Chapter 1 The Market Key Concept Pareto Efficiency

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

• 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.

 • Chapter 1 The Market • A model of the apartment market in

• 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

 • Focus on the market in the inner ring. • Assume the rent

• 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).

 • Consider the demand curve • At every price, how many students would

• 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?

 • A price at which a student is indifferent between paying and living

• 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

 • We can now draw the demand curve.

• We can now draw the demand curve.

 • If a lot of persons, reasonable to assume smoothness. • We see

• 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

 • The idea of surplus

• The idea of surplus

 • Turn to the supply curve. • Landlords want to make as much

• 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.

 • Can similarly have a step-function-like supply curve. • Assume in a short

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

 • In continuous amounts, marginally selling and not selling give the same profit.

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

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

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

 • According to the market mechanism, who is willing to pay above p*

• 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).

 • Equilibrium: • at p* • the number of people who are willing

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

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

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

 • Comparative statics • (1) The university builds some new apartment. All these

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

 • (2) Government passes a law that every landlord has to pay t<p*

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

 • Consider other ways to allocate apartments. • Discriminating monopolist (DM): a single

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

 • Who gets the apartment? • Still those whose reservation price is higher

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

 • Ordinary Monopolist (OM): a single seller who can only charge a price,

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

 • Rent Control (RC) • pmax<p* to be effective • We don’t know

• 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.

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

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

 • Consumers • • DM: indifferent to living in the outer ring OM:

• 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

 • Pareto efficiency, due to Vilfredo Pareto, an economist and sociologist (1848 -1923)

• 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)

 • If there exists a way to make some better off without making

• 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.

 • Let us consider whether the scare resource is allocated efficiently. • Outer

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

 • Now we examine these four mechanisms. • Do people who have lower

• 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?

 • Market: Pareto Efficient. In fact this is the 1 st welfare theorem.

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

 • OM: empty apts in the inner ring, not Pareto efficient. • RC:

• 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.

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

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

 • Endogenous variable and exogenous variable

• Endogenous variable and exogenous variable

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

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

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

• 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.