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Economics 2: Spring 2014

Economics 2: Spring 2014. J. Bradford DeLong <jbdelong@berkeley.edu>; Maria Constanza Ballesteros <mc.ballesteros@berkeley.edu>; Connie Min <conniemin@berkeley.edu> http://delong.typepad.com/sdj/econ-2-spring-2014/. Economics 2: Spring 2014: Supply and Demand Algebra: Price Ceilings .

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Economics 2: Spring 2014

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  1. Economics 2: Spring 2014 J. Bradford DeLong <jbdelong@berkeley.edu>; Maria Constanza Ballesteros <mc.ballesteros@berkeley.edu>; Connie Min <conniemin@berkeley.edu> http://delong.typepad.com/sdj/econ-2-spring-2014/

  2. Economics 2: Spring 2014: Supply and Demand Algebra: Price Ceilings http://delong.typepad.com/sdj/econ-1-spring-2014/ February 5, 2014, 4-5:30 101 Barker, U.C. Berkeley

  3. Consider a Market in Equilibrium…

  4. Consider a Market in Equilibrium… • Demand: • P = 100-(5/3)Qd • Supply: • P = 15Qs • Equilibrium: • Q = (100-0)/(15+(5/3) • P=(15/(15+(5/3)))100+((5/3)/(15+(5/3)))0 • P = 90, Q = 6

  5. Consider a Market in Equilibrium… • Demand: • P = 100-(5/3)Qd • Supply: • P = 15Qs • Equilibrium: • P = 90, Q = 6 • Surplus: • Demanders pay 6x90=540; average value=95; consumer surplus=95x6-540=30

  6. Consider a Market in Equilibrium… • Demand: • P = 100-(5/3)Qd • Supply: • P = 15Qs • Equilibrium: • P = 90, Q = 6 • Surplus: • Consumer surplus = 95x6-540=30 • Suppliers earn 6x90=540; averge cost=45; producer surplus=540-45x6=270

  7. Consider a Market in Equilibrium… • Demand: • P = 100-(5/3)Qd • Supply: • P = 15Qs • Equilibrium: • P = 90, Q = 6 • Surplus: • Consumer surplus = 30 • Producer surplus = 270

  8. The Government Says: This Isn’t Fair! • The situation: • Demand: P = 100-(5/3)Qd • Supply: P = 15Qs • Equilibrium: P = 90, Q = 6 • Surplus: Consumer = 30; Producer = 270 • Why should suppliers get nine times as much surplus? • The Westerosi Army needs to buy other things as well! They will have to face the ice zombies!

  9. The Government Imposes a Price Ceiling on What You Can Charge: 60 • The situation: • Demand: P = 100-(5/3)Qd • Supply: P = 15Qs • Equilibrium: P = 90, Q = 6 • Surplus: Consumer = 30; Producer = 270 • Why should suppliers get nine times as much surplus? • The Westerosi Army needs to buy other things as well! They will have to face the ice zombies!

  10. What Happens? • The situation: • Demand: P = 100-(5/3)Qd • Supply: P = 15Qs • Equilibrium: P = 90, Q = 6 • Surplus: Consumer = 30; Producer = 270 • Why should suppliers get nine times as much surplus? • The government imposes a price ceiling of 60

  11. Ladies and Gentlemen, to Your i>Clickers! • The situation: Demand: P = 100-(5/3)Qd Supply: P = 15Qs Equilibrium: P = 90, Q = 6 Surplus: Consumer = 30; Producer = 270 • A PRICE CEILING OF 60 • How many dragon-training flights will be flown with the price ceiling? • A. 6 • B. 4 • C. 24 • D. 14 • E. None of the above

  12. Ladies and Gentlemen, to Your i>Clickers! • The situation: Demand: P = 100-(5/3)Qd Supply: P = 15Qs Equilibrium: P = 90, Q = 6 Surplus: Consumer = 30; Producer = 270 • A PRICE CEILING OF 6 • How many dragon-training flights will be flown with the price ceiling? A. 6. B. 4. C. 24. D. 14. E. None of the above

  13. Ladies and Gentlemen, to Your i>Clickers! • The situation: Demand: P = 100-(5/3)Qd Supply: P = 15Qs Equilibrium: P = 90, Q = 6 Surplus: Consumer = 30; Producer = 270 • A PRICE CEILING OF 6 • How many dragon-training flights will be flown with the price ceiling? A. 6. [B. 4.] C. 24. D. 14. E. None of the above • Why 4? • Because only 4 potential riders think it’s worth showing up at the dragonstrip if you are only going to be paid £60 • But then what is the 24 number? • That’s how many people show up with plans for training missions…

  14. Is This New Situation a Better Equilibrium? • The situation: • Demand: P = 100-(5/3)Qd Supply: P = 15Qs • Price ceiling = 60 • Equilibrium: P = 60, Q = 4

  15. Let’s Calculate the Surplus… • The situation: • Demand: P = 100-(5/3)Qd Supply: P = 15Qs • Price ceiling = 60 • Equilibrium: P = 60, Q = 4 • Producer Surplus: • 4 missions flown • What’s the average cost?

  16. Ladies, Gentlemen, and Large Intelligent Fire-Breathing Reptiles, to Your i>Clickers… • The situation: • Demand: P = 100-(5/3)Qd Supply: P = 15Qs • Price ceiling = 60 • Equilibrium: P = 60, Q = 4 • What’s the average cost to producers of the four dragon-training missions flown? • A. 45 • B. 60 • C. 30 • D. 15 • E. None of the above

  17. Ladies, Gentlemen, and Large Intelligent Fire-Breathing Reptiles, to Your i>Clickers… • The situation: • Demand: P = 100-(5/3)Qd Supply: P = 15Qs • Price ceiling = 60 • Equilibrium: P = 60, Q = 4 • What’s the average cost to producers of the four dragon-training missions flown? A. 45. B. 60. C. 30. D. 15. E. None of the above

  18. Ladies, Gentlemen, and Large Intelligent Fire-Breathing Reptiles, to Your i>Clickers… • The situation: • Demand: P = 100-(5/3)Qd Supply: P = 15Qs • Price ceiling = 60 • Equilibrium: P = 60, Q = 4 • What’s the average cost to producers of the four dragon-training missions flown? • A. 45. B. 60. [C. 30.] D. 15. E. None of the above • Yes: the first mission costs a little more than 0, the last a little less than 60, the average costs 30

  19. Ladies, Gentlemen, and Large Intelligent Fire-Breathing Reptiles, to Your i>Clickers… • The situation: • Demand: P = 100-(5/3)Qd Supply: P = 15Qs • Price ceiling = 60 • Equilibrium: P = 60, Q = 4 • Average cost: 30 • What’s the producer surplus? • A. 120 • B. 180 • C. 270 • D. 60 • E. None of the above…

  20. Ladies, Gentlemen, and Large Intelligent Fire-Breathing Reptiles, to Your i>Clickers… • The situation: • Demand: P = 100-(5/3)Qd Supply: P = 15Qs • Price ceiling = 60 • Equilibrium: P = 60, Q = 4 • Average cost: 30 • What’s the producer surplus? • A. 120. B. 180. C. 270. D. 60. E. None of the above…

  21. Ladies, Gentlemen, and Large Intelligent Fire-Breathing Reptiles, to Your i>Clickers… • The situation: • Demand: P = 100-(5/3)Qd Supply: P = 15Qs • Price ceiling = 60 • Equilibrium: P = 60, Q = 4 • Average cost: 30 • What’s the producer surplus? • [A. 120.] B. 180. C. 270. D. 60. E. None of the above… • Producer surplus = (price – average cost)x(units) • Producer surpus = (60 – 30) x 4 = 120

  22. Is This New Situation a Better Equilibrium? • The old situation: • Demand: P = 100-(5/3)Qd • Supply: P = 15Qs • Equilibrium: P = 90, Q = 6 • Surplus: Consumer = 30; Producer = 270 • Impose a price ceiling of 60 • New equilibrium: P = 60, Q = 4 • Reduce producer surplus from 270 to 120

  23. Is This New Situation a Better Equilibrium? • The situation: • Demand: P = 100-(5/3)Qd Supply: P = 15Qs • Equilibrium: P = 90, Q = 6 • Surplus: Consumer = 30; Producer = 270 • Impose a price ceiling of 60: • New equilibrium: P = 60, Q = 4. Reduce producer surplus from 270 to 120 • What happens to consumer surplus?

  24. Calculating Consumer Surplus • The situation: • Demand: P = 100-(5/3)Qd Supply: P = 15Qs • Equilibrium: P = 90, Q = 6 • Surplus: Consumer = 30; Producer = 270 • Impose a price ceiling of 60: • New equilibrium: P = 60, Q = 4. Reduce producer surplus from 270 to 120 • What happens to consumer surplus? • Only four of the 24 consumers actually get to fly their planned training mission… • How do you select the four?

  25. Calculating Consumer Surplus • The situation: • Demand: P = 100-(5/3)Qd Supply: P = 15Qs • Equilibrium: P = 90, Q = 6 • Surplus: Consumer = 30; Producer = 270 • Impose a price ceiling of 60: • New equilibrium: P = 60, Q = 4. Reduce producer surplus from 270 to 120 • What happens to consumer surplus? • Only four of the 24 consumers actually get to fly their planned training mission… How do you select the four? • The government asks everybody to raise their hand if they are those who have the four highest willingnesses-to-pay…

  26. Calculating Consumer Surplus • The situation: • Demand: P = 100-(5/3)Qd Supply: P = 15Qs • Equilibrium: P = 90, Q = 6. Surplus: Consumer = 30; Producer = 270 • Impose a price ceiling of 60: • New equilibrium: P = 60, Q = 4. Reduce producer surplus from 270 to 120 • What happens to consumer surplus? Only four of the 24 consumers actually get to fly their planned training mission… How do you select the four? • The government asks everybody to raise their hand if they are those who have the four highest willingnesses-to-pay… • Yeah, right, that’s really going to work

  27. Some Bureaucratic Process Selects Missions Randomly… • The situation: • Demand: P = 100-(5/3)Qd Supply: P = 15Qs • Equilibrium: P = 90, Q = 6. Surplus: Consumer = 30; Producer = 270 • Impose a price ceiling of 60: • New equilibrium: P = 60, Q = 4. Reduce producer surplus from 270 to 120 • What happens to consumer surplus? Only four of the 24 consumers actually get to fly their planned training mission… How do you select the four? • The government asks everybody to raise their hand if they are those who have the four highest willingnesses-to-pay… • Yeah, right, that’s really going to work • What is the average willingness to pay of the four selected missions going to be?

  28. Gentlebeings, to Your i>Clickers… • The situation: • Demand: P = 100-(5/3)Qd Supply: P = 15Qs • Equilibrium: P = 90, Q = 6. Surplus: Consumer = 30; Producer = 270 • Impose a price ceiling of 60: • New equilibrium: P = 60, Q = 4. Reduce producer surplus from 270 to 120 • Only four of the 24 consumers actually get to fly their planned training mission. Some bureaucrat selects the four randomly… • What is the average willingness-to-pay of the four selected missions going to be? • A. 95 • B. 80 • C. 96 2/3 • D. 60 • E. None of the above

  29. Gentlebeings, to Your i>Clickers… • The situation: • Demand: P = 100-(5/3)Qd Supply: P = 15Qs • Equilibrium: P = 90, Q = 6. Surplus: Consumer = 30; Producer = 270 • Impose a price ceiling of 60: • New equilibrium: P = 60, Q = 4. Reduce producer surplus from 270 to 120 • Only four of the 24 consumers actually get to fly their planned training mission. Some bureaucrat selects the four randomly… • What is the average willingness-to-pay of the four selected missions going to be? • A. 95. B. 80. C. 96 2/3. D. 60. E. None of the above

  30. Gentlebeings, to Your i>Clickers… • The situation: • Demand: P = 100-(5/3)Qd Supply: P = 15Qs • Equilibrium: P = 90, Q = 6. Surplus: Consumer = 30; Producer = 270 • Impose a price ceiling of 60: • New equilibrium: P = 60, Q = 4. Reduce producer surplus from 270 to 120 • Only four of the 24 consumers actually get to fly their planned training mission. Some bureaucrat selects the four randomly… • What is the average willingness-to-pay of the four selected missions going to be? • A. 95. [B. 80.] C. 96 2/3. D. 60. E. None of the above • The mission planner with the highest willingness-to-pay is just shy of 100. The mission planner with the lowest willingness-to-pay is just more than 60. The average is 80. • Why is it kosher to calculate the average of the whole distribution by just adding up the biggest and the smallest and dividing by 2, anyway?

  31. Gentlebeings, to Your i>Clickers… • The situation: • Demand: P = 100-(5/3)Qd Supply: P = 15Qs • Equilibrium: P = 90, Q = 6. Surplus: Consumer = 30; Producer = 270 • Impose a price ceiling of 60: • New equilibrium: P = 60, Q = 4. Reduce producer surplus from 270 to 120 • Only four of the 24 consumers actually get to fly their planned training mission. Some bureaucrat selects the four randomly… • What is the average willingness-to-pay of the four selected missions going to be? • A. 95. [B. 80.] C. 96 2/3. D. 60. E. None of the above • The mission planner with the highest willingness-to-pay is just shy of 100. The mission planner with the lowest willingness-to-pay is just more than 60. The average is 80. • Why is it kosher to calculate the average of the whole distribution by just adding up the biggest and the smallest and dividing by 2, anyway? • Anybody?

  32. Gentlebeings, to Your i>Clickers… • The situation: • Demand: P = 100-(5/3)Qd Supply: P = 15Qs • Equilibrium: P = 90, Q = 6. Surplus: Consumer = 30; Producer = 270 • Impose a price ceiling of 60: • New equilibrium: P = 60, Q = 4. Reduce producer surplus from 270 to 120 • Only four of the 24 consumers actually get to fly their planned training mission. Some bureaucrat selects the four randomly… • Average willingness-to-pay: 80 • What is the consumer surplus here?

  33. Gentlebeings, to Your i>Clickers… • The situation: • Demand: P = 100-(5/3)Qd Supply: P = 15Qs • Equilibrium: P = 90, Q = 6. Surplus: Consumer = 30; Producer = 270 • Impose a price ceiling of 60: • New equilibrium: P = 60, Q = 4. Reduce producer surplus from 270 to 120 • Only four of the 24 consumers actually get to fly their planned training mission. Some bureaucrat selects the four randomly… • Average willingness-to-pay: 80 • What is the consumer surplus here? • A. 80 • B. 30 • C. 160 • D. 120 • E. None of the above…

  34. Gentlebeings, to Your i>Clickers… • The situation: • Demand: P = 100-(5/3)Qd Supply: P = 15Qs • Equilibrium: P = 90, Q = 6. Surplus: Consumer = 30; Producer = 270 • Impose a price ceiling of 60: • New equilibrium: P = 60, Q = 4. Reduce producer surplus from 270 to 120 • Only four of the 24 consumers actually get to fly their planned training mission. Some bureaucrat selects the four randomly… • Average willingness-to-pay: 80 • What is the consumer surplus here? • A. 80. B. 30. C. 160. D. 120. E. None of the above…

  35. Gentlebeings, to Your i>Clickers… • The situation: • Demand: P = 100-(5/3)Qd Supply: P = 15Qs • Equilibrium: P = 90, Q = 6. Surplus: Consumer = 30; Producer = 270 • Impose a price ceiling of 60: • New equilibrium: P = 60, Q = 4. Reduce producer surplus from 270 to 120 • Only four of the 24 consumers actually get to fly their planned training mission. Some bureaucrat selects the four randomly… • Average willingness-to-pay: 80 • What is the consumer surplus here? • [A. 80.] B. 30. C. 160. D. 120. E. None of the above… • Consumer surplus = (avg w-t-p – price) x quantity • Avg w-t-p = 80 Price = 60 Quantity = 4 • Consumer surplus = 80

  36. Is This New Situation a Better Equilibrium? • The old situation: • Demand: P = 100-(5/3)Qd Supply: P = 15Qs • Equilibrium: P = 90, Q = 6. Surplus: Consumer = 30; Producer = 270 • Impose a price ceiling of 60: • New equilibrium: P = 60, Q = 4. • Reduce producer surplus from 270 to 120 • Increase consumer surplus from 30 to 80

  37. Is This New Situation a Better Equilibrium? • The old situation: • Demand: P = 100-(5/3)Qd Supply: P = 15Qs • Equilibrium: P = 90, Q = 6. Surplus: Consumer = 30; Producer = 270 • Impose a price ceiling of 60: New equilibrium: P = 60, Q = 4. • Reduce producer surplus from 270 to 120 • Increase consumer surplus from 30 to 80 • Reduced total surplus from 300 to 200

  38. Is This New Situation a Better Equilibrium? • The old situation: • Demand: P = 100-(5/3)Qd Supply: P = 15Qs • Equilibrium: P = 90, Q = 6. Surplus: Consumer = 30; Producer = 270 • Impose a price ceiling of 60: New equilibrium: P = 60, Q = 4. • Reduce producer surplus from 270 to 120 • Increase consumer surplus from 30 to 80 • Reduced total surplus from 300 to 200 • Huh!? Where did the extra £100 of surplus go!?!?!?

  39. Huh?! Where Did the Extra £100 of Surplus Go!?!?!? • In the old situation: • We matched 6 suppliers with an average cost of 45 to 6 missions with an average willingness-to-pay of 95 • Generated 6 x 50 = 300 of surplus

  40. Huh?! Where Did the Extra £100 of Surplus Go!?!?!? • In the old situation: • We matched 6 suppliers with an average cost of 45 • to 6 missions with an average willingness-to-pay of 95 • Generated 6 x 50 = 300 of surplus • With the price ceiling: • We match 4 suppliers with an average cost of 30 • To 4 missions with an average willingness-to-pay of 80 • Generate 4 x 50 = 200 of surplus

  41. Huh?! Where Did the Extra £100 of Surplus Go!?!?!? • In the old situation: • We matched 6 suppliers with an average cost of 45 • to 6 missions with an average willingness-to-pay of 95 • Generated 6 x 50 = 300 of surplus • With the price ceiling: • We match 4 suppliers with an average cost of 30 • To 4 missions with an average willingness-to-pay of 80 • Generate 4 x 50 = 200 of surplus • We have made 4 matches instead of 6 • We haven’t improved the average quality of the matches • We have degraded the average willingness-to-pay of demanders • We have improved the cost of suppliers: if we are only going to fly four missions, these are the four who should be flying those missions

  42. An Anti-Krugman and Wells Rant! • Here is their analysis of a price ceiling—and their equivalent of the -100 loss in surplus that we have calculated—this yellow triangle. • How large is this yellow triangle?

  43. An Anti-Krugman and Wells Rant! • How large is this yellow “surplus loss” Harberger triangle? • Well, its base is from 60 to 100; its height is from 4 to 6… • Its area is: 2 x 40 x ½ = 40 • But we found that the surplus loss was 100…

  44. What Is Going on? Why Do We Find a Surplus Loss of 100 When KW Only Find a Surplus Loss of 20? • Their Harberger triangle is 40… • But we found that the surplus loss was 100… • They assume the high willingness-to-pay demanders get to purchase when there is excess supply…

  45. What Is Going on? Why Do We Find a Surplus Loss of 100 When KW Only Find a Surplus Loss of 20? • Their Harberger triangle is 40… • But we found that the surplus loss was 100… • They assume the high willingness-to-pay demanders get to purchase when there is excess supply… • Sometimes that may happen (secondary markets, scalping)… • Sometimes that may not happen…

  46. What Is Going on? Why Do We Find a Surplus Loss of 100 When KW Only Find a Surplus Loss of 20? • Their Harberger triangle is 40… • But we found that the surplus loss was 100… • They assume the high willingness-to-pay demanders get to purchase when there is excess supply… • Sometimes that may happen (secondary markets, scalping)… • Sometimes that may not happen… • You need to talk about it, not just to assume it…

  47. So I Think KW Get This Really Wrong! • But I haven’t found anything else in KW that I think is equally really wrong…

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