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DEMAND Substitute slices of pizza for bottles. MARKET DEMAND Substitute slices of pizza for bottles. SUPPLY Substitute slices of pizza for bottles. MARKET SUPPLY Substitute slices of pizza for bottles. MARKET EQUILIBRIUM Substitute slices of pizza for bottles. Q demanded = Q supplied.

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DEMAND Substitute slices of pizza for bottles

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DEMANDSubstitute slices of pizza for bottles

MARKET DEMAND

Substitute slices of pizza for bottles

MARKET EQUILIBRIUMSubstitute slices of pizza for bottles

Qdemanded = Qsupplied

“Economic Efficiency”

How demonstrate this?

Welfare Economics

Two ways to look @ Demand Curve

Price

Price

“Willingness to Purchase”

“Willingness to Pay”

\$2

\$2

D

D

Quantity

3

Quantity

3

“Willingness to Pay”

Price willing to pay is a measure of the benefit received

Price

Because we are examining the last coke purchased, we are measuring the “MarginalBenefit” received from the last coke

Quantity

Price

S

\$1

D = MB

Quantity

Consumer Surplus

Price

Total of all marginal Benefits = Total Consumer Benefit

CONSUMER SURPLUS

\$1

D = MB

Quantity

Price

\$1

Quantity

Price

S = MC

\$1

PRODUCER SURPLUS

Quantity

Price

S = MC

\$1

PRODUCER SURPLUS

Quantity

Total Social Surplus

Price

CONSUMER SURPLUS

TOTAL SOCIAL SURPLUS

\$1

PRODUCER SURPLUS

Quantity

Proving “Efficiency” of Markets

Price

CONSUMER SURPLUS

Reduction in Total Social Surplus

\$2

\$1

PRODUCER SURPLUS

Quantity

Proving “Efficiency” of Markets

Price

S = MC

MC > MB

Reduces total Social Benefit

CONSUMER SURPLUS

\$1

PRODUCER SURPLUS

D = MB

Quantity

Price

S = MC

CONSUMER SURPLUS

\$1

PRODUCER SURPLUS

D = MB

Quantity

Maximum Social Benefit@ Market Equilibrium

“Efficiency of Markets”

Given

Society’s Demand

reflection (measurement) of how it values things

ie, how “willing to pay”

Costs of Producing

Then can not achieve

 Social Benefit, or happiness by

 Or  quantity produced

Price

S = MC

CONSUMER SURPLUS

\$1

PRODUCER SURPLUS

D = MB

Quantity

Price

S = MC

CONSUMER SURPLUS

\$1

PRODUCER SURPLUS

D = MB

Quantity

Maximum Social Benefit@ Market Equilibrium

“Efficiency of Markets”

But,

What is Missing in this picture?

Supply curve based on Production Costs

Labor, materials, depreciation

“write a check”

“Internal” Costs

BUT also

Environmental Costs

Pollution of air & water, loss of wetlands, soil damage from Irrigation

“External” to firm producing

But, “Real” costs to society

ATC

MC

Price

S = MC

\$1

Quantity

Other Costs?

How Value ?

Chpt 6

Assume we have their value

New Equilibrium

Higher Price

Lower Quantity

EXTERNAL COSTS

Price

S’ = MSC

S = MC

P2

p1

D

Quantity

q2

q1

Need Mechanism to Internalize “external” costs

Tax

 “market” based solution

How Achieve Lower Quantity?

Price

S’ = MC + tax = MSC

S = MC

P2

p1

Quantity

q2

q1

Government Regulation

Both 1 & 2 are mechanisms to internalize “external” costs

Price

S’ = MSC

S = MC

p1

Quantity

q2

q1

Market Equilibrium & “Efficiency”

Price

S = MC

CONSUMER SURPLUS

\$1

PRODUCER SURPLUS

Marginal “private” benefits

D = MB

Quantity

Third Party Benefits

(people not involved in market transaction)

People living around

airports

universities

parks

“Social Benefits”

EXTERNAL BENEFITS

(external to the market)

How value?

Chpt 6

How Achieve larger Q?

Market Equilibrium & “Efficiency”

Other Benefits?

Price

S = MC

CONSUMER SURPLUS

\$1

PRODUCER SURPLUS

D’ = MSB

D = MPB

Marginal private benefits

Quantity

q1

q2

Need Mechanism to Internalize “external” benefits

 Cost to Supply the good:

Tax breaks

Subsidies

airports

land preserves

parks

Price

S = MC

CONSUMER SURPLUS

P1

PRODUCER SURPLUS

P2

D = MB

Quantity

q2

q1

“Efficiency” with Externalities

the case of “Optimal” pollution

Price

S’ w/ external social costs

Up to q1 pollution permitted

Social benefits of driving

> combined costs of production & pollution

S = MpC

p0

D = MpB

Quantity

q1

q0

 “optimal pollution permitted.

Ironic conclusion of Traditional Environmental Econ based on Neoclass market economics

We’ve used econ theory to prove  pollution OK!

Implication of  demand for cars?

Price

S’ w/ external social costs

S = MpC

p0

D’

D = MpB

Quantity

q1

q0

Lecture 4 Discussion Question

Should our goal be to reduce pollution by 50%, 75%, or 100% ??

Price

S = MC

CONSUMER SURPLUS

\$1

PRODUCER SURPLUS

D = MB

Quantity

Price

Total of all marginal Benefits = Total Consumer Benefit

Quantity

MC

ATC