1. 6-1 Economics: Theory Through Applications

2. 6-2 This work is licensed under the Creative Commons Attribution-Noncommercial-Share Alike 3.0 Unported License. To view a copy of this license, visit http://creativecommons.org/licenses/by-nc-sa/3.0/or send a letter to Creative Commons, 171 Second Street, Suite 300, San Francisco, California, 94105, USA

3. 6-3 Chapter 6 eBay and craigslist

4. 6-4 Learning Objectives What are the gains from trade? How does a market with take-it-or-leave-it offers work? How are the gains from trade split between buyers and sellers? What is economic efficiency? What are the economics of an eBay auction? How should I bid on eBay? How are gains to trade determined and shared when there are multiple buyers?

5. Learning Objectives What is the winner’s curse? What is the outcome of an auction with a large number of buyers and sellers? What is the market demand curve? What is the market supply curve? What is the equilibrium of perfectly competitive markets? Where do the gains from trade come from? What determines who produces which good? 6-5

6. Figure 6.1 - The eBay Home Page 6-6

7. Figure 6.2 - A Trader in Delos 6-7

8. Figure 6.3 - The Buyer’s Valuation 6-8

9. Figure 6.4 - The Seller’s Valuation 6-9

10. The Gains from Trade from a Single Transaction 6-10

11. Figure 6.5 - Buyer and Seller Valuations 6-11

12. The Gains from Trade from a Single Transaction 6-12

13. Figure 6.6 - The Distribution of Total Surplus 6-13

14. Figure 6.7 - The Outcomes from a Take-It-or- Leave-It Offer 6-14

15. Figure 6.8 - Why You Should Bid Your Valuation in an eBay Auction 6-15

16. Table 6.1 - Valuations of Different Bidders in a Winner’s Curse Auction 6-16

17. Figure 6.9 - Trading in a Pit Market 6-17

18. Figure 6.10 - Obtaining the Market Demand Curve 6-18

19. Figure 6.11 - Obtaining the Market Supply Curve 6-19

20. Figure 6.12 - Market Equilibrium 6-20

21. Figure 6.13 - Supply and Demand 6-21

22. The Gains from Trade in Equilibrium 6-22

23. Figure 6.14 - The Gains from Trade in a Single Transaction in Market Equilibrium 6-23

24. Figure 6.15 - Surplus in Equilibrium 6-24

25. Table 6.2 - Julio’s Production Ability 6-25

26. Figure 6.16 - Julio’s Production Ability 6-26

27. Table 6.3 - Julio’s Production Possibilities 6-27

28. Figure 6.17 - Julio’s Production Possibilities 6-28

29. Figure 6.18 - Two Ways of Shifting the Production Possibilities Frontier Outward 6-29

30. Figure 6.19 - Julio’s Allocation of Time to Cooking Meals and Producing Web Pages 6-30

31. Table 6.4 - Production Possibilities for Julio and Hannah 6-31

32. Figure 6.20 - Hannah’s Production Possibilities Frontier 6-32

33. Figure 6.21 - Julio and Hannah’s Joint Production Possibilities Frontier 6-33

34. Figure 6.22 - Julio and Hannah’s Preferred Point 6-34

35. Table 6.5 - Production Possibilities for Julio, Hannah, and Sergio 6-35

36. Figure 6.23 - The Production Possibilities Frontier with Three People 6-36

37. Figure 6.24 - The Production Possibilities Frontier with a Large Number of People 6-37

38. Key Terms Unit supply curve: A supply curve in which the buyer sells either zero units or one unit of a good but no more than one unit Total surplus: A measure of the gains from trade that is equal to the buyer’s valuation minus the seller’s valuation Efficiency: The basis that economists use for judging the allocation of resources in an economy Gains from trade: The total surplus from a trade 6-38

39. Key Terms Second-price sealed-bid auction: An auction in which all bidders submit a single secret bid to the auctioneer, the winner is the person who submits the highest bid, the winner pays an amount equal to the second-highest bid Winner’s curse: The idea that the winner of an auction may end up paying more than the good is actually worth because the true value of the good is unknown to the bidders Double oral auction: A large number of buyers and sellers, each with potentially a different valuation of a good, negotiate with each other, one-on-one, to try to get a better deal 6-39

40. Key Terms Market demand curve: The number of units of a good or a service demanded at each price Market supply curve: The number of units of a good or a service supplied at each price Equilibrium: The equilibrium price and the equilibrium quantity in a market Equilibrium price: The price at which sellers supply the equilibrium quantity and buyers demand the equilibrium quantity 6-40

41. Key Terms Equilibrium quantity: The quantity where the supply and demand curves intersect, so the quantity supplied equals the quantity demanded Competitive market: A market that satisfies two conditions: – There are many buyers and sellers, and – The goods the sellers produce are perfect substitutes Supply and demand: A framework that explains and predicts the equilibrium price and equilibrium quantity of a good Buyer surplus: A measure of how much the buyer gains from a transaction, equal to the buyer’s valuation minus the price 6-41

42. Key Terms Seller surplus: A measure of how much the seller gains from a transaction, equal to the price minus the seller’s valuation Technology: A means of producing output from inputs Production possibilities frontier: The combinations of goods that can be produced with available resources Opportunity cost: What you must give up to carry out an action 6-42

43. Key Terms Absolute advantage: In the production of a good, one person can produce more of a good in a unit of time than another person Comparative advantage: In the production of one good, the opportunity cost, as measured by the lost output of the other good, is lower for that person than for another person

44. Key Takeaways If the seller’s valuation of an object is less than the buyer’s valuation of the same object, then there are gains to trade One mechanism to reap the gains from trade when valuations are known is for the seller to post a price and the buyer to decide to purchase the good or not—that is, the seller makes a take-it-or-leave it offer The way the gains to trade are split between the buyer and the seller depends on the way the bargaining occurs and the information the parties have about each other An allocation is efficient if there is no way to make someone better off without also making somebody else worse off 6-44

45. Key Takeaways On eBay, the best strategy is to bid your true valuation of the object Auctions, like eBay, serve to allocate goods from sellers to buyers If the winner’s curse if present, then you will want to bid less than your estimate of the value of the object In a perfectly competitive market, buyers and sellers take the prices as given In the equilibrium of a perfectly competitive market, there are no further gains to trade 6-45

46. Key Takeaways The outcome of a double oral auction and the supply-and-demand framework are the same Gains in trade partly come from the fact that individuals specialize in production and generalize in consumption The efficient way to organize production is by looking at comparative advantage Gains to trade emerge when individuals produce according to comparative advantage and then trade goods and services with one another 6-46