1. The market (2016)

Apunte Inglés
Universidad Universidad Pompeu Fabra (UPF)
Grado International Business Economics - 1º curso
Asignatura Microeconomics I
Año del apunte 2016
Páginas 7
Fecha de subida 27/04/2016
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Resumen del libro completado con apuntes de clase.

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avillagrasa I.
1st year IBE - 3rd Term Microeconomics I The market Index Constructing a model ....................................................................................................... 2 Optimization and equilibrium........................................................................................... 2 Demand curve................................................................................................................... 2 Supply curve ..................................................................................................................... 3 Market equilibrium ........................................................................................................... 3 In the long run .............................................................................................................. 4 Comparative statics .......................................................................................................... 4 Allocation .......................................................................................................................... 5 Competitive market ...................................................................................................... 5 Discriminating monopolist............................................................................................ 5 Ordinary monopolist..................................................................................................... 6 Rent control .................................................................................................................. 6 Pareto efficiency ............................................................................................................... 6 Which allocation systems is Pareto efficient? .............................................................. 6 Summary ........................................................................................................................... 7 1 avillagrasa 1st year IBE - 3rd Term Microeconomics I Microeconomics: A pillar (together with macroeconomics) of the economy. It‘s the study of the decision making under scarcity (limitations).
Constructing a model Models are a simplified representation of reality. This is because if not we would lose the perspective and be unable to see the important things. The power of the model comes from the elimination of irrelevant details, which allows the economist to focus only on the essential features of the economic reality that he’s trying to explain. This is why he will only take into account the characteristics affecting the matter of study. We will consider other factors as constants (ceteris paribus).
We have to differentiate between exogenous variables (which are not explained by our model) and endogenous variables (which are the ones we’re trying to explain with our model).
Optimization and equilibrium Our models are based on two principles: a) Optimization: people choose the best option they can afford (maximize utility) b) Equilibrium: prices adjust until demand equals supply Demand curve It is constructed starting from the maximum willingness to pay among all the possible buyers and decreasing passing through the willingness to pay of all buyers. Thus, obtaining a downward sloping curve.
It is constructed using the reservation prices, which are the highest prices an individual would be willing to pay for an item.
It relates the number of people that want an asset (quantity) with the price. The higher the price, the less people will be willing to buy and vice-versa.
2 avillagrasa 1st year IBE - 3rd Term Microeconomics I Supply curve It depends on the nature of the market we are in. In the book example it is a vertical straight line because it is studying the apartment market which, in the short run can’t change the supply.
This means that there’s the same number of apartments (willing to be rented) regardless of the price and the demand.
However, most of the times it is represented by an upward slopping curve. This is because the highest the price the asset can be sold at, the higher number of people is willing to supply it. It is constructed according to the minimum willingness to accept (usually the marginal cost).
Market equilibrium The market equilibrium is where the supply and the demand curve intersect. Is the price (p*) at which the quantity demanded equals the quantity supplied. This means that all the people willing to pay more than p* will get the asset and all the suppliers willing to sell for less than p* will be able to sell the asset.
We say that we are in equilibrium because neither the consumers nor the sellers have incentives to change their behaviour, as they can’t be better off. They are not going to move because if p>p* there are too few renters and if p<p* there are too much renters.
3 avillagrasa 1st year IBE - 3rd Term Microeconomics I In the long run In the long run the supply of apartments can change and so does the demand, which will make the equilibrium change. This is what we saw in Introduction to Microeconomics with the restaurant experiment. In the long run more suppliers (seeing that they can get profits) will enter the market, but if the demand doesn’t change there’s a point where they don’t get money, so they have to quit the market.
At the end we saw that there are a determined number of suppliers such that anyone has incentives to enter or exit. This is the equilibrium in the long run.
Comparative statics It consists in seeing how the equilibrium changes when either the supply or the demand curves move (shift). Let’s see some examples: Increase in the supply The supply curve shifts to the right, as now there are more apartments (quantity).
Demand stays the same. The equilibrium now is at the right: with a lower price and a higher quantity.
Decrease in supply and decrease in demand For this example we’re assuming that some apartment have been converted into condominiums1. This means that there’s less supply of apartments (left sift supply).
However there is also less demand of apartments, as some of the people who demanded apartment now will want to have a condominium (left shift demand).
1 Situation where the house is property of 2 or more people 4 avillagrasa 1st year IBE - 3rd Term Microeconomics I Those shifts result in equilibrium at the left, with less quantity but the same price as before, since the supply is inelastic.
Suppliers’ tax If a tax to be paid for suppliers is introduced it is not going to change the supply curve, because it is inelastic. Moreover, the demand curve is also not going to change.
Because of this, the equilibrium is the same as before. The tax is born only by the suppliers.
Buyers’ tax2 If a tax to be paid for the buyers is introduced, the supply doesn’t change. However the demand shifts left () decreasing the same amount as the tax. Because of this, the new equilibrium is at the same quantity as before but at a lower price (people doesn’t want to pay more). As we see, in this case the tax is also born by the suppliers.
Allocation Competitive market The supply accepts the price “imposed” by the demand. This means that the equilibrium price is where the demand and the supply intersect. The surplus is shared among the buyers and the suppliers, but usually the buyers get more surplus.
Discriminating monopolist There’s a monopolist (someone who controls the market being the only seller) and he knows all the reservation prices. Because of this, he can charge different prices to costumers according to their willingness to pay. In this situation the equilibrium is the same as in the competitive market. The difference is that the entire surplus goes to the supplier instead of being shared between suppliers and buyers.
2 Not in the book 5 avillagrasa 1st year IBE - 3rd Term Microeconomics I Ordinary monopolist Usually the monopolist doesn’t know all the reservation prices, so he has to charge the same price to everyone. The monopolist is going to produce until MgCost=MgRevenue, thus leading to a price higher than in the market and a quantity lower than in equilibrium. The total surplus is usually smaller than in the market solution, because the supplier (monopolist) has more surplus than in the market but the costumers have less surplus than in the market).
Rent control It consists in imposing a maximum price. This can affect or not the equilibrium. If the maximum price is above the equilibrium it doesn’t affect the outcome since the market is not affected by it. However, if the price is lower than the equilibrium price there’s going to be an excess of demand. In those cases we don’t know what is going to happen for sure. The only thing we know - as the supply is always the same - is that the quantity will be the same but at the controlled price (maximum price) but we don’t know who is going to get them (unlike before now not only the ones with the higher willingness to pay will get them).
Pareto efficiency To evaluate how good an allocation system is we can think about if it is Pareto efficient or not.
A situation is Pareto efficient if we can’t make someone better off without making someone worst off. This is: make somebody better off without hurting someone. If we can’t improve someone’s situation without making somebody worst off we say that we’re being Pareto efficient.
Which allocation systems is Pareto efficient? The competitive market It is Pareto efficient because if we increase the price some buyers will not be able to buy and so we will be harming them, although we are improving the suppliers’ situation. Also, anyone willing to pay a price higher than the equilibrium price gets an apartment.
Discriminating monopolist Even though costumers are worst off, the outcome is still Pareto efficient, as it only cares about the efficiency of the outcome. There’s no way of increasing the outcome so it is impossible to make any improvement.
6 avillagrasa 1st year IBE - 3rd Term Microeconomics I The ordinary monopolist Is not Pareto efficient because it is not generating he maximum outcome (it is producing less). We can keep making improvements until arriving to where the market equilibrium quantity is.
Rent control It is not Pareto efficient, since some trades are not being carried out. This is because some people that would be willing to pay more than the maximum price ends up paying less, so the final output is lower than what it could have been.
Summary      Models are a simplified representation of reality We’re based on optimization principle (always choose the best option) and the equilibrium principle (prices adjust until demand equals supply) Demand is number of demanders at each price. Supply is the quantity supplied at each price. The equilibrium is where demand equals supply Comparative statics: study of how price and quantity change when conditions change.
Pareto efficient: no way of making someone better off without making someone worst off.
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