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Willingness to Pay (WTP)

1. Demand. Willingness to Pay (WTP). A buyer’s willingness to pay for a good is the maximum amount the buyer will pay for that good. WTP measures how much the buyer values the good. Example: 4 buyers’ WTP for an iPod. the Red Hot Chili Peppers. WTP and the Demand Curve.

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Willingness to Pay (WTP)

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  1. 1. Demand Willingness to Pay (WTP) A buyer’s willingness to pay for a good is the maximumamount the buyer will pay for that good. WTP measures how much the buyer values the good. Example: 4 buyers’ WTP for an iPod the Red Hot Chili Peppers

  2. WTP and the Demand Curve Q:If price of iPod is $200, who will buy an iPod, and what is quantity demanded? A: Flea & Anthonywill buy an iPod, Chad & John will not. Hence, Qd = __when P = $200. 2

  3. WTP and the Demand Curve P (price of iPod) who buys Qd Derive the demand schedule: $301 & up nobody 0 251 – 300 Flea 1 176 – 250 Anthony, Flea 2 126 – 175 Chad, Anthony, Flea 3 0 – 125 John, Chad, Anthony, Flea 4

  4. WTP and the Demand Curve P Qd=0 Qd=1 Qd=2 $175 Qd=3 $125 Qd=4 Q

  5. About the Staircase Shape… P This D curve looks like a staircase with 4 steps. If there were a huge # of buyers, as in a competitive market, there would be a huge # of very tiny steps, and it would look more like a smooth curve. Q

  6. 2. Supply Cost and the Supply Curve • Cost is the value of everything a seller must give up to produce a good (i.e., opportunity cost). • Includes cost of all resources used to produce good, including value of the seller’s time. • Example: Costs of 3 sellers in the lawn-cutting business. A seller will only produce and sell the good if the price exceeds his/her cost. Hence, cost is a measure of willingness to sell.

  7. Cost and the Supply Curve P Qs Derive the supply schedule from the cost data: $0 – 9 0 10 – 19 1 20 – 34 2 35 & up 3

  8. P Q Cost and the Supply Curve $35

  9. 3. Welfare measures—CS and PS (1) Consumer Surplus (CS) Consumer surplus is the amount a buyer is willing to pay minus the buyer actually pays. Suppose P = $260. Flea’s CS = $300 – 260 = $__. The others get no CS because they do not buy an iPod at this price. Total CS = $___. 40 40

  10. Flea’s WTP CS and the Demand Curve P P = $260 Flea’s CS = $300 – 260 = $40 Total CS = $40 Q

  11. Flea’s WTP Anthony’s WTP CS and the Demand Curve P Instead, suppose P = $220 Flea’s CS = $300 – 220 = $80 Anthony’s CS =$250 – 220 = $30 Total CS = $110 Q

  12. CS and the Demand Curve P The lesson: Total CS equals the area below the demand curve & above the price. Q

  13. Price per pair P h 1000s of pairs of shoes D Q CS with Lots of Buyers & a Smooth D Curve The Demand for Shoes Q: P = $30, CS=? A: CS is the area below the D curve and above the P. Recall: area of a triangle equals ½ x base x height So, CS=½ x 15 x $30 = _____ $ $225

  14. (2) Producer Surplus P Producer surplus (PS): the amount a seller is paid for a good minus the seller’s cost. Q

  15. Kitty’s cost Hunter’s cost Angelo’s cost Producer Surplus and the S Curve P Suppose P = $25 Angelo’s PS = $15 Hunter’s PS = $5 Total PS = $20 $25 Total PS equals the area below the price and above the supply curve. Q

  16. Price per pair P S h 1000s of pairs of shoes Q PS with Lots of Sellers & a Smooth S Curve The supply of shoes Q: P=$40, PS=? A: PS is the area below the P and above the S curve. The height of this triangle is $40 – 15 = $25. So,PS= _____________ = $312.5 $15 ½ x 25 x $25

  17. 4. Profit Costs and Revenue MC P = $10 MR ATC profit $6 Q 50 Total profit = TR-TC = ________________ = _________________= _____ P x Q – ATC x Q $10 x 50 - $6 x 50 $200 profit per unit = P – ATC= $10 – $6= $4 Total profit = (P – ATC) x Q = $4 x 50= $200 Greg Mankiw: CHAPTER 14 FIRMS IN COMPETITIVE MARKETS 17

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