Efficiency and Policy Chapter 4+5

Game Plan ● Review intuition from last class ● Efficiency of the market ● Event + Policy Analysis

○ Price Floors ○ Price Ceilings

Announcements: 1. Typo in Problem Set Question: Should say “Quantity Supplied” for Bangor Brownies 2. Short Quiz covering basics of Chapter 3 + Chapter 4→ practice quiz will be on blackboard on Thursday 3. Problem Set due Friday. Next one due next Friday→ to be posted Thursday 4. Discussion Session questions will be posted after class.

Consumer Surplus Consumer Surplus = Willingness to Pay – Price, if WTP > P → 0 otherwise

Willingness to Pay = Maximum one would pay for a good

If Willingness to Pay > Price → I buy the good. I would prefer to buy the good.

If Willingness to Pay < Price → I don’t buy the good.

WTP and Demand 1. Can construct Demand Curve using WTP 2. At each price, quantity = # of units where

The WTP >= that price 3. CS = Area below Demand and above Price

a. You get something like the graph on the right.

Person WTP

John 100

Paul 80

George 70

Ringo 50

WTP and Demand With lots of consumers –> Demand is more like a line Demand Curve at unit n shows the n-th highest WTP

Two ways to read Demand Curve:

1. At this price, how much will people buy?

The answer to question 1 is also the answer to the question:

2. For this quantity, what’s the highest price I could charge?

“Proof”: 1. Suppose At Qa, WTP = Pa. 2. If Price = Pa, I won’t buy less than Qa, because WTP decreases with quantity, and so at quantities less than Qa, WTP > Price 3. If Price = Pa, I won’t buy more than Pa, because WTP decreases with quantity, and so WTP < Price above Qa 4. Therefore, if at Qa WTP = Pa, I will therefore buy Qa if the price is set at Pa.

WTP and Demand With lots of consumers –> Demand is more like a line Demand Curve at unit n shows the n-th highest WTP

Two ways to read Demand Curve:

1. At this price, how much will people buy? a. Number of Units where:

i. the Price =< WTP for those units ii. Price > WTP for all other units iii. Thus Price = WTP

The answer to question 1 is also the answer to the question:

2. For this quantity, what’s the highest price I could charge? a. Price at which:

i. Price < WTP for those units ii. Price > WTP for all other units iii. Thus Price = WTP