Transcript Lecture 2 - Illinois State University


One convenient way to express WTP between price
and quantity is through the inverse demand function.
In an inverse demand function, the price consumers
are willing to pay is expressed as a function of the
quantity available for sale. Suppose the inverse
demand function of a product is
• P=80-q

And the marginal cost of producing the product is
• MC=1q
• A) How much would be supplied in a static efficient allocation?
• B) What would be the magnitude of the net benefits?
Price of
Good
Supply
Equilibrium
Price
Demand
Equilibrium
Quantity
Quantity of
Good
Price of
Good
Supply
Equilibrium
Price
Demand
Equilibrium
Quantity
Quantity of
Good
Price of
Good
Supply
Equilibrium
Price
Demand
Equilibrium
Quantity
Quantity of
Good
Price of
Good
Supply
Equilibrium
Price
Demand
Equilibrium
Quantity
Quantity of
Good
 Exclusivity –
• All benefits and costs accrued as a result of owning
and using the resources should accrue to the owner,
and only the owner, either directly or indirectly by
sale to others
 Transferability –
• All property rights should be transferable from one
owner to another in a voluntary exchange
 Enforceability –
• Property rights should be secure from involuntary
seizure or encroachment by others (ie. eminent
domain)
 Negative
Externalities – the negative
impacts of a market transaction that affect
those not involved in the transaction
 Positive
Externalities – the positive
impacts of a market transaction that affect
those not involved in the transaction

Suppose the inverse demand function of a product is
• P=80-q

And the marginal private cost of producing the product is
• MC=1q

Suppose also that the production of this good produces a
negative externality of $10 per unit produced.
A) What would be the market equilibrium?
B) What would be the socially efficient equilibrium?
C) What would be the net benefits under the market equilibrium?
D) What would be the net benefits under the socially efficient
equilibrium?
• E) What would external cost under the market equilibrium?
• F) What would be the external cost under the socially efficient
equilibrium?
•
•
•
•
Price of
Good
Marginal
Social Cost
Marginal
Private Cost
P*
Market
Price
Demand
Q* Market
Quantity
Quantity of
Good
 How
would you model a positive
externality?
 Example, when
Duncan Hines produces
brownie mix, it pollutes a small amount of
cocoa powder into the air. This makes
the air smell like brownies, and increase
the MSB from the production of brownies.
 Consider
the following supply and
demand schedule for steel:

Pri 20 40 60 80 100 120 140 160 180
ce
Qd 200 180 160 140 120 100 80 60 40
Qs 20 60 100 140 180 220 260 300 340
 Pollution
from steel production is
estimated to create an external cost of
sixty dollars per ton.
 Show the external cost, market
equilibrium, and social optimum on a
graph.
 What
kinds of policies might help to
achieve the social optimum? How would
this policy affect consumers? How would
this policy affect producers? What effect
would the policy have on market
equilibrium price and quantity?
 Finish
reading Chapter 3 on the Pigovian
tax and the Coase Theorem.
 Review the definitions of well-defined
property rights.