IMBA Managerial EconomicsJack Wu

Econ Efficiency: Conditionsfor all users, same marginal benefit for all suppliers, same marginal costmarginal benefit = marginal cost

Equal Marginal Benefitif not equalprovide more to user with higher marginal

benefittake away from user with lower marginal

benefit

Equal Marginal Costif not equalsupplier with lower marginal cost should

produce moresupplier with higher marginal cost should

produce less

Marginal Benefit/Costif marginal benefit > marginal cost, produce

more of the itemif marginal benefit > marginal cost, produce

less of the item

Adam Smith’s Invisible Hand: PriceCompetitive market achieves three sufficient

condition for economic efficiency:buyers and sellers in a market system act

independently and selfishly, yet the overall outcome is efficient

i) users buy until marginal benefit equals price; ii) producers supply until marginal cost equals

prices; iii) users and producers face same price.

Example of Invisible HandMajor policy issue: how to allocate licenses for 3G

wireless telecommunications;pioneer: in early 1990s, US Federal

Communications Commission showed that spectrum licenses were worth billions;

created pressure on other governments to allocate by auction and not favoritism.

Auction ensures that item goes to user with highest marginal benefit.

De-centralizationcreate internal marketif there is a competitive market for an item,

set transfer price equal to market priceconsuming units should be allowed to

outsource

UCLA Anderson School, 1989Half an invisible hand is worse than nonepriced photocopying paperfree bond paper

Price CeilingUpper limit that sellers can charge and buyers can pay rent control regulated price for electricity

0

1100

290 300 310

supply

demand

b

equilibriumexcess demand

Quantity (Thousand units a month)

Pri

ce (

$ p

er

month

)

Rent Control: Equilibrium

1000 900

0

1100

290 300 310

supply

demand

b

Quantity (Thousand units a month)

Pri

ce (

$ p

er

month

)

Rent Control: Surpluses

1000 900

d

g

e

buyer surplus gain = cfeg buyer surplus loss = dgbseller surplus loss = cfeg + geb

c

f

Rent Control: Lossesdeadweight losses -- sellers willing to provide

item at price that buyers willing to pay, but provision doesn’t occur

price elasticities of demand and supply _demand more inelastic --> larger loss _ supply more elastic --> larger loss

Price FloorLower limit that sellers can charge and buyers can pay minimum wage agricultural price supports

0

4.20

8 10 11

supply

demand

a

b

c

equilibrium

excess supply

Quantity (Billion worker-hours a week)

Wage (

$ p

er

hour)

Minimum Wage: Equilibrium

4.00

0

4.20

8 10 11

supply

demand

a

b

c

Quantity (Billion worker-hours a week)

Wage (

$ p

er

hour)

Minimum Wage: Surpluses

4.00

f

d

e

g

seller surplus gain = fdgeseller surplus loss = ghb buyer surplus loss = fdge + egb

h

Minimum Wage: Lossesdeadweight losses -- sellers willing to provide

item at price that buyers willing to pay, but provision doesn’t occur

price elasticities of demand and supply _supply more inelastic --> larger loss _demand more elastic --> larger loss

Tax: Commodity Tax“the only two sure things in life are death and taxes” buyer’s price - tax = seller’s price payment vis-à-vis incidence

US: airlines pay tax Asia: passengers pay

0

800

900

e

Quantity (Thousand tickets a year)

Pri

ce (

$ p

er

tick

et)

supply

demand

$10

Tax: Equilibrium

b

h

804

794

920

0

800

900

e

Quantity (Thousand tickets a year)

Pri

ce (

$ p

er

tick

et)

supply

demand

$10

Tax: Surpluses

b

h

804

794

920

f

d

j

buyer surplus loss = fdge + egb seller surplus loss = djhg + ghb revenue gain = fdge + djhg

g

Incidenceincidence and deadweight loss depend on

price elasticities of demand and supplyideal tax (no deadweight loss): inelastic

demand/supplywho pays the tax not relevant

Discussion Question 1Consider a company that manages a network

of hospitals across several counties in one state. Household incomes and the cost of living are higher in urban than rural areas. The company, however, has set the same prices for pharmaceuticals and services in all of its hospitals. It has also paid the same salaries for doctors, nurses, and other professional staff throughout the state.

Discussion Question 1:continuedManagement has noticed that there are long

waiting lists for treatment at its urban hospitals. Can you explain this problem?

The company has had great difficulty in recruiting professional staff for its urban hospitals. Can you explain this problem?

What advice would you give to management?

Discussion Question 2E-commerce is predicted to reduce the cost

of intermediary services such as those of travel agencies, real-estate brokers, and investment advisors. Consider the market for air travel. Suppose that, with conventional travel agencies, the market equilibrium price is $300 per ticket, including a $15 intermediation cost. The quantity bought is 2 million tickets a year. With e-commerce, however, the intermediation cost falls to $2 per ticket.

Discussion Question 2:continuedUsing suitable demand and supply curves,

illustrate the original equilibrium with conventional travel agencies. Represent the intermediation cost by shifting the supply curve.

 Illustrate the new equilibrium with e-commerce.

 What factors determine the extent to which

consumers will benefit from e-commerce? Explain your answer with demand and supply curves.

Discussion Question 3Typical real-estate broker: "In California, the

seller always pays the broker's commission, so, buyers get brokerage services free."

 MBA: "If the custom were for the buyer to pay

the commission, then would sellers get brokerage services free?"

 Real-estate broker, clearly losing patience:

"That is a purely hypothetical scenario, but if that situation were to arise, yes, I guess you're right."

Discussion Question 3:continuedAssume that each seller pays a brokers'

commission of $18,000. Then, the supply of houses includes the cost of brokerage. Illustrate the market equilibrium with a price of $310,000 per house and sale of 200,000 houses a year.

Now suppose that buyers rather than sellers pay the $18,000 commission. Using your figure, illustrate the following: (i) shift the supply curve down by $18,000 since sellers do not pay the commission, and (ii) shift the demand curve down by $18,000 since buyers now pay the commission.