1. DEMAND Substitute slices of pizza for bottles

2. MARKET DEMAND Substitute slices of pizza for bottles

3. SUPPLY Substitute slices of pizza for bottles

4. MARKET SUPPLY Substitute slices of pizza for bottles

5. MARKET EQUILIBRIUM Substitute slices of pizza for bottles Q demanded = Q supplied “Economic Efficiency” How demonstrate this? Welfare Economics

6. Two ways to look @ Demand Curve Quantity Price Quantity Price “Willingness to Pay” “Willingness to Purchase” $2 3 3 D D

7. “Willingness to Pay” Quantity Price Price willing to pay is a measure of the benefit received Because we are examining the last coke purchased, we are measuring the “Marginal Benefit” received from the last coke

8. MARGINAL BENEFIT Quantity Price $1 D = MB S

9. Consumer Surplus Quantity Price Total of all marginal Benefits = Total Consumer Benefit $1 CONSUMER SURPLUS D = MB

10. Producer Surplus Quantity Price $1

11. Producer Surplus Quantity Price $1 PRODUCER SURPLUS S = MC

12. Quantity Price $1 PRODUCER SURPLUS S = MC

13. Total Social Surplus Quantity Price $1 PRODUCER SURPLUS CONSUMER SURPLUS TOTAL SOCIAL SURPLUS

14. Proving “Efficiency” of Markets Quantity Price $1 PRODUCER SURPLUS CONSUMER SURPLUS $2 Reduction in Total Social Surplus

15. Proving “Efficiency” of Markets Quantity Price $1 PRODUCER SURPLUS CONSUMER SURPLUS D = MB S = MC MC > MB Reduces total Social Benefit

16. Maximum Social Benefit @ Market Equilibrium Quantity Price $1 PRODUCER SURPLUS CONSUMER SURPLUS D = MB S = MC “Efficiency of Markets”

17. What Have We Proven? Given 1.Society’s Demand reflection (measurement) of how it values things ie, how “willing to pay” 2.Costs of Producing Then can not achieve  Social Benefit, or happiness by  Or  quantity produced Quantity Price $1 PRODUCER SURPLUS CONSUMER SURPLUS D = MB S = MC

18. Maximum Social Benefit @ Market Equilibrium Quantity Price $1 PRODUCER SURPLUS CONSUMER SURPLUS D = MB S = MC “Efficiency of Markets” But, What is Missing in this picture?

19. Other Costs? Supply curve based on Production Costs –Labor, materials, depreciation –“write a check” “Internal” Costs BUT also Environmental Costs Pollution of air & water, loss of wetlands, soil damage from Irrigation “External” to firm producing But, “Real” costs to society Quantity Price $1 S = MC ATC MC

20. EXTERNAL COSTS How Value ? –Chpt 6 –Assume we have their value Add to Firm’s Existing Costs New Equilibrium Higher Price Lower Quantity Quantity Price p1 S = MC S’ = MSC D q1 P2 q2

21. How Achieve Lower Quantity? Need Mechanism to Internalize “external” costs 1.Tax  “market” based solution Quantity Price p1 S = MC S’ = MC + tax = MSC q1 P2 q2

22. How Achieve Lower Quantity? 2.Government Regulation Both 1 & 2 are mechanisms to internalize “external” costs Quantity Price p1 S = MC S’ = MSC q1q2

23. Market Equilibrium & “Efficiency” Quantity Price $1 PRODUCER SURPLUS CONSUMER SURPLUS D = MB S = MC Marginal “private” benefits Accruing to owner or buyer

24. Other Benefits? Third Party Benefits (people not involved in market transaction) People living around –airports –universities –parks “Social Benefits” EXTERNAL BENEFITS (external to the market) How value? Chpt 6 How Achieve larger Q? Quantity Price $1 PRODUCER SURPLUS CONSUMER SURPLUS D = MPB Marginal private benefits S = MC q1 q2 D’ = MSB Market Equilibrium & “Efficiency”

25. How Achieve larger Q? Need Mechanism to Internalize “external” benefits   Cost to Supply the good: Tax breaks Subsidies airports land preserves parks Quantity Price P1 PRODUCER SURPLUS CONSUMER SURPLUS D = MB S = MC P2 q1 q2

26. Figure 3-1: Automobile Market with External Costs

27. Figure 3-2 : Automobile Market with Pollution Tax

28. Figure 3-3: A Positive Externality

29. Figure 3-4: A Subsidy for Open and Rural Land Use

30. Figure 3-6: Welfare Analysis of the Automobile Market with Pollution Costs

31. “ Efficiency” with Externalities Quantity Price D = MpB S = MpC the case of “Optimal” pollution S’ w/ external social costs p0 q0 q1 Up to q1 pollution permitted Social benefits of driving > combined costs of production & pollution

32. Implication of  demand for cars?  “optimal pollution permitted. Ironic conclusion of Traditional Environmental Econ based on Neoclass market economics We’ve used econ theory to prove  pollution OK! Quantity Price D = MpB S = MpC S’ w/ external social costs p0 q0 q1 D’

33. Lecture 4 Discussion Question Should our goal be to reduce pollution by 50%, 75%, or 100% ?? Explain your answer.

34. Quantity Price $1 PRODUCER SURPLUS CONSUMER SURPLUS D = MB S = MC

35. Quantity Price Total of all marginal Benefits = Total Consumer Benefit

36. ATC MC

37. Figure 3-5: Welfare Analysis of the Automobile Market