DEMANDSubstitute slices of pizza for bottles

MARKET DEMANDSubstitute slices of pizza for bottles

SUPPLY Substitute slices of pizza for bottles

MARKET SUPPLY Substitute slices of pizza for bottles

MARKET EQUILIBRIUM Substitute slices of pizza for bottles

Qdemanded = Qsupplied

“Economic Efficiency”How demonstrate this?

Welfare Economics

Two ways to look @ Demand Curve

Quantity

Price

Quantity

Price

“Willingness to Pay”

“Willingness to Purchase”

$2

3 3

$2

D D

“Willingness to Pay”

Quantity

PricePrice willing to pay is a measure of the benefit received

Because we are examining the last coke purchased, we are measuring the “Marginal Benefit” received from the last coke

MARGINAL BENEFIT

Quantity

Price

$1

D = MB

S

Consumer Surplus

Quantity

Price Total of all marginal Benefits = Total Consumer Benefit

$1

CONSUMER SURPLUS

D = MB

Producer Surplus

Quantity

Price

$1

Producer Surplus

Quantity

Price

$1

PRODUCER SURPLUS

S = MC

Quantity

Price

$1

PRODUCER SURPLUS

S = MC

Total Social Surplus

Quantity

Price

$1

PRODUCER SURPLUS

CONSUMER SURPLUS

TOTAL SOCIAL SURPLUS

Proving “Efficiency” of Markets

Quantity

Price

$1

PRODUCER SURPLUS

CONSUMER SURPLUS

$2 Reduction in Total Social Surplus

Proving “Efficiency” of Markets

Quantity

Price

$1PRODUCER SURPLUS

CONSUMER SURPLUS

D = MB

S = MC MC > MB

Reduces total Social Benefit

Maximum Social Benefit@ Market Equilibrium

Quantity

Price

$1PRODUCER SURPLUS

CONSUMER SURPLUS

D = MB

S = MC

“Efficiency of Markets”

What Have We Proven?

Given 1. Society’s Demand

• reflection (measurement) of how it values things

• ie, how “willing to pay”

2. Costs of Producing

Then can not achieve

Social Benefit, or happiness by

Or quantity producedQuantity

Price

$1PRODUCER SURPLUS

CONSUMER SURPLUS

D = MB

S = MC

Maximum Social Benefit@ Market Equilibrium

Quantity

Price

$1PRODUCER SURPLUS

CONSUMER SURPLUS

D = MB

S = MC

“Efficiency of Markets”

But,

What is Missing in this picture?

Other Costs? Supply curve based on Production Costs– Labor, materials,

depreciation– “write a check”

“Internal” Costs

BUT also

Environmental CostsPollution of air & water, loss of

wetlands, soil damage from Irrigation

“External” to firm producing

But, “Real” costs to societyQuantity

Price

$1

S = MC

ATCMC

EXTERNAL COSTS

How Value ?– Chpt 6– Assume we have their

value

Add to Firm’s Existing Costs

New EquilibriumHigher Price

Lower Quantity

Quantity

Price

p1

S = MC

S’ = MSC

D

q1

P2

q2

How Achieve Lower Quantity?

Need Mechanism to Internalize “external” costs

1.Tax “market” based

solution

Quantity

Price

p1

S = MC

S’ = MC + tax = MSC

q1

P2

q2

How Achieve Lower Quantity?

2. Government Regulation

Both 1 & 2 are mechanisms to internalize “external” costs

Quantity

Price

p1

S = MC

S’ = MSC

q1q2

Market Equilibrium & “Efficiency”

Quantity

Price

$1PRODUCER SURPLUS

CONSUMER SURPLUS

D = MB

S = MC

Marginal “private” benefits

Accruing to owner or buyer

Other Benefits?Third Party Benefits(people not involved in

market transaction)

• People living around– airports– universities– parks

“Social Benefits”

EXTERNAL BENEFITS(external to the market)

How value?Chpt 6

How Achieve larger Q?Quantity

Price

$1PRODUCER SURPLUS

CONSUMER SURPLUS

D = MPBMarginal private benefits

S = MC

q1 q2

D’ = MSB

Market Equilibrium & “Efficiency”

How Achieve larger Q?Need Mechanism

to Internalize “external” benefits

Cost to Supply the

good:Tax breaksSubsidies

airportsland preservesparks

Quantity

Price

P1PRODUCER SURPLUS

CONSUMER SURPLUS

D = MB

S = MC

P2

q1 q2

Figure 3-1: Automobile Market with External Costs

Figure 3-2: Automobile Market with Pollution Tax

Figure 3-3: A Positive Externality

Figure 3-4: A Subsidy for Open and Rural Land Use

Figure 3-6: Welfare

Analysis of the

Automobile Market with

Pollution Costs

“Efficiency” with Externalities

Quantity

Price

D = MpB

S = MpC

the case of “Optimal” pollution

S’ w/ external social costs

p0

q0q1

Up to q1 pollution permitted

Social benefits of driving

> combined costs of production & pollution

Implication of demand for cars? “optimal pollution

permitted.

Ironic conclusion of Traditional Environmental Econ based on Neoclass market economics

We’ve used econ theory to prove pollution OK!

Quantity

Price

D = MpB

S = MpC

S’ w/ external social costs

p0

q0q1

D’

Lecture 4 Discussion Question

 

Should our goal be to reduce pollution by 50%, 75%, or 100% ??

Explain your answer.

Quantity

Price

$1PRODUCER SURPLUS

CONSUMER SURPLUS

D = MB

S = MC

Quantity

Price Total of all marginal Benefits = Total Consumer Benefit

ATCMC

Figure 3-5: Welfare

Analysis of the

Automobile Market