1 Market Economies
-
Upload
julialarisa -
Category
Documents
-
view
222 -
download
0
Transcript of 1 Market Economies
-
8/11/2019 1 Market Economies
1/80
1. The Market Economy
Fall 2008
-
8/11/2019 1 Market Economies
2/80
Outline
A. Introduction: What is Efficiency?
B. Supply and Demand (1 Market)
C. Efficiency of Consumption (Many Markets)
D. Production Efficiency (Many Markets)
-
8/11/2019 1 Market Economies
3/80
A. Introduction
Economics is based on assumptions of maximizationandequilibrium:
Individuals taking decisions to maximizeprofit or utility.(individualistic)
These decisions interact in markets and we use the notionof equilibrium to predict what is the outcome.
We build modelswho gets what and why they get it. (How
resources are allocated.)These have testable implications.
-
8/11/2019 1 Market Economies
4/80
Key themes
Incentives: Why do optimizers do what they do?
Information: What do individuals know and is this useful?
Surprising idea: Individual optimization can promote thecommon good. (In certain cases.)
Markets and other domains where individuals interact
aggregate individuals decisions and information.
-
8/11/2019 1 Market Economies
5/80
Pareto Efficiency
Definition: An allocationof resources is Pareto Efficientif it isnot possible to reallocate resources to make everyone
better off.
How do we measure better off?
We use Utilityto measure welfare/happiness.
-
8/11/2019 1 Market Economies
6/80
Utility Possibilities: What is Feasible
1s Utility
2s Utility
-
8/11/2019 1 Market Economies
7/80
Utility Possibilities: What is Feasible
1s Utility
2s Utility
Allocations
-
8/11/2019 1 Market Economies
8/80
Pareto efficiency: There is no waste
1s Utility
2s Utility
Pareto efficient Allocation
-
8/11/2019 1 Market Economies
9/80
Equity: equal shares
1s Utility
2s Utility U1= U2
-
8/11/2019 1 Market Economies
10/80
Utilitarianism: Maximize U(1)+U(2)
1s Utility
2s Utility
-
8/11/2019 1 Market Economies
11/80
Rawls: Maximize min{U(1),U(2)}
1s Utility
2s Utility
-
8/11/2019 1 Market Economies
12/80
Example: Efficiency in Exchange
A buyer values the good at 4 (and gets 0 otherwise).
A seller who values the good at 2 (and gets 0 otherwise).
They can trade at the pricep.
Buyer Seller
Seller keeps the good no trade 0 2
Buyer pays sellerp and 4-p p
buyer gets the good
Q: What values ofpis trade better than no trade?
-
8/11/2019 1 Market Economies
13/80
B. The Supply and Demand Fable
Suppose you have: 100 people each wanting a cup of coffee, but valuing the coffee differentamounts.
80 people willing to make a cup, but with different costs.
Your job is to decide who should get a cup and who should make it.
What do you want to avoid:(1) A $5 buyer not getting a coffee but a $1 buyer getting one.
(allocative inefficiency)(2) A $1 seller not making a coffee but a $5 seller getting one.
(production inefficiency)
(3) A $3 seller providing coffee to a $2 buyer. (over provision)(4) A $4 buyer not getting a coffee although there are sellers with $2 costsnot making coffees. (under provision)
(5) Some coffee not being consumed by anyone.
-
8/11/2019 1 Market Economies
14/80
Possible mechanisms
(1) Central Planning/Fiat: (Centralized)
Tell people what to do. (After first having tried to find out whatpeople want.) Likely to fail all the above tests.
(2) Organize an Auction (Centralized)Tell buyers and sellers to submit bids likely to fail all tests.
(3) Organize a Market (Centralized & Decentralized)
Call out a price for coffee.
(4) Put them all in a room and let them get on with it!
(Decentralized)
-
8/11/2019 1 Market Economies
15/80
P
Q of Coffee
Demand (100)
-
8/11/2019 1 Market Economies
16/80
P
Q of Coffee
Supply (80)
-
8/11/2019 1 Market Economies
17/80
P
Q of Coffee
Demand Supply
-
8/11/2019 1 Market Economies
18/80
P
Q of Coffee
Demand Supply
-
8/11/2019 1 Market Economies
19/80
P
Q of Coffee
Demand Supply
-
8/11/2019 1 Market Economies
20/80
P
Q of Coffee
Demand Supply
-
8/11/2019 1 Market Economies
21/80
P
Q of Coffee
Demand Supply
-
8/11/2019 1 Market Economies
22/80
Conclusions
If
(1) a market is organized,
(2) the market is perfectly competitive,
(3) price is at the equilibrium,
then
full efficiency is achieved.
-
8/11/2019 1 Market Economies
23/80
C. Efficiency of Economies with ManyGoods (No Production)
Consumer Behaviour with Many Goods
Quantity of A
Quantity of B
-
8/11/2019 1 Market Economies
24/80
C. Efficiency with Many Goods
Indifference Curves
Quantity of A
Quantity of B
utility =2
-
8/11/2019 1 Market Economies
25/80
C. Efficiency with Many Goods
Indifference Curves
Quantity of A
Quantity of B
utility =3
-
8/11/2019 1 Market Economies
26/80
C. Efficiency with Many Goods
indifference curves
Quantity of A
Quantity of B
utility =4
-
8/11/2019 1 Market Economies
27/80
C. Efficiency with Many Goods
Indifference Curves
Quantity of A
Quantity of BHigher Utility
-
8/11/2019 1 Market Economies
28/80
Budget Constraints
Quantity of A
Quantity of B
With $10 can afford 10 = pAX(Units of A) + pBX(Units of B)
10 = pAQA+ pBQB
-
8/11/2019 1 Market Economies
29/80
Budget Constraints
Quantity of A
Quantity of B
With $10 can afford 10 = pAX(Units of A) + pBX(Units of B)
-
8/11/2019 1 Market Economies
30/80
Budget Constraints
Quantity of A
Quantity of B
With $10 can afford 10 = pAX(Units of A) + pBX(Units of B)
-
8/11/2019 1 Market Economies
31/80
Consumer Optimum
Quantity of A
Quantity of B
-
8/11/2019 1 Market Economies
32/80
Consumer Optimum
Quantity of A
Quantity of B Here Slopes areequal
-
8/11/2019 1 Market Economies
33/80
Equal Slopes
Slope of Budget Line:
= - pA/pB
Slope of Indifference Curve
= - MUA / MUB
-
8/11/2019 1 Market Economies
34/80
Equal Slopes
Slope of Budget Line:
= - pA/pB
Slope of Indifference Curve
= - MUA / MUB
This is called:
The Marginal Rate of Substitution
-
8/11/2019 1 Market Economies
35/80
Equal Slopes
Slope of Budget Line:
= - pA/pB
Slope of Indifference Curve
= - MUA / MUB
Equality ImpliesMUA / MUB = pA/pB
Or
MUB/ pB = MUB/pB
Interpretation:Extra utility from $1 = Extra utility from $1
spent on A spent on B
-
8/11/2019 1 Market Economies
36/80
At Last: Efficiency with Many Goods
Imagine 2 people: person I (she) and person II (he).
They begin life with:
Good A Good B
Person I 5 units 1 unitPerson II 1 unit 5 units
These are called endowments.
They want to trade to achieve better bundles.
-
8/11/2019 1 Market Economies
37/80
Their Resources
Is Quantity of A
Is Quantity of B
IIs Quantity of B
IIs Quantity of A
-
8/11/2019 1 Market Economies
38/80
Their Endowment
Quantity of A
Quantity of B
1
5
IIs Quantity of B
IIs Quantity of A 1
5
-
8/11/2019 1 Market Economies
39/80
Is Preferences
Quantity of A
Quantity of B
1
5
IIs Quantity of B
IIs Quantity of A 1
5
-
8/11/2019 1 Market Economies
40/80
IIs Preferences
Quantity of A
Quantity of B
1
5
IIs Quantity of B
IIs Quantity of A 1
5
-
8/11/2019 1 Market Economies
41/80
Putting Preferences together
Quantity of A
Quantity of B
1
5
IIs Quantity of B
IIs Quantity of A 1
5
-
8/11/2019 1 Market Economies
42/80
Pareto efficiency: Is where cannot make Ibetter off with out making II worse off.
Quantity of A
Quantity of B
1
5
IIs Quantity of B
IIs Quantity of A 1
5
-
8/11/2019 1 Market Economies
43/80
Pareto efficiency: Is where cannot make Ibetter off with out making II worse off.
Quantity of A
Quantity of B
1
5
IIs Quantity of B
IIs Quantity of A 1
5
-
8/11/2019 1 Market Economies
44/80
Pareto efficiency: Is where cannot make Ibetter off with out making II worse off.
Quantity of A
Quantity of B
1
5
IIs Quantity of B
IIs Quantity of A 1
5
-
8/11/2019 1 Market Economies
45/80
Pareto efficiency: Is where cannot make Ibetter off with out making II worse off.
Quantity of A
Quantity of B
1
5
IIs Quantity of B
IIs Quantity of A 1
5
-
8/11/2019 1 Market Economies
46/80
Pareto efficiency: Is where cannot make Ibetter off with out making II worse off.
Quantity of A
Quantity of B
1
5
IIs Quantity of B
IIs Quantity of A 1
5
-
8/11/2019 1 Market Economies
47/80
Allocation of Resources is efficient ifSlope of Is Indifference = Slope of IIs Indifference
Curve Curve
Is MRS = IIs MRS
MU(I)A
/ MU(I)B
= MU(II)A
/ MU(II)B
Or
MU(I)A / MU(II)A = MU(I)B / MU(II)B
Extra utility I gets from Extra utility I gets from
small increase in A at the = small increase in B at theexpense of IIs small decrease expense of IIs small decrease
in A. in B.
-
8/11/2019 1 Market Economies
48/80
All the Pareto efficient places
Quantity of A
Quantity of B
1
5
IIs Quantity of B
IIs Quantity of A 1
5
-
8/11/2019 1 Market Economies
49/80
These join to give the Contract Curve
Quantity of A
Quantity of B
1
5
IIs Quantity of B
IIs Quantity of A 1
5
-
8/11/2019 1 Market Economies
50/80
Pareto efficiency: Utility Possibilities
Is Utility
IIs Utility
Pareto efficient Allocation
-
8/11/2019 1 Market Economies
51/80
D. Production Efficiency
One firm uses inputs:
Land and Labour to produce good A
Another firm:uses Land and Labour to produce good B.
-
8/11/2019 1 Market Economies
52/80
Production Functions & Isoquants
Quantity of
Labour
Quantity ofland
Output = 1 Unit of A
-
8/11/2019 1 Market Economies
53/80
Production Functions & Isoquants
Quantity of
Labour
Quantity ofland
Output = 1 Unit of A
Output = 2 Unit of A
-
8/11/2019 1 Market Economies
54/80
Production Functions & Isoquants
Quantity of
Labour
Quantity ofland
Output = 1 Unit of A
Output = 3 Unit of A
Output = 2 Unit of A
-
8/11/2019 1 Market Economies
55/80
Production Functions & Isoquants
Quantity of
Labour
Quantity ofland
Output = 1 Unit of A
Output = 3 Unit of A
Output = 2 Unit of A
Output = 5 Unit of A
Output = 4 Unit of A
-
8/11/2019 1 Market Economies
56/80
Most Efficient way of producing Output =3
Quantity of
Labour
Quantity ofland
$8 = PL QL+ PNPN
-
8/11/2019 1 Market Economies
57/80
Most Efficient way of producing Output =3
Quantity of
Labour
Quantity ofland
$9 = PL QL+ PNPN
$8 = PL QL+ PNPN
-
8/11/2019 1 Market Economies
58/80
Most Efficient way of producing Output =3
Quantity of
Labour
Quantity ofland
$10 = PL QL+ PNPN
$9 = PL QL+ PNPN
$8 = PL QL+ PNPN
-
8/11/2019 1 Market Economies
59/80
Most Efficient way of producing Output =3
Quantity of
Labour
Quantity ofland
Output = 3 Unit of A
-
8/11/2019 1 Market Economies
60/80
Most Efficient way of producing Output =3
Quantity of
Labour
Quantity ofland
Output = 3 Unit of A
-
8/11/2019 1 Market Economies
61/80
Most Efficient way of producing Output =3
Quantity of
Labour
Quantity ofland
Here Slopes areequal
Output = 3 Unit of A
-
8/11/2019 1 Market Economies
62/80
SLOPES ARE EQUAL SO:
Slope of Isoquant= - MPN/MPL
= Marginal rate of technical substitution
Slope of Cost Line
= - PN/PL
Equal Slopes MPN/MPL = PN/PL
or MPN/PN = MPL/PL
-
8/11/2019 1 Market Economies
63/80
Production Functions & Isoquants
Quantity of
Labour
Quantity ofland
Here Slopes areequal
Output = 1 Unit of A
Output = 3 Unit of A
Output = 2 Unit of A
Output = 5 Unit of A
Output = 4 Unit of A
-
8/11/2019 1 Market Economies
64/80
Many Firms Producing
Firm 1s Labour
Firm 1s Land
Firm IIs Land
Firm IIs Labour
-
8/11/2019 1 Market Economies
65/80
Many Firms Producing
Firm 1s Labour
Firm 1s Land
Firm IIs Land
Firm IIs Labour
-
8/11/2019 1 Market Economies
66/80
Many Firms Producing: Efficient Production
Firm 1s Labour
Firm 1s Land
Firm IIs Land
Firm IIs Labour
-
8/11/2019 1 Market Economies
67/80
SLOPES ARE EQUAL SO:
Slope of Isoquant Firm I= - MP(I)N/MP(I)L
= Marginal rate tech substitution (I)
Slope of Isoquant Firm II= - MP(II)N/MP(II)L
= Marginal rate tech substitution (I)
Equal Slopes MP(I)N/MP(I)L = MP(II)N/MP(II)Lor
MP(I)N/MP(II)N = MP(I)L/MP(II)L
-
8/11/2019 1 Market Economies
68/80
Many Firms Producing: Efficient Production
Firm 1s Labour
Firm 1s Land
Firm IIs Land
Firm IIs Labour
-
8/11/2019 1 Market Economies
69/80
Production Possibility Frontier
Firm 1s Labour
Firm 1s Land
Firm IIs Land
Firm IIs Labour
-
8/11/2019 1 Market Economies
70/80
Production Possibilities: What is Feasible
Firm 1s Output
Firm 2s Output
-
8/11/2019 1 Market Economies
71/80
Production Possibilities: What is Feasible
Firm 1s Output
Firm 2s OutputSlope of this line represents howeconomy is able to move fromproduction of 2 into 1 =
Marginal Rate of Transformation
At Last: Production Efficiency with Many
-
8/11/2019 1 Market Economies
72/80
At Last: Production Efficiency with ManyGoods and One Consumer
Quantity of A
Quantity of BHigher Utility
How the consumer values goods
-
8/11/2019 1 Market Economies
73/80
What can be produced
Firm 1s Output
Firm 2s Output
-
8/11/2019 1 Market Economies
74/80
Maximizing Utility given Production
Quantity of A
Quantity of BHigher Utility
How the consumer values goods
Slope of Indifference = Slope of Production
-
8/11/2019 1 Market Economies
75/80
Slope of Indifference = Slope of ProductionPossibilities = Ratio of Prices
Quantity of A
Quantity of BHigher Utility
How the consumer values goods
-
8/11/2019 1 Market Economies
76/80
Efficiency with Many Goods and Production
Slope of Indifference = Marginal Rate of Substitution
Equals
Slope of Production Possibilities = Marginal Rate ofTransformation
Equals
Ratio of Prices
-
8/11/2019 1 Market Economies
77/80
Efficiency with Many Goods and Production
Quantity of A
Quantity of B
1
5
IIs Quantity of B
IIs Quantity of A 1
5
Many Firms Producing: What is produced is
-
8/11/2019 1 Market Economies
78/80
Many Firms Producing: What is produced isdetermined by input prices
Firm 1s Labour
Firm 1s Land
1
5
Firm IIs Land
Firm IIs Labour 1
5
-
8/11/2019 1 Market Economies
79/80
Their Preferences
Quantity of A
Quantity of B
1
5
IIs Quantity of B
IIs Quantity of A 1
5
-
8/11/2019 1 Market Economies
80/80