Chapter 1 The Market Key Concept: Pareto Efficiency ( 如果能皆大歡喜那為什麼不做呢 ?)

1. Chapter 1 The Market • Key Concept: Pareto Efficiency (如果能皆大歡喜那為什麼不做呢?) • Market is Pareto efficient. • Discriminating Monopolist is Pareto efficient too. • Pareto efficiency is silent on distributional issues.

2. Chapter 1 The Market • A model of the apartment market in a college town • Every student needs one apartment. • All apts are identical except: inner ring and outer ring

4. Focus on the market in the inner ring. • Assume the rent in the outer ring is fixed and in enough supply (the second best alternative).

5. Consider the demand curve • At every price, how many students would be willing to rent the apartments? • When would a student be willing to rent one unit?

6. A price at which a student is indifferent between paying and living in the inner ring and renting an apt in the outer ring. • Reservation price • a person’s maximum willingness to pay for something

7. We can now draw the demand curve.

8. Fig. 1.1

9. If a lot of persons, reasonable to assume smoothness. • We see downward sloping and if goods are continuous. • marginally indifferent between buying this extra amount and not

10. Fig. 1.2

11. The idea of surplus

12. Fig. 1.1

13. Turn to the supply curve. • Landlords want to make as much profit as possible, so they jump in when renting and not renting yield equal profit.

14. Can similarly have a step-function-like supply curve. • Assume in a short run, reasonable to have a vertical supply curve

15. Fig. 1.3

16. In continuous amounts, marginally selling and not selling give the same profit. • Similarly we have the idea of producer’s surplus.

17. Put demand and supply curve together. • We get an equilibrium price p*.

18. Fig. 1.4

19. According to the market mechanism, who is willing to pay above p* gets to live in the inner ring. • Those who are not willing to pay as high as p* live in the outer ring. • Those who trade in the market all get some surplus (你情我願).

20. Equilibrium: • at p* • the number of people who are willing to rent (d) equals • the number of apartments available for renting (s) • consistency

21. Fig. 1.4

22. Equilibrium: • p>p*: d<s (surplus, incentives to lower the price) • p<p*: d>s (shortage, incentives to raise the price)

23. Comparative statics • (1) The university builds some new apartment. All these inner ring apartments are the same.

24. Fig. 1.5

25. (2) Government passes a law that every landlord has to pay t<p* for every apartment he owns.

26. Fig. 1.4

27. Consider other ways to allocate apartments. • Discriminating monopolist (DM): a single seller who can perfectly discriminate by charging every consumer’s reservation price.

28. Who gets the apartment? • Still those whose reservation price is higher than p*.

29. Ordinary Monopolist (OM): a single seller who can only charge a price, so he maximizes pD(p). • Suppose he therefore charges p’>p*. • Those whose reservation price is higher than p’ get apts.

30. Fig. 1.7

31. Rent Control (RC) • pmax<p* to be effective • We don’t know who gets the apt except their reservation price will be at least pmax.

32. Fig. 1.4

33. We now compare which is better. • Suppliers • DM > OM > Market > RC

34. Consumers • DM: indifferent to living in the outer ring • OM: some surplus • Market: more people with higher surplus • RC: some with highest surplus, but some become indifferent to living in the outer ring

35. Pareto efficiency, due to Vilfredo Pareto, an economist and sociologist (1848-1923) • If there exists a way to make some better off without making anyone worse off, then it is a Pareto improvement. (皆大歡喜)

36. If there exists a way to make some better off without making anyone worse off, then it is a Pareto improvement. • An allocation that allows for a Pareto improvement is Pareto inefficient while an allocation that does not allow for a Pareto improvement is Pareto efficient.

37. Let us consider whether the scare resource is allocated efficiently. • Outer ring: 400 and inner ring: 300 • Inner ring: an empty apartment

38. Now we examine these four mechanisms. • Do people who have lower reservation prices live in the inner ring? • Are there empty apartments in the inner ring?

39. Market: Pareto Efficient. In fact this is the 1st welfare theorem. • DM: Pareto Efficient • Efficiency says nothing about distribution.

40. OM: empty apts in the inner ring, not Pareto efficient. • RC: not Pareto Efficient because random assignment may not give apartments to those value them highest.

41. Remark • Model: not a one-to-one correspondence to reality

43. Endogenous variable and exogenous variable

44. Optimization (U-max, profit max) • Equilibrium (behaviors consistent)

45. Chapter 1 The Market • Key Concept: Pareto Efficiency (如果能皆大歡喜那為什麼不做呢?) • Market is Pareto efficient. • Discriminating Monopolist is Pareto efficient too. • Pareto efficiency is silent on distributional issues.