Surplus Measures Applications & Elasticity Measures Lecture 9 Dr. Jennifer P. Wissink ©2018 John M. Abowd and Jennifer P. Wissink, all rights reserved. February 26, 2018

Producers’ Surplus (PS) = TR – VC, when QS=6+P or PS=-6+Q and P. =17 Q PS on 1st unit: Price PS on 7th unit: Supply = MC PS on 23rd unit: PS on 23 units: P*=17 1 6 7 Q*=23 Quantity

i>clicker question Suppose Butch Sunkissed’s supply price for juice (i.e. what he is willing to sell for) is as follows: $0.25 for the first can of juice, $0.30 for the second, $0.60 for the third and $1.20 for the fourth. Suppose a can of juice sells for $0.75. How much producer’s surplus will Butch get from his juice sales? A. $0.05 B. $2.25 C. $1.15 D. $1.10 E. $0.65

Net Social Surplus (NSS) CS & PS Market equilibrium: P* & Q* $ $CS = $TB - $TE $TB = area OCAQ* $TE = area OP*AQ* $CS = area P*CA $CS=area under demand and above price demanders pay C Supply=MC $PS = $TR - $VC $TR = area OP*AQ* $VC =area OEAQ* $PS = area OP*AE $PS=area under price suppliers receive and above supply A P* Demand=MB O E Q* Quantity $NSS = $TB - $VC $NSS = area OCAE area between demand and supply

Reprise of Frannie & Butch from i>clicker Qs with P*=$0.75 When P*=$0.75 Juice cans $MBFran $MCButch Trade? NSS CS PS 1st $3 $0.25 2nd $2 $0.30 3rd $1 $0.60 4th $0.50 $1.20 On Total Traded

Market Equilibrium & Efficiency Suppose all private valuations equal social valuations. Then at a market equilibrium, you get what economists call “efficiency”. aka Pareto efficiency aka allocative efficiency That is, NSS is maximized at the market equilibrium. GOOD NEWS result for markets! Now, suppose “something” keeps us away from Q*. The market is not efficient. What is the “cost” of that? Dead Weight Loss Demand=MB Supply=MC $ Quantity P* Q* O C A E

i>clicker question Consider demand and supply in the market for unskilled labor. Suppose a binding minimum wage is imposed. Which one of the following is false when we compare the before and after situation? Consumers’ Surplus under the minimum wage is lower. Net Social Surplus under the minimum wage is higher. There will be surplus labor under the minimum wage. Producers’ Surplus may be higher or lower under the minimum wage. Before After NSS CS PS $wage C S=MC A 10=w* E D=MB O Q* Labor Hrs 100

Why Commodity Taxes are Inefficient $P S=MC C G F A P* I H D=MB E O QN QO Gas gallons

Marshall’s Diamond Water Paradox - Resolved $P diamonds $P water Q diamonds Q water

Sure Seems That Sensitivities Matter They matter for… How much quantity demanded or quantity supplied will change when a good’s price changes. How much equilibrium price and quantity will change when you do comparative statics. How much unemployment will be generated with a price floor. How much surplus there is and how it is shared between buyers and sellers. How the economic price incidence of a tax will be shared between suppliers and demanders. And so much more… So what are they and how can we define this better?

What is an Elasticity? A unit free measure. Measurement of the percentage change in one variable that results from a 1% change in another variable. Lots of them! Example: Suppose when the PX rises by 1%, quantity demanded of X falls by 5%. The own price elasticity of demand is -5 in this example.

2 Very Important Elasticities Own Price Elasticity of Demand for X: Captures how sensitive the quantity demanded of X is to a change in X’s own price. Using percent changes Own Price Elasticity of Supply for X: Captures how sensitive the quantity supplied of X is to a change in X’s own price.

Examples: Own Price Demand Elasticities Suppose data tells us that when the price of gasoline rises by 1% the quantity demanded falls by 0.2%. Gas demand is not very price sensitive. Own price elasticity of demand for gas is -0.2. Suppose data tells us that when the price of gold jewelry rises by 1% the quantity demanded falls by 2.6%. Jewelry demand is very price sensitive. Own price elasticity of demand for jewelry is -2.6.

Examples: Own Price Supply Elasticities Suppose we know that when the price of DaVinci paintings increases by 1% the quantity supplied doesn’t change at all. The quantity supplied of DaVinci paintings is completely insensitive to their price. Own price elasticity of supply is 0. Suppose we observe that when the price of beef increases by 1% the quantity supplied increases by 5%. Beef supply is very price sensitive. Own price elasticity of supply is 5.