Willingness to Pay (WTP) A buyer’s willingness to pay for a good is the maximum amount the buyer will pay for that good. WTP measures how much the buyer values the good. 1 nameWTP Flea$300 Anthony250 Chad175 John125 Example: 4 buyers’ WTP for an iPod 1. Demand

WTP and the Demand Curve Q:If price of iPod is $200, who will buy an iPod, and what is quantity demanded? 2 A:Flea & Anthony will buy an iPod, Chad & John will not. Hence, Q d = __ when P = $200. nameWTP Flea$300 Anthony250 Chad175 John125

WTP and the Demand Curve Derive the demand schedule: 3 4 John, Chad, Anthony, Flea 0 – Chad, Anthony, Flea 126 – 175 2Anthony, Flea176 – 250 1Flea251 – 300 0nobody$301 & up QdQd who buys P (price of iPod) nameWTP Flea$300 Anthony250 Chad175 John125

WTP and the Demand Curve PQdQd $301 & up0 251 – – – – 1254 P Q Q d =0 Q d =1 Q d =2 Q d =3 Q d =4 $175 $125 4

About the Staircase Shape… This D curve looks like a staircase with 4 steps. 5 P Q If there were a huge # of buyers, as in a competitive market, there would be a huge # of very tiny steps, and it would look more like a smooth curve.

Cost and the Supply Curve Cost is the value of everything a seller must give up to produce a good (i.e., opportunity cost). Includes cost of all resources used to produce good, including value of the seller’s time. Example: Costs of 3 sellers in the lawn-cutting business. 6 namecost Angelo$10 Hunter20 Kitty35 A seller will only produce and sell the good if the price exceeds his/her cost. Hence, cost is a measure of willingness to sell. 2. Supply

Cost and the Supply Curve & up 220 – – 19 0$0 – 9 QsQs P Derive the supply schedule from the cost data: namecost Angelo$10 Hunter20 Kitty35

Cost and the Supply Curve P Q PQsQs $0 – – – & up3 $35 8

(1) Consumer Surplus (CS) Consumer surplus is the amount a buyer is willing to pay minus the buyer actually pays. 9 nameWTP Flea$300 Anthony250 Chad175 John125 Suppose P = $260. Flea’s CS = $300 – 260 = $ __. The others get no CS because they do not buy an iPod at this price. Total CS = $ ___. 3. Welfare measures—CS and PS

CS and the Demand Curve 10 P Q Flea’s WTP P = $260 Flea’s CS = $300 – 260 = $40 Total CS = $40

CS and the Demand Curve 11 P Q Flea’s WTPAnthony’s WTP Instead, suppose P = $220 Flea’s CS = $300 – 220 = $80 Anthony’s CS = $250 – 220 = $30 Total CS = $110

CS and the Demand Curve 12 P Q The lesson: Total CS equals the area below the demand curve & above the price.

P Q CS with Lots of Buyers & a Smooth D Curve Q: P = $30, CS=? A: CS is the area below the D curve and above the P. Recall: area of a triangle equals ½ x base x height So, CS=½ x 15 x $30 = _____ 13 The Demand for Shoes D h $ Price per pair 1000s of pairs of shoes

(2) Producer Surplus P Q Producer surplus (PS): the amount a seller is paid for a good minus the seller’s cost. 14

Producer Surplus and the S Curve P Q Suppose P = $25 Angelo’s PS = $15 Hunter’s PS = $5 Total PS = $20 Kitty’s cost Hunter’s cost Angelo’s cost Total PS equals the area below the price and above the supply curve. $25 15

P Q PS with Lots of Sellers & a Smooth S Curve The supply of shoes S Q: P=$40, PS=? A: PS is the area below the P and above the S curve. The height of this triangle is $40 – 15 = $25. So,PS= _____________ = $312.5 h Price per pair1000s of pairs of shoes $15 16

profit 17 Q Costs and Revenue MC ATC P = $10 MR 50 $6 profit per unit = P – ATC = $10 – $6 = $4 Total profit = (P – ATC) x Q = $4 x 50 = $200 Total profit = TR-TC = ________________ = _________________ = _____ Greg Mankiw: CHAPTER 14 FIRMS IN COMPETITIVE MARKETS 4. Profit