Transcript AGEC/FNR 406 LECTURE 8 A rural market in the Philippines Static Efficiency Lecture Goals: 1.

AGEC/FNR 406
LECTURE 8
A rural market in the Philippines
Static Efficiency
Lecture Goals:
1. Bring together supply and demand analysis
2. Identify equilibrium conditions and the
key aspects of static efficiency
Markets
What is a market?
1. A place where buyers and sellers interact
(either physically or virtually)
2. A place where consumers reveal their
willingness (and ability) to pay
3. A place where producers (or sellers) reveal
the cost of supplying goods
4. A place where private decisions regarding
optimality are made.
Part 1: Consumer Demand
Consumers make tradeoffs. Why?
1. Different bundles of goods provide
different levels of utility
2. Marginal utility is diminishing
3. Prices influence decision making
4. Choices depend on income
Key Point
A consumer’s optimal consumption pattern
occurs where the marginal utilities of
consumption are equal to the ratio of prices,
i.e. where the budget constraint is tangent to
the indifference curve.
The goods that consumers demand reflect the
tradeoffs that consumers are willing to accept.
Demand curve
Price
25
20
A demand curve measures
the amount of a particular
good that a person would
be willing to purchase at a
range of prices, i.e. the
marginal benefit.
•
D = MB
1
Quantity
Willingness to pay
Price
25
•
willingness to pay =
area under demand curve
•
Total willingness to pay =
sum of willingness to pay for
each and every unit of a good
D
1 2
Quantity
Willingness to pay
Price
Total willingness to pay =
area under the demand curve,
located to the left of the
allocation of interest.
•
D
Total willingness to pay is
a measure of private benefits
associated with consumption.
Quantity
Importance of demand curves:
Price
20
•
demand = willingness to pay
willingness to pay is an indicator
of private value to the individual
•
5
Demand for CDs
1
4
Quantity of CDs purchased
Willingness to pay
Total willingness to pay is a narrow definition:
it measures what someone would be willing to pay.
If no one is willing to pay, is the value zero?
From an economic perspective, the answer is:
YES
willingness to pay  price
Price
25
20
•
willingness to pay
= area under demand curve
For 1 CD, individual pays $20
BUT... willingness to pay > price
WTP = $20 x 1 + ($5 x 1)/2 = $22.5
Demand for CDs
1
Quantity of CDs purchased
willingness to pay  price
Price
25
For 4 CDs, individual pays
$5 x 4 = $20
BUT...
5
•
WTP = $5 x 4 + ($20 x 4)/2 = $60
Demand for CDs
4
Quantity of CDs purchased
Can we be creative in assessing
willingness to pay? YES
Q: What is the value of an Oak Savannah
Remnant?
A: The price The Nature Conservancy is
willing to pay to purchase and protect
it.
Can we be creative in assessing
willingness to pay? YES
Q: What is the value of having clean
drinking water?
A: The price of bottled water or the cost of
a water filtration system.
Consumer surplus
Price
25
5
The excess of willingness to pay
over the amount actually paid
(i.e. the triangle in the graph)
is called “consumer surplus”.
•
4
Part 2: Supply
The supply curve is an
incremental measure
of the private cost of
producing additional
units of a good.
To get more, a higher
price must be paid.
P
S=MC
Q
Producer surplus
Price
25
5
•
4
The excess of price over
the cost of production
(i.e. the triangle in the
graph) is called
“producer surplus”.
Market Equilibrium
A market will reach an
equilibrium where the
quantity demanded
equals the quantity
supplied.
P
S=MC
P*
D=MB
Q*
Q
Market Equilibrium
At a given price...
P
S=MC
If supply exceeds demand:
Price will fall and
quantity demanded will
increase.
D=MB
QD
QS
Q
Market Equilibrium
At a given price...
P
S
If demand exceeds supply:
Price will rise and
quantity demanded will
fall.
D
QS
QD
Q
Market Equilibrium
When
D=S,
MB=MC
P
S=MC
P*
D=MB
Market achieves
“Static Efficiency”
Q*
Q
Calculating Net Benefit
Total Benefit = area
under the demand curve
Total Cost = area
under the supply curve
Net Benefit = Total
Benefit - Total Cost
P
S=MC
D=MB
Q
Static Efficiency
Static Efficiency is
obtained when
Net Benefit is
Maximized,
i.e. when MB=MC
P
S=MC
D=MB
Q
Conditions satisfied by static
efficiency
1. Factors paid marginal value product (MVP)
2. Price ratio = MRTS
3. Ratio of MUs = Ratio of prices
As a result, opportunity costs in consumption
equal opportunity costs in production
Static vs. dynamic efficiency
The “model” discussed above is static,
meaning it is concerned with maximization
of net benefits for a single time period.
Many economic decisions that occur over
time are a series of static decisions.
Example: Shopping for Food
Choose groceries each week, consume them,
then start over again next week.
Static vs. dynamic efficiency
A dynamic decision is one in which today’s
decision has some impact on the choices or
outcomes available in the future.
Many economy-environment decisions are
inherently dynamic decisions.
Example: Forestry
If you choose to harvest trees this year,
harvesting next year is no longer an option.