ECON 100 Lecture 16 Wednesday, November 12

Announcements MIDTERM #1: Wednesday November 19, starts at 7 P.M. Only material covered in lectures will be on the midterm. Solutions to old midterm exams are posted on webpage (Spring 2014, 2013, and 2012). Announcements section. Answers to PS #6 are posted on webpage. PS#7 is the last exercise set before the midterm exam. It will be posted later in the week. Webpage : https://ais.ku.edu.tr/course/25089/Default.html

Make-up Exam Policy If you are going to miss an exam you must (1) send me an email before the exam explaining why you cannot attend the exam, and (2) make an appointment to see me and explain why you could not attend the exam within three work days of the exam. A make-up exam will be given only in case of properly documented emergencies, such as a medical report from the school medical center. If you do not follow these instructions, you will receive a 0 for the exam that you missed.

Problem Session / KOLT tutors PS1: FRIDAY B4 (at 13:00) in room SOS B21 PS2: FRIDAY B5 (at 14:30) in room SOS B08 No attendance is taken at the PSs. Econ 100 KOLT tutors: Sonkurt, Jülide, and Ilgaz

Please turn off your phones. Class participation You must attend the section where you are registered. Your in-class exercise is your participation record. I collect them at the end of the lecture. Please turn off your phones.

Monday’s lecture was about Competitive markets and welfare

SUPPLY AND DEMAND II: MARKETS AND WELFARE 3 SUPPLY AND DEMAND II: MARKETS AND WELFARE

Summary of Monday’s lecture Measuring the welfare of the buyers and sellers in a market Consumer surplus Producer surplus

Summary of Monday’s lecture Consumer surplus is the amount that a buyer is willing to pay for a good minus the amount she actually pays for it. It measures the benefit to buyers of participating in a market. Consumer surplus can be computed by finding the area below the demand curve and above the price.

Summary of Monday’s lecture Producer surplus is the amount a seller is paid for a good minus the seller’s cost. It measures the benefit to sellers of participating in a market. Producer surplus can be computed by finding the area below the price and above the supply curve.

MARKET EFFICIENCY Economists use the consumer surplus and producer surplus to address the following question: Is the allocation of resources determined by free markets in any way desirable?

Evaluating the Market Equilibrium Buyers Free markets allocate the supply of goods to the buyers who value them most highly, as measured by their willingness to pay. Sellers Free markets allocate the demand for goods to the sellers who can produce them at least cost.

At the market equilibrium price The total surplus (consumer surplus + producer surplus) is maximized at the market equilibrium.

Consumer and Producer Surplus in the Market Equilibrium Price A C B D E Demand Consumer surplus Supply Equilibrium price quantity Producer surplus Quantity Copyright©2010 South-Western

The competitive equilibrium: welfare maximization and efficiency An allocation of resources that maximizes the sum of consumers’ and producers’ surplus is said to be efficient. The total surplus (consumers’ surplus + producers’ surplus) is maximized at the competitive equilibrium. Therefore, the competitive equilibrium is efficient.

MARKET EFFICIENCY Consumer Surplus = Value to buyers – Amount paid by buyers (Value means Benefit as measured by willingness to pay) and Producer Surplus = Amount received by sellers – Cost to sellers

MARKET EFFICIENCY Total surplus = Consumer surplus + Producer surplus or = Value to buyers – Cost to sellers

A simple example

My favorite example Buyer’s name Buyer’s WtP Seller’s name Seller’s cost A 100 10 B 90 15 C 80 20 D 70 25 E 60 30 F 50 35 G 40 H 45 Each consumer will consume at most 1 unit. Each firm can produce at most 1 unit.

If you had a single unit of this good… You would give it to consumer A because A is the consumer who has the highest valuation for this good. If you had to produce a single unit of this good… You would ask seller A to produce it, because A has the lowest cost That way one unit (the first unit) of this good would create a net benefit of 100 – 10 = 90.

Suppose you already had 6 units of this good produced Consumers A to F consume one unit, produceer A to F produce one unit Will you ask for one more unit to be produced? Yes, it will create a benefit of 40 to consumer G and it will cost 40 (by seller G) But. I would not ask the 8th unit to be produced, The 8th unit of this good costs 45 to produce but delivers a benefit of 30, it would reduce the net benefit that we have achieved at 7 units of production and consumption by 15. Total surplus we have at 7 units is the maximum we can have.

Compute the equilibrium price and quantity. Equilibrium means demand = supply In this example where every individual either buys or sells at most one unit equilibrium means that the number of sellers = number of buyers. Rule for buyers: buy if WtP ≥ P Rule for sellers: sell if cost ≤ P P = 60 there are 6 buyers who have WtP ≥ 60 and there are 6 sellers who have cost ≤ 60

This is a remarkable situation! The equilibrium quantity is exactly the same that we found in the first part where we were trying to maximize the value to buyers minus the cost to sellers. This is what economists mean when they say the competitive equilibrium maximizes total surplus, and therefore is efficient.

Your turn now

My favorite example: 8 sellers for 8 buyers Buyer’s name Buyer’s WtP Seller’s name Seller’s cost A 85 70 B 80 65 C 75 60 D 55 E 50 F 45 G 40 H 35 Each consumer will consume at most 1 unit. Each firm can produce at most 1 unit.

What is the quantity demanded when P = 65? 5 units What is the quantity supplied when P = 65? 7 unit How many units of excess demand (or excess supply) are there when P = 65? 2 units of excess supply

Compute the equilibrium price. Compute the quantity demanded and quantity supplied in equilibrium. 6 units

Compute the consumers surplus in the competitive equilibrium. 75 Compute the producers surplus in the competitive equilibrium. Compute the total welfare in the competitive equilibrium. 150

Try something else Match each consumer to a producer, so that consumer’s WtP > producer’s cost for every pair. Let each pair trade at the price that gives each one half of the net benefit: P = (WtP+cost)/2 Compute the total surplus. (for all pairs) Total surplus is 120.

End of the lecture