Outline for Thursday, August 7

� Remember

� Last homework due Friday

� Last quiz on Monday

� Review welfare� Review welfare

� Pareto Efficiency

� Price discrimination

� Other pricing methods

Shifting curves by taxes

� Inverse demand is the highest price buyers are

willing to pay for the next unit

� Inverse supply is the lowest price sellers are willing

to be paid for the next unitto be paid for the next unit

Shifting curves by taxes

� Inverse demand is the highest price buyers are

willing to pay for the next unit

� Inverse supply is the lowest price sellers are willing

to be paid for the next unitto be paid for the next unit

� So, when a tax is applied to buyers PD(Q)

� But when it’s applied to sellers PS(Q)

� Illustration: part of hw6, question 4.b

Welfare

� It’s maximized at equilibrium

� No policy can increase welfare

� The most any party can get is that area

� It’s how much buyers and sellers value the market at� It’s how much buyers and sellers value the market at

� If the market didn’t exist, they would pay W to create

it

Market interventions

� When the government uses

� Price ceilings and floors

� Taxes

� Rationing� Rationing

and other similar policies, there is a

� Deadweight loss (DWL): the change in welfare

DWL = ∆CS + ∆PS + ∆G

where G is net government expenditure

� It’s called the DWL of the policy

Price ceilings and floors

� If the quantity traded after a price floor is 50, and

the quantity traded after a price ceiling is also 50,

then the DWL of each policy is the same

Rationing

� With price ceilings and floors, we know that buyers

with the highest WTP get the good

Rationing

� With price ceilings and floors, we know that buyers

with the highest WTP get the good

� Rationing means fixing Q = 50 and allocating via

� Queuing – first come first serve� Queuing – first come first serve

Rationing via queuing

� Low-valuers may try to get rents: sell the good to

high-valuers on the black market

� Selling Nintendo Wiis on eBay

� Squatting on land someone else needs� Squatting on land someone else needs

� Squatting on WWW domains

Rationing

� With price ceilings and floors, we know that those

with the highest WTP get the good

� Rationing means fixing Q = 50 and allocating via

� Queuing – first come, first serve� Queuing – first come, first serve

� Free tickets – each of 100 buyers gets a half a ticket

Rationing via free tickets

� Creates a (black) market in tickets

PQ

PQ

S

D

=

−=

3

1100

� Creates a (black) market in tickets

� Think of the highest 50 valuers as demand and

the lowest 50 valuers as supply

� Will all the tickets be transferred to high-valuers?

Rationing

� With price ceilings and floors, we know that those

with the highest WTP get the good

� Rationing means fixing Q = 50 and allocating via

� Queuing – first come, first serve� Queuing – first come, first serve

� Free tickets – each of 100 buyers gets a half a ticket

� Sold tickets – government sells 50 tickets at market price

and buyers still have to pay sellers of the good

Rationing via sold tickets

� WTP for tickets is WTP minus the price of the good

PQ

PQ

S

D

=

−=

3

1100

� WTP for tickets is WTP minus the price of the good

� Supply for tickets is inelastic at 50

� What is the price of tickets

Rationing

� With price ceilings and floors, we know that those

with the highest WTP get the good

� Rationing means fixing Q = 50 and allocating via

� Queuing – first come, first serve� Queuing – first come, first serve

� Free tickets – each of 100 buyers gets a half a ticket

� Sold tickets – government sells 50 tickets at market price

� The DWL is the same if rationing gives the good to

the highest-valuers

� Let’s verify…

Rationing via queuing DWL

� Low-valuers may get rents

PQ

PQ

S

D

=

−=

3

1100

� Low-valuers may get rents

� High-valuers pay those rents

� Sellers are forced to produce

� It costs the government nothing

� To find DWL

� Find the welfare of each group and add up

� Compare with old welfare

Rationing via free tickets DWL

� Low-valuers sell tickets in a secondary market

PQ

PQ

S

D

=

−=

3

1100

� Low-valuers sell tickets in a secondary market

� High-valuers buy tickets

� Sellers are forced to produce

� It costs the government nothing

� To find DWL

� Find the welfare of each group and add up

� Compare with old welfare

Rationing via sold tickets DWL

� High-valuers buy tickets from the government

PQ

PQ

S

D

=

−=

3

1100

� High-valuers buy tickets from the government

� High-valuers still have to pay P = 50

� Sellers get paid P = 50

� The government collects revenue

� To find DWL

� Find the welfare of each group and add up

� Compare with old welfare

Rationing

� With price ceilings and floors, we know that those

with the highest WTP get the good

� Rationing means fixing Q = 50

� If a rationing method gives the good to the highest-� If a rationing method gives the good to the highest-

valuers, then the welfare is the same as under price

ceilings or floors

Rationing

� With price ceilings and floors, we know that those

with the highest WTP get the good

� Rationing means fixing Q = 50

� If a rationing method gives the good to the highest-� If a rationing method gives the good to the highest-

valuers, then the welfare is the same as under price

ceilings or floors

� If rationing doesn’t give the good to the highest-

valuers, the DWL is greater

Rationing

� With price ceilings and floors, we know that those

with the highest WTP get the good

� Rationing means fixing Q = 50

� If a rationing method gives the good to the highest-� If a rationing method gives the good to the highest-

valuers, then the welfare is the same as under price

ceilings or floors

� If rationing doesn’t give the good to the highest-

valuers, the DWL is greater

� So if the “right” people get the good, only Q matters

Outline for Thursday, August 7

� Remember

� Last homework due Friday

� Last quiz on Monday

� Review welfare� Review welfare

� Pareto Efficiency

� Price discrimination

� Other pricing methods

Pareto Efficiency

� If the market did not exist, buyers and sellers would

pay up to W = CS + PS to create it

Pareto Efficiency

� If the market did not exist, buyers and sellers would

pay up to W = CS + PS to create it

� Would buyers, sellers and other interested parties be

willing to pay the DWL to move the market back to willing to pay the DWL to move the market back to

normal?

Pareto Efficiency

� If the market did not exist, buyers and sellers would

pay up to W = CS + PS to create it

� Would buyers, sellers and other interested parties be

willing to pay the DWL to move the market back to willing to pay the DWL to move the market back to

normal?

� A Pareto improvement leaves

� At least one person better off

� None worse off

Pareto Efficiency

� If the market did not exist, buyers and sellers would

pay up to W = CS + PS to create it

� Would buyers, sellers and other interested parties be

willing to pay the DWL to move the market back to willing to pay the DWL to move the market back to

normal?

� A Pareto improvement leaves

� At least one person better off

� None worse off

� When no Pareto improvement is possible, we say that

the situation is efficient

Pareto Efficiency

� A Pareto improvement leaves

� At least one person better off

� None worse off

� When no Pareto improvement is possible, we say that � When no Pareto improvement is possible, we say that

the situation is efficient

� When a Pareto improvement is possible, we say that

the situation is inefficient

Pareto Efficiency

� A Pareto improvement leaves

� At least one person better off

� None worse off

� When no Pareto improvement is possible, we say that � When no Pareto improvement is possible, we say that

the situation is efficient

� When a Pareto improvement is possible, we say that

the situation is inefficient

� Equilibrium is efficient because no one can be made

better off without making someone else worse off

Pareto Efficiency

� A Pareto improvement has

� ∆CS>0 for some consumer or ∆PS>0 for some firm or

∆G>0

� And ∆CS<0 for any consumer, ∆PS<0 for any firm, and

∆G<0

Pareto Efficiency

� A Pareto improvement has

� ∆CS>0 for some consumer or ∆PS>0 for some firm or

∆G>0

� And ∆CS<0 for any consumer, ∆PS<0 for any firm, and

∆G<0

� A welfare improvement has

� ∆W = ∆CS + ∆PS + ∆G > 0

� So any Pareto improvement is a welfare

improvement, but not vice versa

Pareto Efficiency

� A Pareto improvement has

� ∆CS>0 for some consumer or ∆PS>0 for some firm or

∆G>0

� And ∆CS<0 for any consumer, ∆PS<0 for any firm, and

∆G<0

� A welfare improvement has

� ∆W = ∆CS + ∆PS + ∆G > 0

� So any Pareto improvement is a welfare

improvement, but not vice versa

� Is returning to equilibrium always a Pareto

improvement?

Rationing via queuing efficiency

� Low-valuers may get rents

PQ

PQ

S

D

=

−=

3

1100

� Low-valuers may get rents

� High-valuers pay those rents

� Sellers are forced to produce

� It costs the government nothing

� Will anyone be worse off if we go back to

equilibrium?

Rationing via free tickets efficiency

� Low-valuers sell tickets in a secondary market

PQ

PQ

S

D

=

−=

3

1100

� Low-valuers sell tickets in a secondary market

� High-valuers buy tickets

� Sellers are forced to produce

� It costs the government nothing

� Will anyone be worse off if we go back to

equilibrium?

Rationing via sold tickets efficiency

� High-valuers buy tickets from the government

PQ

PQ

S

D

=

−=

3

1100

� High-valuers buy tickets from the government

� High-valuers still have to pay P = 50

� Sellers get paid P = 50

� The government collects revenue

� Will anyone be worse off if we go back to

equilibrium?

Price ceilings and floors efficiency

� What are the CS and PS at equilibrium?

PQ

PQ

S

D

=

−=

3

1100

� What are the CS and PS at equilibrium?

� What are the welfare effects of a price floor at 50?

� What are the welfare effects of a price ceiling of

150?

� Will anyone be worse off if we go back to

equilibrium?

Price ceilings and floors efficiency

� What are the CS and PS at equilibrium?

PQ

PQ

S

D

=

−=

3

1100

� What are the CS and PS at equilibrium?

� What are the welfare effects of a price floor at 50?

� What are the welfare effects of a price ceiling of

150?

� Will anyone be worse off if we go back to

equilibrium?

Pareto Efficiency outside markets

� A Pareto improvement leaves

� At least one person better off

� None worse off

� A welfare improvement leaves� A welfare improvement leaves

� Total welfare greater

� We can use these definitions outside of markets

Pareto Efficiency outside markets

� Mr. Burns says the allocation is already Pareto

Efficient: “Yes, well the problem is: if you had it, I

wouldn’t.”

Pareto Efficiency outside markets

� Homer’s welfare is

� If he doesn’t have the coin

— his net cash

� If he has the coin � If he has the coin

— his net cash + how much he values the coin

� And the same for Burns

Pareto Efficiency outside markets

� Homer’s welfare is

� If he doesn’t have the coin

— his net cash

� If he has the coin � If he has the coin

— his net cash + how much he values the coin

� And the same for Burns

� Arbitrage is making a profit off of

differences in prices or values

Pareto Efficiency recap

� If the situation is efficient

� No unambiguous improvement can be made

� Anything that makes one person better off must make

another person worse off

� Efficiency is not a number

� Improving efficiency means making an unambiguous

improvement

� Any Pareto improvement increases welfare

Outline for Thursday, August 7

� Remember

� Last homework due Friday

� Last quiz on Monday

� Review welfare� Review welfare

� Pareto Efficiency

� Price discrimination

� Other pricing methods

Rent seeking

� Total welfare is maximized at equilibrium for W0

� No party can get more than W0 as surplus

� But they can try to get a larger portion

Rent seeking

� Total welfare is maximized at equilibrium for W0

� No party can get more than W0 as surplus

� But they can try to get a larger portion

� Consumer groups can lobby for price ceilings

Rent seeking

� Total welfare is maximized at equilibrium for W0

� No party can get more than W0 as surplus

� But they can try to get a larger portion

� Consumer groups can lobby for price ceilings

� Producers can try to get

� Price floors

� The power to set prices

Rent seeking

� Producers in a particular industry can lobby the

government for help

� Production subsidies or price supports

Rent seeking

� Producers in a particular industry can lobby the

government for help

� Production subsidies or price supports

� Restricting entry or blocking competitors� Restricting entry or blocking competitors

� Bans, quotas or tariffs on imports

� Legal requirements to operate a firm

Rent seeking

� Producers in a particular industry can lobby the

government for help

� Production subsidies or price supports

� Restricting entry or blocking competitors� Restricting entry or blocking competitors

� Bans, quotas or tariffs on imports

� Legal requirements to operate a firm

� Monopoly price-setting power

� Government mandate

� Exclusive rights to sell a good

� Patents

� Intellectual property

Price discrimination

� Total welfare is maximized at equilibrium for W0

� The monopoly wants to get as much of W0 as

possible

Price discrimination

� Total welfare is maximized at equilibrium for W0

� The monopoly wants to get as much of W0 as

possible

� If it charges all buyers the same price� If it charges all buyers the same price

� It will produce where MC = MR

� Buyers still get some Consumer Surplus

� There’s a Deadweight Loss

Price discrimination

� Total welfare is maximized at equilibrium for W0

� The monopoly wants to get as much of W0 as possible

� If it charges all buyers the same price

� It will produce where MC = MR

� Buyers still get some Consumer Surplus

� There’s a Deadweight Loss

� If it knew each buyers demand curve

� It would charge each consumer their marginal WTP for each unit

� The monopoly “extracts” all CS

� There’s no DWL

First-degree price discrimination

� If the monopoly knows each buyers demand curve

� It would charge each consumer their marginal WTP for

each unit. Prices are

� different for different consumers

� And different at different quantities

� The monopoly gets W0 so there’s no DWL

Figure 12.1 Perfect Price

Discrimination

6

5

4 MCe

© 2007 Pearson Addison-Wesley.

All rights reserved. 12–53

3

2

1

Q, Units per day

6543210

Demand, Marginal revenueMR1 = $6 MR

2 = $5 MR3 = $4

Figure 12.2 Competitive, Single-Price, and Perfect

Discrimination Equilibria

E

D

CB

A

MCs

pc = MCcec

esps

p1

MC

© 2007 Pearson Addison-Wesley.

All rights reserved. 12–54

D

Q, Units per dayQs Qc = Qd

MCs

Demand, MRd

MRs

MC1

First-degree price discrimination

� If the monopoly knows each buyers demand curve

� It would charge each consumer their marginal WTP for

each unit. Prices are

� different for different consumers

� And different at different quantities

� The monopoly gets W0 so there’s no DWL

� In the real world…

� Amazon.com collects data on its users and changes its

prices accordingly (or used to)

� Grocery chains might send different member-card

holders different coupons in the mail

Types of price discrimination

� To set different prices, the monopoly needs info

about consumers

� First-degree price discrimination uses what you want

Types of price discrimination

� To set different prices, the monopoly needs info

about consumers

� First-degree price discrimination uses what you want

� Second-degree PD uses what you do (demand q)� Second-degree PD uses what you do (demand q)

� Third-degree PD uses what group you belong to

Second-degree price discrimination

� Second-degree PD uses what you do

� Depending on how much you buy, you’ll be charged a

different per-unit price

� “Quantity discrimination”

Figure 12.3 Quantity Discrimination

50

70

90

(a) Quantity Discrimination

A =$200

C =$200

B =$1,200

D =

60

90

(b) Single-Price Monopoly

F = $900

E = $450

© 2007 Pearson Addison-Wesley. All rights reserved. 12–59

30

Q, Units per day

20 40 900

m

Demand

$1,200D =$200

30

Q, Units per day

30 900

m

Demand

G = $450

MR

Third-degree price discrimination

� Third-degree PD uses what group you belong to

� Consumers are charged different prices depending on

� Where they live

� If they’re a student, child or senior

� Create two or more separate markets for the good