will consume less of her own endowed good as its price rises Clicker Question Barry has the following set of MV s for clay pots He owns 4 clay pots Quantity Marginal Value gtOOl How many pots does he sell Of cial Answer he will offer to sell 2 clay pots Table 4Meena s Supply behavior 16 15 14 13 Market Price per unit S Quantity of books supplied 0 O 2 1 4 2 6 3 8 4 10 5 12 6 14 7 Consider Meena s supply behavior Suppose the market price is 8 per book How many books does Meena sell What is her total revenue 8X 4 32 What is the seller s cost The books are just sitting on her bookshelf so is there any cost to the seller We do not have a production cost here since she is not producing any book It would look like there is no cost here since the books are just there in her house But if you look at the supply schedule below closely you will see that she requires 2 to offer her first book for sale As a seller she will NOT sell this rst book at 0 10 50 or 70 or 10 but she will only offer it for sale if she is offered at least 2 Please note the asymmetry of behavior as a buyer versus a seller as a consumer she values her 8th book at 0 but as a seller she will sell it for 0 To sell the 1 unit book she requires a minimum payment of 2 In other Words she values the first book that she is o ering for sale at 2 As a seller when she gives up something she values she incurs a cost And she values the first unit of the book that she is offering to sell at 2 We denote the cost of giving up a unit of a good that a seller value as the seller s Marginal Cost MC The minimum payment the seller requires to be paid in order to give up her first book is her MC of selling the first book To sell the 2nd unit she requires a minimum payment of 4 To sell the 3rd unit she requires a minimum payment of 6 To sell the 4th unit she requires a minimum payment of 8 Please note There is some asymmetry of behavior here due to the use of discreet numbers As a buyer she values the 8th book at 0 however to give that book up for sale she requires a payment of 2 She will not sell her first book for 0 The total minimum she requires for selling 4 units is simply the sum of the above this is also the Total Cost of the seller which is the addition of all her MC 2 46 8 2O Since the market price of each book is 8 her Total Revenue is P X Q 8X 4 32 Now let s look at her producer Surplus At the market price of 8 her Producer Surplus also called seller s rent is 12 Derivation of the Market Supply Curve Consider two individual suppliers of a good P Which one of the following graphs best depicts the Market Supply Total Revenue A square from the beginning 0 where X axis and yaxis meet out to the Width of the graphed line and up along the height of the graphed line then back to the yaxis Total cost The triangle under the graphed line to the Xaxis Sellers rent or net gains is above the The triangle above the graphed line to the yaxis Derivation of the Market Supply Curve
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