INTRO MICROECON ECON 200
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This 24 page Class Notes was uploaded by Miss Adeline Weimann on Wednesday September 9, 2015. The Class Notes belongs to ECON 200 at University of Washington taught by Salehi-Esfahani in Fall. Since its upload, it has received 16 views. For similar materials see /class/192478/econ-200-university-of-washington in Economcs at University of Washington.
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Date Created: 09/09/15
Session 7Econ 200 Chapter 4Source of Mutual gains from exchange An Example Trevor is shirtless would like to buy a shirt He values a shirt at 20 MV of the first shirt what he is willing to give up of other goods to acquire this shirt Sunil has received and accumulated a lot of shirts on his various birthdays He values 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 lfP 10 Trevor gains and Sunil gains lfP 12 Trevor gains and Sunil gains lfP 5 Trevor gains 15 and Sunil gains 5 What common attribute do all these calculation have in common What is the sum of their gains from trade The source of mutual bene t is the differences between marginal evaluations of a good by different people 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 A has no shirts at all B has 11 shirts Table 1 MV forA 11 0 0 For B the 11th item has a MV of 0 For the 1St item that B gives up A would be willing to pay 12 So the difference in MVs is 12 and maximum amount of mutual gains from this trade is The 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 A values the 2nd shirt at 10 The maximum mutual gains from this trade is The next 3rd item is valued by B at 4 and by A at 8 so the maximum mutual gains from this trade is The 4th item is valued by B at 6 and by A at 6 so the gains from trade from this exchange are The 5th shirt is valued by B at 8 and by A at 4 Will this trade take place Therefore shirts are to be purchased by A from B The total gains from trade are 1284 0 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 Two major insights about trade 1 Some trade is better than none 2 More trade is not necessarily preferred by all to less trade Deriving the supply behavior in pure exchange Table 2 Market Price per shirt B s Q Demanded B s Q of shirts Supplied stock Table 3 Market Price per shirt B s Q Demanded B s Q of shirts Supplied stock The rst and the third column of the table above show the supply schedule for person B How do we explain the supply behavior of B Let s start with price of 20 per shirt Consider the price to be 20 per shirt We know that B will consume 1 shirt when price is 20 per shirt since her MV of the 1st unit is also 20 Now look at the second short B s MV of consumption of211d shirt is 18 That is she would be willing to forgo 18 of other goods and services to get the 2m1 shirt At price of 20 per shirt she does not want a second shirt But remember she has a stock of 11 shirt She does not want the second shirt and she will be happy to offer it for sale at 20 Why Because as she is only willing to forgo 18 worth of other goods for the second shirt she would indeed forgo 20 worth of other goods if she does not sell her second shirt at 20 the 2nd shirt is too expensive for her to keep The price she can get for the second shirt is after all 20 So she will voluntarily sell the second shirt at 20 Now let s keep the price still at 20 per shirt Let s look at her 3rd shirt She values the consumption of the 3rd shirt at 16 This means she would be swilling to forgo 16 worth of other goods and services The price of the 3rd shirt is indeed 20 If she does not offer her 3rd shirt for 20 she would be forgoing not 16 her MV but in fact 20 worth of other goods and services So keeping the 3r shirt is in fact too expensive for her and she willingly and voluntarily gives it up So all in all how many shirts om her stock of 11 does she voluntarily offer for sale when the price per shirt is 20 Now let s look at a new situation Suppose the market price of a shirt is now 18 We know that B s decision to consume shirts according to her MV schedule is 2 shirts So she demands 2 shirts Let s look at what happens with her 3rd shirt Remember that the price is 18 per shirt For her 3rd shirt she values it at 16 implying she is wiling to forgo 16 of other goods and services to have this 3r shirt But the price is 18 and if she does not offer it for sale at 18 she would be forgoing 18 worth of other goods and services not the 16 she intends In other words at 18 a piece the 3rd shirt is too expensive for her to keep so she willingly and voluntarily offers the 3rd shirt for sale Can you continue this analysis for her 4 h up to the 9th out of stock of 11 that she gives up At 18 per shirt how many will B offer for sale The supply curve on a graph 39 B As P rises B is willing to sell more Since it will consume less of its own endowed good Seller s rents also called the producer surplus Just as the consumer has a surplus the seller does have a surplus too The area under the supply up the quantity is the minimum total amount the seller must be paid to voluntarily offer the good at that quantity for sale Table 4 Consider B s supply behavior Suppose the market price is 8 per shirt How many shirts is individual B selling What is her total revenue Now let s look at her producer Surplus To sell the lSt unit she requires a minimum payment of To sell the 2nd unit she requires a minimum payment of To sell the 3rd unit she requires a minimum payment of To sell the 4th unit she requires a minimum payment of The total minimum she requires for selling 4 units is simply the sum of the above Her producer Surplus is Derivation of the Market Supply Curve Consider two individual suppliers of a good Which one of the following best depicts the Market Supply Derivation of the Market Supply Curve 7 E E E E E Market Equilibrium and Economic efficiency P Supply 4 0 El The figure above shows the D and S together At the 1st unit MV for buyer is 22 and that of seller is 6 The difference is 16 There will be voluntary exchange of 1st unit For the 2nd unit the MV for buyer is 20 that of the seller 8 so again as long as MVs are different exchange will be mutually beneficial Exchange will take place until which point Where will it stop What will be the MVMC of each side and how much will be exchanged When the MV for buyer is 14 and for the seller MC is 14 further exchange stops There are no further gains from exchange At MV or Price of 14 all gains from trade are exhausted At P 14 we say our market is in a Pareto Optimal or ef cient situation Here the gains from exchange are maximized These gains are the CS and seller s rents together the triangle to the left of 50 units Important features ofthe organized markets 0 In a modern economy with organized markets there is a single price for most goods 0 No haggling in most marketsl What is the cost of haggling 0 Why do people usually haggle over the price of cars and houses 0 How is the equilibrium price PE and quantity traded QE established Session 3 Econ 200 Chapter 2 Remember this example from last time Sooki s MV and TV of various quantities of blue jeans per year Q MV Total Value 1 50 50 2 40 90 3 30 120 4 20 140 5 10 150 6 0 150 We said that if P 30 then Sooki will buy pairs of jeans per year For the first pair she is willing to forgo 50 dollars of other goods to acquire the first pair but she is only asked to forgo 30 The concept of consumer surplus Total Value sum of MV up to quantity we purchase Market price is 30 per pair Consumer Surplus for the first pair is Total Value Total Expenditure Q MV TV Total Exp CS 1 50 50 30 20 2 40 90 60 30 3 30 120 90 30 4 20 140 120 20 5 10 150 150 0 6 0 150 180 30 We said if price is given at 30 per pair Sooki buys pairs At What Q is her Consumer Surplus maximized Therefore at a Q Where MV P CS is also maximized Beyond 3 pairs she does have some CS but it is smaller than at Q 3 Now let s go to the original table of MV and Total Value IfP 50 what is Sooki s best choice of Q IfP 40 Q pairs and CS 10 and that is maximum IfP 30 Q pairs and CS is max at 30 If P 20 Q and CS is 60 and it is maX Let s draw the MV curve against Q per year and find out what her demand is Marginal Value S Q of jeans per year So What is S00ki s demand curve for blue jeans Why is it downward sloping Sooki s demand curve for blue jeans Price per pair AK L E Q 0fjreans per year Which area shows the total expenditures on 3 pairs of blue jeans per year Which area shows the total value of purchase of 3 pairs of blue jeans per year CS or consumer gain is the area between the price and the demand Total Expenditure Total Value and Consumer Surplus Price Q Total Exp Total value Consumer surplus 50 1 50 50 0 40 2 80 90 10 30 3 90 120 30 20 4 80 140 40 10 5 50 150 100 Example Donations to charity as an application oflaw of demand They say people are less charitable now than some 60 years ago Did people just become less charitable or has there been a change in some constraint In the US charitable donations are deducted from income before taxes are calculated In the 1950s and 60s the top taX bracket was 70 So a dollar given to charity would cost only 30 cents since 1 less of income would be reported and 70 cents taX on it would have been paid Then in 1980s taX codes changed and fell to about 34 Did giving to charity cost more or less than before Now a dollar given to charity costs the donor 66 cents As the cost goes up the amount of donations Deriving the Market Demand from Individual demand curves Consider the individual demand curves of Jane and Jack for ice cream P P Which one of the following 3 diagrams depicts the combined demand for Jane and Jack the market demand Q Applications of concepts of marginal value and total value The WaterDiamond Paradox Diamonds are much more highly priced than water Does it mean that we Value diamonds which we can live without more than water which is essential to life L r P EPE P QQ The Hint is in the following table from the blue jeans example Q MV Total Value 1 50 2 40 90 3 30 120 4 20 140 5 10 1 5 0 Notice that in the above with increasing Q MV but Total Value So how do we explain the waterdiamond paradox E Water E Diamonds L Q Per period Q Per period Applications of WaterDiamond Paradox 1 Comparable Worth 0 Of plumbers and nurses which one earns a higher salary Does this mean that people care more about their kitchen sinks than their health 0 Would you expect university professors to earn the same salary across all fields Does the lower salary of philosophy professors re ect the fact that we do not value them as much as computer science professors 2 Suppose during a drought spell the city government decides to restrict water use by equal amounts to all businesses and households Let s say the government allows no more than 100 gallon per day for each customer Does this imply that all persons and businesses equally share the burden of the drought Laundromat D l3 Photocopy store T D L L Q of Water per day Q of Water per day Both customers pay the same price but have different total value of all the water they use Notes for Session 17 Chapter 9 Property Rights and Transaction Costs Three assertions 1 Where transactions costs are prohibitively high implying that property rights can not be established there will be no trade and no economic growth 2 Clearly de ned and enforced property rights require no effort to establish or enforce them and hence there are no transactions costs where property rights are fully defined and enforced With clear definition of property rights the gains from trade are maximized The Coase Theorem 3 Where transaction costs exist it implies that property rights are not well defined or enforced Presence of transaction costs leads to inefficient outcomes Examples of externality and the economically efficient solution with zero transaction costs Example 1 Suppose an ostrich grower and a vegetable farmer are neighbors Each ostrich destroys 40 worth of vegetables No of ostriches Marginal Marginal Crop Marginal Social Private Cost Damage Cost 1 30 40 70 2 40 40 80 3 50 40 90 4 60 40 100 5 70 40 1 10 6 80 40 120 7 90 40 130 8 100 40 140 Suppose the price of an ostrich is 90 i The ostrich grower does not care about what happens to farmer and considers only his own private cost How many ostriches it will grow ii Now suppose the laws are clearly de ned as to who should compensate who Suppose the ostrich grower is held liable for having his ostriches trample over the farm How many ostriches are grown now 40 Marginal social cost C Marginal rivate cost G B p 90 39 Q of 3 7 ostriches iii Now consider no liability for the ostrich grower in this case In other words the law clearly holds the farmer liable for its own loss How will the farmer and the grower negotiate How many ostriches will be produced For the lSt ostrich the marginal private cost MPC and the price is 90 so the grower earns in rents gains and the farmer loses 40 when the 1St ostrich is produced Is there any way the farmer could compensate the grower not to grow the rst ostrich With the 2nd ostrich the ostrich grower s MPC is 40 and price is 90 so the grower earns in rents while the farmer loses 40 when the 21d ostrich is produced Is there any way the farmer could compensate the grower not to grow the second ostrich With the 3rd ostrich grower earns net gains of and the farmer loses so it is even between the two We will simply take it that the grower will produce this 3rd ostrich as well With the 4th ostrich growers MPC 60 P 90 he earns rents of while the farmer is losing 40 Is there a mutually advantageous trade here The farmer can pay 31 to grower not to grow ostrich The grower makes 31 instead of 30 and the farmer gains He would have lost 40 but is now losing only 31 With the 5th ostrich again the grower earns 20 of gains while the farmer loses 40 Is there a mutually advantageous trade here The farmer can pay off the grower anything slightly above the net rents of the grower say payoff the grower by 21 and therefore gain 19 A similar analysis holds for the 6 h and the 7th ostriches All in all with this payoff scheme how many ostriches will be produced How is this result different om the result in part ii The total payments by farmer could be 31 21 11 1 64 which is much lower than his otherwise total loss of 440 160 Example 2 An application of the Coase Theorem Marriage and Divorce with M transaction costs Fault Laws in divorce No Faultquot Laws in divorce A numerical example with Q transaction costs ie complete delineation of rights the outcome is the same under fault or fault laws Net daily bene ts to husband and wife in two states of the world married and divorced Husband Wife Married 100 100 Divorced 120 60 Maximizing the net gains from exchange will this couple stay married or will they divorce Under fault law will they stay married and what is the payoff Under no fault law will they stay married and what is the payoff Assertion 3 Examples of the effects of presence of transaction costs a Marriage and divorce with transaction costs The same numerical example as before Net daily benefits to husband and wife two states of the world married and divorced Husband Wife Married 100 100 Divorced 120 60 Maximizing the gains om exchange will this couple stay married or will they divorce Suppose the wife can not claim full rights to her investments in the household e g her investments in her husband s career Under no fault law will they stay married Other examples of presence of transaction costs b Sale by owner for house sales and the role of real estate agents c Signaling use of a college degree in nding employment d Adverse selection provision of health insurance Suppose the insurance premium for health care for a person who takes good care of himselfherself and is basically healthy is 100 per year The insurance premium for the opposite type of person is 1000 The insurance company is not able to reliably nd out if the person to be insured is sick or healthy What premium will the insurance company charge on average for insurance Who would want to buy health insurance Would the insurance company be willing to provide health insurance to mostly sick persons at that premium e Property right issues in love and marriage Why do traditional societies marry off their daughters to relatives An application of externality in common property highway congestion Consider a section of highway where up to 5 cars can travel with no congestion The average travel time without congestion is 20 minutes up to 5 cars Beyond that each added car slows everyone else travel time by 2 minutes Assume there is an alternative route a side street that would take 44 minutes to travel verage time minutes minutes time minutes For all drivers attempting to save travel time om the alternate route on the side street how many cars will be on the eeway Why does the presence of 17 cars signal lost gains om trade an inefficient outcome What is the rule that describes an economically efficient outcome Since each car entering the freeway imposes extra travel time on others the efficient number of cars is such that the last car entering the highway produces slightly more time saved for this car than travel time added to all other cars In our solution the economically efficient outcome is to have the last car entering the highway saving as much time as it adds to all other cars travel time Beyond this the next car entering the freeway will hurt other driver s more than it saves time Which economic concept would produce the efficient outcome How many cars would be on the freeway Would extra cars voluntarily stay away The marginal travel time for the 6th car 22 25 32 minutes 6th car saves 4422 22 minutes but hurts others by 10 extra minutes The marginal travel time for the 7th car 24 26 36 minutes The marginal travel time includes the impact the 7th driver has on others The above relationship can be shown in a general form Algebraically Total Cost total travel time of n cars is TCn n ACn Total Cost total travel time of n1 cars is TCn1 n1 ACn1 And we know MCn1 TCn1 TCn MCn1 n1 ACn1 n ACn or MCn1 n ACn1 1 ACnl n ACn MCn1 1 ACn1 n ACn1 ACn MCn1 ACn1 n ACn1 ACn Let s look at the 8th car This car saves 4426 18 minutes but imposes extra time 27 14 minutes on other cars When the 9th car that enters the highway this car saves 4428 16 minutes over the alternative route but imposes 2 gt 8 16 minutes to other s commute time When the 10th car that enters the highway freeway it will have an average travel time of 30 minutes so it saves 44 30 14 minutes over the alternative route but it slows down 9 before him by 2 minutes each which is added time for others of 18 minutes So there is more loss than gain here The 17th driver adds 76 minutes of total travel time for highway users his own 44 minutes plus 216 which is 32 minutes of added travel time for 16 others before him Since the travel time for the 17th car is 44 minutes this car would personally not lose any time if he took the side street and he would save 16 others 2 minutes of travel time each In other words by not taking the highway the 17th driver would have generated 32 extra minutes of time saved a benefit for the society while generating no loss for him We established the efficient outcome at cars Does this imply that at cars there is no congestion at all Is there a way for drivers to contract with each other to arrive at the efficient solution
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