Topics Today 9408

1
Topics Today (9/4/08)

• Basic Economics Review
• Theory of Value
• Supply and Demand
• Markets
• Efficiency and the Welfare Theorem
• Property Rights
• No discussion this week.
• Read Ch. 1 and Ch. 2.1-2.3 in book for Tuesday.

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Theory of Value

• Q Which commodity is more valuable, water or
  diamonds?
• Paradox
• Useful items gt low prices
• Non-essential items gt high prices

3
Theory of Value

• Production cost (Ricardo early 1800s)
• Value is driven by production cost.
• Counter example
• Cost to catch a Golden Gopher 1 hour of labor
• Cost to catch a Badger 3 hours of labor
• 1 Badger would exchange for 3 Golden Gophers
• But who in Madison wants a Golden Gopher?
• This explanation doesnt account for demand.

4
Theory of Value

• Marginalist Principle (late 1800s)
• Total usefulness ? gt value.
• Usefulness of the last unit consumed gt value.
• Water gt plentiful gt low marginal value.
• Diamonds gt scarce gt high marginal value.
• Marginal Willingness to Pay (MWTP) the most a
  person is willing to pay for the last unit of a
  good.

5
Demand

• Ex/ Demand for Badger Football tickets

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Demand
7
Demand

• If price 70 how many tickets are purchased?
• If price 25 how many tickets are purchased?
• Decisions made on a unit-by-unit (marginal) basis.

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Demand

• How much would individual pay for 5 tickets?
• 5040302010150
• This is total willingness to pay.

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Demand

• If price 25, would individual buy 5 tickets?
• 25x5125.
• TWTP for 5 tickets is 150.
• Individual would not buy 5 tickets. Why?
• Price gt MWTP for the 4th and 5th units.
• Decisions made on a marginal basis.

10
Demand

• Consumer Surplus the difference between how much
  an individual (or individuals) is willing to pay
  and how much they have to pay.

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Demand
If price 25, Consumer Surplus (50-25)
(40-25) (30-25) 45
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Demand

• Demand curve - a schedule that tells us how many
  units of a good an individual (or a group of
  individuals) will purchase at a given price.
• A point on the demand curve indicates MWTP for a
  particular unit.

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Market Demand



3
3
3
Q
39
74
Q
Q
35
Individual 1
Individual 2
Market
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Shifts in Demand

• Factors causing a shift in the demand curve
• Size of market
• Tastes and preferences
• Income
• Price of related goods
• Expectations

D1
D0
D2
Q
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Supply

• Marginal cost (MC) how much it costs a firm to
  produce the last unit of a good.

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Supply

• Ex/ Supply for Badger Football tickets

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Supply
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Supply

• Ex/ Supply for Badger Football tickets
• If price 5, how many units will be sold?
• If price 25, how many units will be sold?
• Seller makes decisions on a unit-by-unit
  (marginal) basis.

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Supply

• Producer surplusthe difference between how much
  a firm (or firms) receives for its good and how
  much it costs the firm to produce it.

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Supply
If price 25, Producer Surplus (25-0)
(25-10) (25-20) 45
21
Supply

• Supply curve - a schedule that tells us how many
  units of a good an individual (or firm) will sell
  at a given price.
• A point on the supply curve indicates the
  marginal cost for producing a particular unit.

Q
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Market Supply



3
3
3
Q
39
74
Q
Q
35
Firm 1
Firm 2
Market
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Shifts in Supply

• Factors causing a shift in the supply curve
• Seller Numbers.
• Resource prices (e.g. price of labor).
• Technology.
• Price expectations.

S1

S0
S2
Q
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Competitive Market Equilibrium

• Competitive market equilibrium the price and
  quantity of a good that equates demand and
  supply.

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Competitive Market Equilibrium

• How many units will be sold?
• 3
• Why? MWTP gt MC on units 1 through 3.

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Competitive Market Equilibrium

• What is equilibrium price (p)?
• Between 20 and 30.
• Why? Because MCltpltMWTP.
• Assume that p25.

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Competitive Market Equilibrium

MC
P
MWTP
Q
Q
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Competitive Market Equilibrium

• Competitive means that there are lots of buyers
  and sellers of the good, implying no single firm
  or consumer can influence the price.
• Markets are institutions through which voluntary
  exchange of scarce resources take place.
• Equilibrium means there are no forces acting to
  change the price and quantity.

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Efficiency

• An allocation of resources is efficient if it is
  not possible to reallocate resources without
  making at least one person worse off.
• Ex/ Suppose only two Badger tickets were sold.
  Then both the buyer and seller are worse off than
  the competitive equilibrium. Why?
• Because they could both be better off by trading
  for the 3rd ticket.
• MWTP gt MC for the 3rd ticket.

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Welfare Theorem

• A competitive market will result in an efficient
  allocation of resources, provided the following
  assumptions hold
• Property rights to resources are well-defined.
• Information between buyers and sellers is
  complete.

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Property Rights

• Property rights a bundle of entitlements,
  privileges, and limitations defining the owners
  rights to use a resource.
• Assignment through laws
• Enforcement through courts

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Property Rights

• A system of well-defined property rights has the
  following four characteristics
• Comprehensive all resources are owned, all
  entitlements defined.
• Exclusive all benefits and costs from use of a
  resource accrue to the owner.
• Transferable property right is transferable
  through voluntary exchange.
• Secure property right is secure from
  involuntary seizure by others.

See page 14 in your book