Microeconomics 2 Lecture 2 Gains from exchange

Who will win the Nobel Prize in economics in 2013? In below Al Roth Lloyd Shapley See the Guardian videovideo

What did I ask you to do? Recall/find the definition of a reservation price for a buyer (perhaps you used a different expression for it?). Recall/find the definition of a reservation price for a seller (perhaps you used a different expression for it?). Assume a discrete good – single units. You might also have done this below: Recall/find the definition of surplus for a buyer. Recall/find the definition of surplus for a seller.

Today’s lecture We are going to study some different exchange/market mechanisms; is there a ‘best’? In the olden days, when there were not many students, I used to get the students to play a little game. I cannot do it here as there are too many of you, but you can imagine it. And you could do it with your friends tonight.

An imaginary market/an experiment Buyers and Sellers, a discrete good. Each Buyer wants to buy at most one unit. Each Seller wants to sell at most one unit. Each Buyer has a reservation price for the one unit – this is the maximum that he or she will pay for that one unit. Each Seller has a reservation price for the one unit – this is the minimum that he or she will accept for that one unit.

Profit/Surplus The profit/surplus of a buyer is the difference between the reservation price and the price paid. The profit/surplus of a seller is the difference between the price received and the reservation price. We will formalise this later. Both want to maximise their surplus.

A Particular Market Mechanism Bilateral Trades Buyers and Sellers negotiate individually and see if they can agree on a price. I asked students to pretend that this was a real experiment and I would pay them their surpluses. So for the buyers I would pay the difference between the reservation price and the price paid; and for the buyers I would pay the difference between the price recieved and the reservation price.

What do you think of this exchange mechanism? What do you think of it? Do you think it might be efficient? Do you think that it might be fair? There are lots of other market mechanisms. Is there a ‘best’? Let us study a particular mechanism – a competitive market – in which a price is chosen such that the demand equals the supply. What are the properties of this mechanism? Let us go to the html file.

Properties of Competitive Market Mechanism Total surplus is maximised. With any other single price (not a competive equilibrium price) the total surplus is less. So this mechanism maximises the total surplus extracted from the market. Note however that it says nothing about the distribution of the surplus or whether it is a fair mechanism. You should also think of other exchange mechanisms and see if they are efficient and/or fair.

Goodbye!! See you next week.