### Applying the Competitive Model

```Applying the Competitive Model
Perloff Chapter 9
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.
Consumer Surplus
p, \$ per magazine
5
a
b
4
CS1 = \$2 CS2 = \$1
c
3
Price = \$3
2
E 1 = \$3
E2 = \$3
E 3 = \$3
Demand
1
0
1
2
3
4
5
q, Magazines per week
Consumer Surplus with Continuous
Demand
p, \$ per
Consumer
surplus, CS
p1
Expenditure, E
Demand
Marginal willingness to
pay for the last unit of output
q1
¢ per stem
57.8
Aggregate consumer surplus and the
effect of a price change
Influenced by:
• Position of the demand curve
(revenue)
• Elasticity of demand
A = \$149.64 million
b
32
30
B = \$23.2 million
C = \$0.9 million
a
Demand
0
1.16 1.25
Q, Billion rose stems per year
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.
• VCn=MC1+MC2+ … +MCn
Producer Surplus
p, \$ per unit
Supply
4
p
PS1 = \$3 PS 2 = \$2 PS 3 = \$1
3
2
1
MC1 = \$1 MC2 = \$2 MC3 = \$3 MC4 = \$4
0
1
2
3
4
q, Units per week
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
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.
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.
The effect of reducing output on welfare
p, \$ per unit
Supply
A
p
MC
1
e2
2
= p1
B
D
C
E
e1
Demand
MC 2
F
Q2
Q 1 Q , Units per year
Explanation
• At competitive equilibrium P = MC
• Consumers are prepared to pay (value) the last
unit produced at exactly what it costs to produce.
• P > MC consumers increase in satisfaction
outweighs producers reduction as output expands.
• P < MC consumers reduction in satisfaction
folowing a reduction in output is less than
producers increase.
Effect of a restriction on the number of
taxis
p, \$ per ride
p, \$ per ride
AC 1
AC 2
MC
S2
A
p2
e2
E2
p2
p
B
C
p1
e1
p1
S1
E1
D
q1 q 2
q, Rides per month
n2 q 1
Q 2 = n2 q 2
Q 1 = n1 q1
Q, Rides per month
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
Effects of a tax
Supply
p, ¢ per stem
A
B
32
30
t = 11
D
e2
C
e1
E
Demand
21
F
0
1.16
1.25
Q, Billion rose stems per year
Effects of a price floor
p, \$ per bushel
Supply
A
p = 5.00
Price support
D
B
C
E
F
e
p1 = 4.59
Demand
G
3.60
0
MC
Qd = 1.9
Q 1= 2.1 Qs = 2.2
Q g = 0.3
Q, Billion bushels of soybeans per year
• Allow free trade (domestic price is the
world price).
• Ban all imports.
• Set a non-zero import quota.
• Set a tariff on imported goods.
Free trade versus an import ban
a
2
Demand S = S
p, 1988 dollars
per barrel
A
e2
29.04
B
C
e1
14.70
0
S 1, World price
D
8.2 9.0
10.2
11.8
13.1
Imports = 4.9
Q, Million barrels of oil per day
t
Tariff or quota versus import ban
p, 1988 dollars
per barrel
Sa = S 2
A
29.04
e2
e3
S3
19.70
= 5.00
B
14.70
F
D
C
e1
E
G
S1, World price
H
Demand
0
8.2 9.0
11.8
13.1
Imports = 2.8
Q, Million barrels of oil per day
```