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Title: ENV 536: Environmental Economics and Policy (Lecture 3) Modeling the Market Process: A Review of the Basics


1
ENV 536 Environmental Economics and Policy
(Lecture 3) Modeling the Market Process A
Review of the Basics
  • Asst.Prof. Dr. Sasitorn Suwannathep
  • School of Liberal Arts
  • King Mongkuts University of Technology Thonburi

2
Circular Flow Model of Economic Activity

3
Materials Balance Model The Interdependence of
Economic Activity and Nature
4
The Materials Balance Model
  • Environmental problems are directly linked to
    market activities.
  • Environmental pollution is characterized as a
    market failure.
  • Environmental economics uses market failure
    models to analyze the problem and to identify
    solutions.

5
Market Models The Fundamentals
  • A market refers to the interaction between
    consumers (or buyers) and producers (or sellers)
    for the purpose of exchanging a commodity.

6
The Model of Supply and Demand
  • The decisions for producers are modeled through a
    supply function.
  • For consumers, the decisions are shown through a
    demand function.
  • The main objective of the supply and demand model
    is to facilitate an analysis of market conditions
    and any observed price changes.

7
The Model of Supply and Demand (cont)
  • An investigate of price movements can identify
  • shortages and surpluses
  • The existence of resource misallocations
  • And the economic implications of government
    policy.

8
Basic Assumptions to Supply and Demand Model
  • A competitive goods market
  • A large number of buyers and sellers
  • A homogeneous product
  • The absence of entry barriers
  • Perfect information
  • A competitive resources market
  • A private good
  • Rivalry in consumption
  • Excludability

9
Demand Model
  • The demand function is the relationship between
    quantity demanded and price.
  • Demand is defined as the quantities of a good the
    consumer is willing and able to purchase at some
    set of prices during some time period, cetiris
    paribus (c.p.).
  • Willing to pay demand price
    marginal benefit (MB)
  • Ability to pay (income constraint)

10
Individual Demand Curve (details in CC ch 3,
fig. 3.1 p. 36)
Price P
Demand Function qd -2P 23
11.50
d MB
0
Quantity Q
23
11
Law of Demand
  • The relationship between quantity demanded and
    price is inverse one.
  • P Qd , P Qd

12
Demand Model (cont)
  • Many factors influence individual demand
  • Wealth or income
  • The prices of related goods (i.e., substitutes or
    complements)
  • Preference
  • Price expectations

13
Market Demand
  • Market demand is the sum of individual demands
    (we sum the quantities at each demand price).

Demand for consumer 1 qd1 -2P 23 Demand
for consumer 2 qd2 -4P 46
Market demand (Dm) -6P 69 (ass. There are two
persons in the market)
14
Market Demand Curve
Price P
11.50
Market Demand Qd -6P 69
Dm
0
69
Quantity Q
15
Supply Model
  • Supply refers to the quantities of a good the
    producer is willing and able to bring to market
    at a given set of prices during some time period,
    c.p.

16
Firm Supply Curve
Price P
Supply Function qs -4 16P
S MC
2.00
Note qs MC As the firm produces more output
(Q), the total costs (TC) will be rise, which
mean that change in Q ( ? Q) cause change in TC
(or ? TC) or (? TC/ ? Q) MC
0.25
0
28
Quantity Q
17
Law of Supply
  • The relationship between quantity supplied and
    price is a positive one.

P Qs , P Qs
18
Supply Model (cont)
  • Several factors determine supply
  • Production technology
  • Input price
  • Tax and subsidies
  • Price expectations

19
Market Supply
  • Market supply is the sum of individual supply at
    each price.

Supply of producer 1 qs1 -4 16P Supply
of producer 2 qs2 -4 16P
Market Supply (Sm) -8 32P (ass. There are two
producers in the market)
20
Market Supply Curve
Price P
Supply Function Qs -8 32P
Sm ? MC
2.00
0.25
0
Quantity Q
56
21
Equilibrium Price and Quantity
  • The forces of demand and supply determine a
    equilibrium price (PE) and quantity (QE)

Price
Surplus
Sm
P1
E
PE
Shortage
P2
Dm
Quantity
0
QE
22
Economic Criteria of Efficiency
  • Allocative Efficiency the proper allocation of
    resources among alternative uses.
  • Technical Efficiency the economizing resources
    used in production.

23
Allocative Efficiency
  • To evaluate resource allocation, we can do
    through
  • Assessment of benefits and costs
  • The use of marginal analysis

24
Allocative Efficiency (cont)
  • Resource Allocation at the Market Level
  • At market level, the price along the demand curve
    are measures of marginal benefit (MB).
  • On supply side, the prices are measures of
    economic cost, the market supply is the sum of
    firms marginal cost (MC).
  • Allocative efficiency requires that the
    additional value society place on another unit of
    the good is equal to what society must give up in
    resources to produce it.

MB MC
25
Allocative Efficiency (cont)
  • Resource Allocation at Firm Level
  • the firm prefers profit maximization.
  • TR P q when P market price
  • q the sold output
  • TC all economic costs associated with
    production
  • Total profit ( ? ) Total Revenue (TR) Total
    Costs (TC)

26
Allocative Efficiency (cont)
  • If TR gt TC, the firm will increase production.
  • MR gt MC , M ? gt 0
  • when MR ? TR / ? q
  • MC ? TC / ? q
  • Profit maximization occurs when

MR MC , M ? 0
27
MR lt MC, decrease output
MR gt MC, produce more output
MR MC
Source Callan, S. J. and Thomas, J. M. 2007.
Environmental Economics and Management
Theory, Policy, and Applications.
28
Technical Efficiency
  • Technical efficiency refers to production
    decisions that generate maximum output with a
    given resource or use minimum inputs with a given
    output.
  • Market forces can achieve technical efficiency as
    long as competitive condition prevail.

29
Welfare Measures
  • We use welfare measures to assess the gains or
    losses of the society.
  • Consumer surplus
  • Producer surplus

30
Consumer surplus
  • A measure of net benefit to the buyers estimated
    by the excess of what they are willing to pay
    (WTP) over what they actually pay (P).

31
Source Callan, S. J. and Thomas, J. M. 2007.
Environmental Economics and Management
Theory, Policy, and Applications.
32
Producer Surplus
  • Measures a net gain to sellers estimated by the
    excess of market price (P) over marginal cost
    (MC).

33
Source Callan, S. J. and Thomas, J. M. 2007.
Environmental Economics and Management
Theory, Policy, and Applications.
34
Societys Welfare Sum of Consumer and Producer
Surplus
  • Societys welfare is measured as the sum of
    consumer and producer surplus, which is maximized
    when allocative efficiency is achieved.
  • Deadweight loss to society the net loss of
    consumer and producer surplus due to an
    allocatively inefficient market event.

35
Source Callan, S. J. and Thomas, J. M. 2007.
Environmental Economics and Management
Theory, Policy, and Applications.
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