Outline Session 7
Econ 200
1. Chapter 4- The process of voluntary exchange between a seller and a buyer: Trade takes place until the mutual gains are exhausted—an example 2. How do we derive the supply behavior in pure exchange? a. The graphical representation of the supply schedule . Does a seller have a “sellers surplus! "sellers rent#? 4. How do we derive the !ar"et supply curve? $$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$ •
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Readings to be done before Tuesday, Jan. 27: Chapter 4 up to Section 4.4 Readings to be done before Thursday, Jan. 29: Chapter 4 to the end
#roble!s to do $ith your peer group %or on your o$n& 'ro! Chapter 4( )*evie$ +uestions,( nu!bers 1- and in the )#roble!s, section( nu!bers 1 2 a 4-10. /lso relevant is *eading under Files and then Readings. n'or!ation about your +ui 3 on riday 5an. 0 is posted on the course $ebsite. n'or!ation about the !aterial 'or your irst Exa! %held on 6hursday eb. & is posted on the course $ebsite under Announcements. -------------------------------------------------------------------------------These notes highlight important concepts that are covered in the lectures% They may not coincide exactly with the materials discussed in this particular session% These summary notes are provided as a sca&old to focus your learning% 'ession ($)con *++ ,hapter 'ource of .utual gains from exchange—,hapter 1
/n Exa!ple( Trevor is shirtless "/# would like to buy a shirt% He values a shirt at 0*+ ".1 of the 2rst shirt$$ what he is willing to give up of other goods to ac3uire this shirt#% 'unil has received and accumulated many shirts on his various birthdays% He values a shirt at + ".1 4 0+#% Trevor would be happy to buy a shirt from 'unil for anything less than 0*+ and 'unil would be happy to get anything from Trevor% 5f 6 4 07+8 Trevor gains 0 $$$$$$ and 'unil gains 0 $$$$$ 5f 6 4 07*8 Trevor gains 0 $$$$$ and 'unil gains 0 $$$$$ 5f 6 4 098 Trevor gains 079 and 'unil gains 09% hat common attribute do all these calculation have in common? hat is the sum of their gains from trade? 6he source o' !utual benet 'ro! exchange is the di8erence bet$een the !arginal evaluations o' a good by di8erent people. .utual ;ains from Trade: Trade takes place until all the mutual gains from trade are exhausted%
for shirts% 9e assu!e that / has no shirts at all. : has 11 shirts.
+uantity 7 * @ 9 A ( B 7+ 77
;<%=&'or/ 7* 7+ A * + + + + +
;<%=&'or: *+ 7 7A 77* 7+ A * +
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Cor :8 the 77 th item has a .1 of +% Cor the 7 st item that : gives up8 / would be willing to pay 07*% 'o the di&erence in .1s is 07* and maximum amount of mutual gains from this trade is $$$$$$$% The next item is valued by : at 0* " : is willing to give up 0* of other goods to have this unit#% 5f : is o&ered 0@ for the shirt8 will she give it up and sell it to /?
/ values the * nd shirt at 07+% The maximum mutua l gains from this trade is 0 $$$$$% The next "@rd# item is valued by : at 0- and by / at 08 so the "maximum# mutual gains from this trade is 0 $$$$% The -th item is valued by : at 0A and by / at 0A8 so the gains from trade from this exchange are 0 $$$$$$
%$The 9th shirt is valued by : at 0 and by / at 0-% ill this trade take place? Therefore $$$$$ shirts are to be purchased by / from :% The total gains from trade are 07*00- 4 0*-% e conclude that trade takes place until all the gains from trade are exhausted// The “price! they agree upon may change the distribution of the gains between the buyer and the seller8 but the total gains will be 0*- for any set of mutually agreed prices%
/n i!portant insight about trade( •
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Trade is mutually bene2cial% .ore trade is not necessarily preferred by all "to less trade# as some groups may lose% Cor example8 some groups lose from expansion of domestic trade to international trade% The gains to millions of consumers outweigh the losses to some groupsE 3
>eriving the supply behavior in pure exchange(
6able 2?;eena@s ;< Schedule ;arginal
+uantity o' Co!ic :oo"s 7 * @ 9 A (
This table shows that at the market price of 07- per book8 .eena will de!and a 3uantity such that her .1 4 market price% Therefore at the market price of 07-8 .eena will de!and 7 book% 'ince she has 8 how many will she o&er for sale? =t a market price of 07- per book8 why does she not keep two books and sell the rest? The answer lies in the .1 table: she only “values! the second book at 07* of other goods and services given up8 not 07-% Cor a market price of 07- per book8 if she keeps the second book8 she would have to give up 07- worth of other goods and services to have that * nd book% 'ince she only values the second book at 07*8 the second book is “too expensive! for her to keep and so she o&ers it for sale/ hy would she not keep the third book? 'he values the @ rd book at 07+% 5f she keeps it when she can get 07- for it in sale8 she would have given up 4
07- worth of other goods8 while she is only willing to give up 07+% ,learly8 the @rd book is too expensive for her to keep so she o&ers it for sale% =nd so on for the rest of the books with lower .1s% Therefore8 at a market price of 07-8 she keeps "i%e%8 demands# 7 book and o&ers ( for sale% FGne important point of this exercise is to appreciate that given a market price for a good8 a person who owns some 3uantities of this good can be on either side of the market: buyer andor seller//I Jow consider another scenario% 'uppose now the !ar"et price of comic books drops to 07* per book% =t a price of 07*8 how many books does .eena demand "in this case8 keep#? 'he demands * books% 'he will o&er the rest—that is8 A books$$ for sale/ hy does she not keep the @ rd book? 'he only values the @rd book at 07+8 while if she sells it8 she can get 07* for it% How about the -th book? 'he values that at 0 while she can get 07* for it% >y the same reasoning she puts up a total of A books up for sale% Jow suppose the market price changes again% Jow the market price is 07+ per book% How many books does she demand "i%e%8 keep#? How many books does she o&er for sale? Crom our analysis above8 we can build the supply schedule for books .eena o&ers for sale "columns 7 and @ $Table @ below#:
6able - >eriving ;eena@s Supply Schedule ;ar"et #rice per :oo" %=& 77* 7+ A
;eena@s +uantity >e!anded 7 * @ 9
;eena@s Auantity o' boo"s supplied ( A 9 @
* +
A (
* 7 +
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The 2rst and the third column of the table above show the supply schedule for .eena% Therefore8 if the market price for a comic book is 07-8 she o&ers ( books for sale% =t a market price of 07*8 she o&ers A books for sale and so on%
The supply curve "in continuous form# on a graph:
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=s 6 rises8 .eena is willing to sell more books/ F'ince she will consume less of her own endowed good as its price risesI 'ellers rents "also called the producer surplus#: Kust as the consumer has a surplus8 the seller does have a surplus too% The area under the supply up the 3uantity is the minimum total amount the seller must be paid to voluntarily o&er the good at that 3uantity for sale%
6able 4-;eena@s Supply behavior 6
;ar"et #rice per unit %=& + * A 7+ 7* 7-
+uantity o' boo"s supplied + 7 * @ 9 A (
,onsider .eenas supply behavior% 'uppose the market price is 0 per book% How many books does .eena sell? hat is her total revenue? hat is the sellers cost? The books are Lust sitting on her bookshelf so is there any cost to the seller? e do not have a production cost here since she is not producing any book% 5t would look like there is no cost here since the books are Lust there in her house% >ut if you look at the supply schedule below closely8 you will see that she re3uires 0* to o&er her 2rst book for sale/ =s a seller8 she will JGT sell this 2rst book at 0+8 0%7+8 0%9+8 or 0%(+ or 07%+Ebut she will only o&er it for sale if she is o&ered at least 0*% F6lease note the asymmetry of behavior as a buyer versus a seller: as a consumer she values her th book at 0+8 but as a seller8 she will not sell it for 0+%I To sell the 7st unit "book#8 she re3uires a minimum payment of $$$$$$$$$$$% F5n other words8 she values the 2rst book$$ that she is ofering or sale— at 0*% As a seller8 when she gives up something she values she incurs a cost% =nd she values the 2rst unit of the book $$that she is o&ering to sell$$ at 0*% 9e denote the cost o' giving up a unit o' a good that a seller values as the seller@s ;arginal Cost %;C&. The minimum payment the seller re3uires to be paid in order to give up her 2rst book is her ., of selling the 2rst book%I To sell the *nd unit8 she re3uires a minimum payment of $$$$$$$$$$$$ To sell the @rd unit8 she re3uires a minimum payment of $$$$$$$$$$$$ 7
To sell the -th unit8 she re3uires a minimum payment of $$$$$$$$$$$$ F6lease note: There is some asymmetry of behavior here—due to the use of discreet numbers% =s a buyer8 she values the th book at 0+8 however8 to give that book up for sale8 she re3uires a payment of 0*% 'he will not sell her 2rst book for 0+%I The total minimum she re3uires for selling - units is simply the sum of the above—this is also the 6otal Cost of the seller which is the addition of all her .,: 'ince the market price of each book is 08 her 6otal *evenue is: Jow lets look at her “producer 'urplus!/ =t the market price of 08 her “6roducer 'urplus! Malso called sellers rent $$is:
>erivation o' the ;ar"et Supply Curve(
,onsider two individual suppliers of a good:
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hich one of the following graphs best depicts the .arket 'upply?
>erivation o' the ;ar"et Supply Curve( P
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