Applying the Competitive Model

1
Applying the Competitive Model

• Perloff Chapter 9

2
Consumer Welfare

• Measure how much consumers are affected by shocks
  which affect the equilibrium.
• Marginal Willingness to Pay
• The maximum amount a consumer will pay for an
  extra unit.
• The monetary difference between what a consumer
  is willing to pay and what the good actually
  costs.

3
Consumer Surplus
p
, per magazine
a
5
b
4


CS


1
CS


2
2
1
c
3
Price

3

2



E


3
E


3
E


3
Demand
1
2
3
1
5
4
3
2
1
0
q
, Magazines per week
4
Consumer Surplus with Continuous Demand
p
, per
trading card
Consumer
surplus,
CS
p
1
Demand
Expenditure,
E
Marginal willingness to
pay for the last unit of output
q
q
, Trading cards per year
1
5
Aggregate consumer surplus and the effect of a
price change
p
,

per stem
57.8

• Influenced by
• Position of the demand curve (revenue)
• Elasticity of demand

A
149.64 million
C
0.9 million
b
32
B
23.2 million
a
30
Demand
1.16
0
1.25
Q
, Billion rose stems per year
6
Producer Welfare

• Difference between the amount that a good sells
  for and the minimum they have to be paid to
  produce (avoidable cost).
• VC costs that change as output changes.
• MC change in cost when output changes by one
  unit.
• VCnMC1MC2 MCn

7
Producer Surplus
Supply
p
, per unit
4
p
PS



2
PS



1
PS



3
2
3
1
3
2
1
MC



2
MC



3
MC



4
MC


1
2
3
4
1
4
3
2
1
0
q
, Units per week
8
Producer Surplus in the Market
p
, Price per unit
Market supply curve
Market price
p

Producer surplus,
PS
Variable cost,
VC

Q
Q
, Units per year
9
Producer surplus and profit

• Producer surplus is revenue minus variable costs.
• In the long run
• all costs are variable
• profit is zero
• producer surplus is zero
• Long run supply curve is horizontal
• In an increasing cost industry fixed factors earn
  a return equal to their opportunity cost, rent.
• Producer surplus is rent in the long run.

10
Competition maximises welfare

• How should we measure societies welfare?
• W CS PS
• Weights both producers and consumers equally
• If output is either more or less than the
  competitive equilibrium, welfare is reduced.

11
The effect of reducing output on welfare
p
, per unit
Supply
A
e
2
p
e
2
1
C
B
MC

p
1
1
E
Demand
D
MC
2
F
Q
Q
, Units per year
Q
2
1
12
Explanation

• At competitive equilibrium P MC
• Consumers are prepared to pay (value) the last
  unit produced at exactly what it costs to
  produce.
• P gt MC consumers increase in satisfaction
  outweighs producers reduction as output expands.
• P lt MC consumers reduction in satisfaction
  folowing a reduction in output is less than
  producers increase.

13
Effect of a restriction on the number of taxis
p
, per ride
p
, per ride
2
AC
M
C
1
AC
2
S
A
E
p
p
2
e
2
2
2
p
B
C
1
S
p
p
1
1
e
E
1
1
D
q
q
n
q
Q

n
q
Q


n
q
2
1
2
1
2
2
2
1
1
1
q
, Rides per month
Q
, Rides per month
14
Accounting for the effects of a tax

• Prices to consumers and producers change. PS and
  CS change.
• Government raises tax revenues which is spent to
  raise peoples welfare.
• W PS CS T

15
Effects of a tax
Supply
,
p

per stem
e
A
2
e
32
1
B
C
30
Demand
t
11
E
D
21
F
0
1.16
1.25
Q
, Billion rose stems per year
16
Effects of a price floor
p
, per bushel
Supply
A
p
5.00
Price support
D
B
C
e
p
4.59
1
Demand
F
E
G
3.60
MC

1.9


Q


Q

2.1
Q

2.2
0
d
1
s

Q
0.3

g
Q
, Billion bushels of soybeans per year
17
Trade Policies (imports)

• Allow free trade (domestic price is the world
  price).
• Ban all imports.
• Set a non-zero import quota.
• Set a tariff on imported goods.

18
Free trade versus an import ban
p
, 1988 dollars
a
2

S


S
Demand
per barrel
A
e
29.04
2
B
C
e
1
1
14.70
S
, World price
D
0
9.0
10.2
8.2
11.8
13.1
Imports 4.9
Q
, Million barrels of oil per day
19
Tariff or quota versus import ban
p
, 1988 dollars

a
2
S
S
per barrel
A
e
29.04
2
e
3
3
19.70
S
t
5.00
D
B
e
C
E
1
1
14.70
S
, World price
F
G
H
Demand
9.0
8.2
11.8
13.1
0
Imports 2.8
Q
, Million barrels of oil per day