Economics 2: Spring 2014 J. Bradford DeLong ; Maria Constanza Ballesteros ; Connie Min

Economics 2: Spring 2014

J. Bradford DeLong <[email protected]>; Maria Constanza Ballesteros <[email protected]>;

Connie Min <[email protected]>

http://delong.typepad.com/sdj/econ-2-spring-2014/

Economics 2: Spring 2014: Supply and Demand Algebra:

Price Ceilingshttp://delong.typepad.com/sdj/econ-1-spring-2014/

February 5, 2014, 4-5:30101 Barker, U.C. Berkeley

Consider a Market in Equilibrium…


• Demand:– P = 100-(5/3)Qd

• Supply:– P = 15Qs

• Equilibrium:– Q = (100-0)/(15+(5/3)– P=(15/(15+(5/3)))100+

((5/3)/(15+(5/3)))0

– P = 90, Q = 6

Consider a Market in Equilibrium…• Demand:– P = 100-(5/3)Qd


• Equilibrium:– P = 90, Q = 6

• Surplus:– Demanders pay

6x90=540; average value=95; consumer surplus=95x6-540=30

Consider a Market in Equilibrium…• Demand:– P = 100-(5/3)Qd



• Surplus:– Consumer surplus =

95x6-540=30– Suppliers earn

6x90=540; averge cost=45; producer surplus=540-45x6=270


• Demand:– P = 100-(5/3)Qd



• Surplus:– Consumer surplus =

30– Producer surplus =

270

The Government Says: This Isn’t Fair!

• The situation:– Demand: P = 100-(5/3)Qd

– Supply: P = 15Qs

– Equilibrium: P = 90, Q = 6– Surplus: Consumer = 30;

Producer = 270• Why should suppliers

get nine times as much surplus?

• The Westerosi Army needs to buy other things as well! They will have to face the ice zombies!

The Government Imposes a Price Ceiling on What You Can Charge: 60




Producer = 270• Why should suppliers

get nine times as much surplus?

• The Westerosi Army needs to buy other things as well! They will have to face the ice zombies!

What Happens?

• The situation:– Demand: P = 100-

(5/3)Qd


– Equilibrium: P = 90, Q = 6

– Surplus: Consumer = 30; Producer = 270

• Why should suppliers get nine times as much surplus?

• The government imposes a price ceiling of 60

Ladies and Gentlemen, to Your i>Clickers!

• The situation: Demand: P = 100-(5/3)Qd Supply: P = 15Qs Equilibrium: P = 90, Q = 6 Surplus: Consumer = 30; Producer = 270

• A PRICE CEILING OF 60• How many dragon-training flights will be flown

with the price ceiling?• A. 6• B. 4• C. 24• D. 14• E. None of the above



• A PRICE CEILING OF 6• How many dragon-training flights will be

flown with the price ceiling? A. 6. B. 4. C. 24. D. 14. E. None of the above



• A PRICE CEILING OF 6• How many dragon-training flights will be flown with

the price ceiling? A. 6. [B. 4.] C. 24. D. 14. E. None of the above

• Why 4?• Because only 4 potential riders think it’s worth

showing up at the dragonstrip if you are only going to be paid £60

• But then what is the 24 number?• That’s how many people show up with plans for

training missions…

Is This New Situation a Better Equilibrium?


(5/3)Qd Supply: P = 15Qs

– Price ceiling = 60

• Equilibrium: P = 60, Q = 4

Let’s Calculate the Surplus…



– Price ceiling = 60• Equilibrium: P = 60,

Q = 4• Producer Surplus:– 4 missions flown– What’s the average

cost?

Ladies, Gentlemen, and Large Intelligent Fire-Breathing Reptiles, to Your

i>Clickers…• The situation:

– Demand: P = 100-(5/3)Qd Supply: P = 15Qs – Price ceiling = 60


• What’s the average cost to producers of the four dragon-training missions flown?• A. 45• B. 60• C. 30• D. 15• E. None of the above


i>Clickers…• The situation:– Demand: P = 100-


– Price ceiling = 60• Equilibrium: P = 60,

Q = 4

• What’s the average cost to producers of the four dragon-training missions flown? A. 45. B. 60. C. 30. D. 15. E. None of the above



– Demand: P = 100-(5/3)Qd Supply: P = 15Qs

– Price ceiling = 60• Equilibrium: P = 60, Q = 4

• What’s the average cost to producers of the four dragon-training missions flown?• A. 45. B. 60. [C. 30.] D. 15. E. None of the

above• Yes: the first mission costs a little more than

0, the last a little less than 60, the average costs 30






• Average cost: 30

• What’s the producer surplus?• A. 120• B. 180• C. 270• D. 60• E. None of the above…


i>Clickers…• The situation:– Demand: P = 100-


– Price ceiling = 60• Equilibrium: P = 60, Q

= 4• Average cost: 30

• What’s the producer surplus?• A. 120. B. 180. C. 270. D. 60. E. None of the

above…





• Equilibrium: P = 60, Q = 4• Average cost: 30

• What’s the producer surplus?• [A. 120.] B. 180. C. 270. D. 60. E. None of

the above…• Producer surplus = (price – average

cost)x(units)• Producer surpus = (60 – 30) x 4 = 120


• The old situation:– Demand: P = 100-

(5/3)Qd


– Equilibrium: P = 90, Q = 6

– Surplus: Consumer = 30; Producer = 270

• Impose a price ceiling of 60– New equilibrium: P =

60, Q = 4– Reduce producer

surplus from 270 to 120



Supply: P = 15Qs


Producer = 270• Impose a price ceiling of

60:– New equilibrium: P = 60,

Q = 4. Reduce producer surplus from 270 to 120

• What happens to consumer surplus?

Calculating Consumer Surplus


Supply: P = 15Qs


Producer = 270• Impose a price ceiling of 60:

– New equilibrium: P = 60, Q = 4. Reduce producer surplus from 270 to 120


• Only four of the 24 consumers actually get to fly their planned training mission…

• How do you select the four?

Calculating Consumer Surplus• The situation:


– Equilibrium: P = 90, Q = 6– Surplus: Consumer = 30; Producer =

270

• Impose a price ceiling of 60:– New equilibrium: P = 60, Q = 4.

Reduce producer surplus from 270 to 120


• Only four of the 24 consumers actually get to fly their planned training mission… How do you select the four?

• The government asks everybody to raise their hand if they are those who have the four highest willingnesses-to-pay…

Calculating Consumer Surplus• The situation:


– Equilibrium: P = 90, Q = 6. Surplus: Consumer = 30; Producer = 270



• What happens to consumer surplus? Only four of the 24 consumers actually get to fly their planned training mission… How do you select the four?– The government asks everybody to

raise their hand if they are those who have the four highest willingnesses-to-pay…

• Yeah, right, that’s really going to work

Some Bureaucratic Process Selects Missions Randomly…

• The situation:– Demand: P = 100-(5/3)Qd Supply: P =

15Qs


• Impose a price ceiling of 60:– New equilibrium: P = 60, Q = 4. Reduce

producer surplus from 270 to 120

• What happens to consumer surplus? Only four of the 24 consumers actually get to fly their planned training mission… How do you select the four?– The government asks everybody to

raise their hand if they are those who have the four highest willingnesses-to-pay…

• Yeah, right, that’s really going to work

• What is the average willingness to pay of the four selected missions going to be?

Gentlebeings, to Your i>Clickers…• The situation:



• Impose a price ceiling of 60:


• Only four of the 24 consumers actually get to fly their planned training mission. Some bureaucrat selects the four randomly…

• What is the average willingness-to-pay of the four selected missions going to be?• A. 95• B. 80• C. 96 2/3• D. 60• E. None of the above

Gentlebeings, to Your i>Clickers…

• The situation:– Demand: P = 100-(5/3)Qd Supply:

P = 15Qs




• Only four of the 24 consumers actually get to fly their planned training mission. Some bureaucrat selects the four randomly…• What is the average willingness-to-pay of the four selected

missions going to be?• A. 95. B. 80. C. 96 2/3. D. 60. E. None of the above







• What is the average willingness-to-pay of the four selected missions going to be?• A. 95. [B. 80.] C. 96 2/3. D. 60. E. None of the above

• The mission planner with the highest willingness-to-pay is just shy of 100. The mission planner with the lowest willingness-to-pay is just more than 60. The average is 80.

• Why is it kosher to calculate the average of the whole distribution by just adding up the biggest and the smallest and dividing by 2, anyway?







• What is the average willingness-to-pay of the four selected missions going to be?

• A. 95. [B. 80.] C. 96 2/3. D. 60. E. None of the above

• The mission planner with the highest willingness-to-pay is just shy of 100. The mission planner with the lowest willingness-to-pay is just more than 60. The average is 80.

• Why is it kosher to calculate the average of the whole distribution by just adding up the biggest and the smallest and dividing by 2, anyway?

• Anybody?

Gentlebeings, to Your i>Clickers…

• The situation:– Demand: P = 100-(5/3)Qd Supply:

P = 15Qs





• Average willingness-to-pay: 80

• What is the consumer surplus here?








• What is the consumer surplus here?• A. 80• B. 30• C. 160• D. 120• E. None of the above…




• Impose a price ceiling of 60:– New equilibrium: P = 60, Q = 4. Reduce

producer surplus from 270 to 120



• What is the consumer surplus here?• A. 80. B. 30. C. 160. D. 120. E. None of the

above…








• What is the consumer surplus here?• [A. 80.] B. 30. C. 160. D. 120. E. None of

the above…• Consumer surplus = (avg w-t-p – price) x

quantity• Avg w-t-p = 80 Price = 60 Quantity = 4

• Consumer surplus = 80


• The old situation:– Demand: P = 100-(5/3)Qd

Supply: P = 15Qs


• Impose a price ceiling of 60:– New equilibrium: P = 60,

Q = 4.• Reduce producer surplus

from 270 to 120• Increase consumer

surplus from 30 to 80



Supply: P = 15Qs


• Impose a price ceiling of 60: New equilibrium: P = 60, Q = 4.

• Reduce producer surplus from 270 to 120

• Increase consumer surplus from 30 to 80

• Reduced total surplus from 300 to 200



Supply: P = 15Qs


• Impose a price ceiling of 60: New equilibrium: P = 60, Q = 4.

• Reduce producer surplus from 270 to 120

• Increase consumer surplus from 30 to 80

• Reduced total surplus from 300 to 200

• Huh!? Where did the extra £100 of surplus go!?!?!?

Huh?! Where Did the Extra £100 of Surplus Go!?!?!?

• In the old situation:–We matched 6

suppliers with an average cost of 45 to 6 missions with an average willingness-to-pay of 95

– Generated 6 x 50 = 300 of surplus


• In the old situation:– We matched 6 suppliers with

an average cost of 45 – to 6 missions with an

average willingness-to-pay of 95

– Generated 6 x 50 = 300 of surplus

• With the price ceiling:– We match 4 suppliers with

an average cost of 30– To 4 missions with an

average willingness-to-pay of 80

– Generate 4 x 50 = 200 of surplus


• In the old situation:– We matched 6 suppliers with an average cost

of 45 – to 6 missions with an average willingness-to-

pay of 95– Generated 6 x 50 = 300 of surplus

• With the price ceiling:– We match 4 suppliers with an average cost of

30– To 4 missions with an average willingness-to-

pay of 80– Generate 4 x 50 = 200 of surplus

• We have made 4 matches instead of 6• We haven’t improved the average

quality of the matches– We have degraded the average

willingness-to-pay of demanders– We have improved the cost of

suppliers: if we are only going to fly four missions, these are the four who should be flying those missions

An Anti-Krugman and Wells Rant!

• Here is their analysis of a price ceiling—and their equivalent of the -100 loss in surplus that we have calculated—this yellow triangle.

• How large is this yellow triangle?

An Anti-Krugman and Wells Rant!

• How large is this yellow “surplus loss” Harberger triangle?

• Well, its base is from 60 to 100; its height is from 4 to 6…

• Its area is: 2 x 40 x ½ = 40

• But we found that the surplus loss was 100…

What Is Going on? Why Do We Find a Surplus Loss of 100 When KW Only Find a

Surplus Loss of 20?• Their Harberger

triangle is 40…• But we found that the

surplus loss was 100…• They assume the high

willingness-to-pay demanders get to purchase when there is excess supply…


Surplus Loss of 20?• Their Harberger

triangle is 40…• But we found that the



• Sometimes that may happen (secondary markets, scalping)…

• Sometimes that may not happen…


Surplus Loss of 20?• Their Harberger triangle is

40…• But we found that the



• Sometimes that may happen (secondary markets, scalping)…

• Sometimes that may not happen…

• You need to talk about it, not just to assume it…

So I Think KW Get This Really Wrong!

• But I haven’t found anything else in KW that I think is equally really wrong…

Economics 2: Spring 2014 J. Bradford DeLong ; Maria Constanza Ballesteros ; Connie Min

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Transcript of Economics 2: Spring 2014 J. Bradford DeLong ; Maria Constanza Ballesteros ; Connie Min