Econ 2 Office Hours Sequoyah Hall Room 250 Tuesday 2:00-3:00Pm Wednesday 1:30-2:30Pm

Instructor: Richard Carson

Econ 2 Office Hours Sequoyah Hall Room 250 Tuesday 2:00-3:00pm Wednesday 1:30-2:30pm

Email: [email protected] Phone: (858) 534-3384

TA Section Time Office Hour Office Hours All Sections Meet Location WLH 2205 Zachary Cloyd W 5pm Sequoyah 244 T 4-5pm Th 4-5pm

Denise Th 8am Sequoyah 256 T 3:30-5:30pm Hernandez Text:

Eric Giambattisata W 4pm Sequoyah 244 T 11-12pm Robert H. Frank and Ben S. Bernanke, Th 11-12pm Principles of Economics, Second edition,

Marya Gottlieb M 9am Sequoyah 206 M 10:30-12:30pm 2004, McGraw-Hill Irwin. Course website: Margaret Huang F 2pm Sequoyah 256 W 1-2pm http://weber.ucsd.edu/~rcarson/econ2.html F 1-2pm

Justin Rao T 7pm Sequoyah 228 M 10-11am W 10-11am

To drop or add the course or change Exams: discussion section: Thursday Feb 2 9:30-10:50 a.m. Sequoyah Hall Room 245 8:00 a.m. – Thursday Feb 23 9:30-10:50 a.m. 12:00 p.m. and 1:00 p.m. – 4:30 p.m. Friday March 24, 8:00-11:00 a.m. No one can leave exam room during an exam

1 Option 1: Problem sets: 25% first exam • Are not required 25% second exam • Don’t count for your grade 50% on final • Are nevertheless a good idea • Should be done before your discussion Option 2: section meets 25% on best of first two exams 75% on final

Problem Set 1 (Should be done before Comments on taking notes: before your discussion section meets (1) Copies of slides posted on course web week of Jan 16-20) page day after lecture. (2) Private notes are available through AS Prob # 1a-b-c, pages 188-189. Lecture Notes (located by the old student center over in Revelle College) Prob #4a-b-c, pages 189-190.

Chapter 7: Efficiency and Exchange A. Producer surplus Employment opportunity:

landscape services 10 hours per week cash pay, no benefits

2 Employment Hourly wage Number of workers opportunity: $4 1 landscape services 10 hours per week $6 6 cash pay, no benefits

$8 40

Supply of labor curve

Supply of labor curve: $12 $10 to hire a given number of workers $8 (represented by a point on horizontal axis) $6 we would have to pay a certain wage $4

Wage ($ per hour) per ($ Wage $2 (represented by a point on vertical axis) $0 0 20406080100 Number of workers

Height = opportunity cost for that potential If you would be willing to work for $8 and we worker pay you $10, then your surplus as a producer is $2

3 Supply of labor curve Supply of labor curve

$14 $14 $12 $12 $10 $10 th $8 $8 Surplus of 100 person is $2 $6 $6 $4 $4

Wage($ per hour) $2 Wage($ per hour) $2 $0 $0 0 100 200 300 400 0 100 200 300 400 Number of workers Number of workers

Supply of labor curve

If hire 200 workers and pay each one $10, $14 $12 total producer surplus is area above $10 supply curve and below the wage th $8 Surplus of 100 person is $2 $6 Surplus of 50th person is $4 $4

Wage($ per hour) $2 $0 0 100 200 300 400 Number of workers

Supply of labor curve

$14 Another example: to bring more strawberries $12 to market, producers could: $10 $8 • Harvest more intensively $6 • Cultivate land being used for something $4

Wage($ per hour) $2 else $0 • Cultivate less desirable land 0 100 200 300 400 Number of workers

4 Supply of strawberries curve

If this region is a triangle, can find its area $9 $8 from Area = (1/2) base x height $7 $6 $5 $4 $3

Price per pound $2 $1 $0 0 50 100 150 Tons of strawberries

MB MC MB MC Producer Surplus in the Market for Milk Chapter 7: Efficiency and Exchange

A. Producer surplus S 3.00 B. Consumer surplus

2.50

2.00 Producer surplus 1.50 = $4,000/day Price ($/gallon) Price 1.00 D .50

0 1 23456789101112 Quantity (1,000s of gallons/day)

MB MC MB MC `

Price Number willing to buy

10 cents 112

50 cents 27

$1.00 9

$2.00 2

5 MB MC MB MC Demand for coke curve

Demand curve: $2.50

$2.00 to sell a certain number of units

$1.50 (represented by a point on horizontal

$1.00 axis)

Price($ per can) $0.50 we would have to charge a sufficiently $0.00 low price (represented by a point on 0 50 100 150 Number willing to buy vertical axis)

MB MC MB MC

Height = value of the product to that If you would be willing to pay 75 cents potential buyer and we sell it to you for 50 cents, then your surplus as a consumer is 25 cents

MB MC MB MC Demand for coke curve Demand for coke curve

$2.50 $2.50

$2.00 $2.00

$1.50 $1.50

th $1.00 $1.00 Surplus of 40 buyer is 25 cents

Price ($ per can) $0.50 Price ($ per can) $0.50

$0.00 $0.00 0 50 100 150 0 50 100 150 Number willing to buy Number willing to buy

6 MB MC MB MC Demand for coke curve

If 65 people each pay 50 cents, total $2.50

$2.00 consumer surplus is area below

$1.50 demand curve and above the price

nd $1.00 Surplus of 22 buyer is 50 cents

Price ($ per can) $0.50

$0.00 0 50 100 150 Number willing to buy

MB MC MB MC Consumer surplus

If this region is a triangle, can find its area from Area = (1/2) base x height

MB MC MB MC Example: Demand for heating oil Chapter 7: Efficiency and Exchange

2.00 S 1.80 A. Producer surplus Consumer surplus = 1.60 B. Consumer surplus (1/2) (0.6) (3000) = $900/day 1.40 C. Total economic surplus 1.20 1.00 D .80 Total economic surplus in a given market is the total surpluses of all participants in the Price ($/gallon) Price market If only participants are buyers and sellers, then total economic surplus is the sum of 12345 8 Quantity (1,000s of gallons/day) producer surplus plus consumer surplus

7 MB MC Economic Surplus in an Unregulated MB MC Chapter 7: Efficiency and Market for Home Heating Oil Exchange Consumer surplus 2.00 = $900/day S 1.80 A. Producer surplus 1.60 B. Consumer surplus 1.40 Producer surplus 1.20 = $900/day C. Total economic surplus

1.00 Without price controls: D •Equilibrium Price = $1.40 D. Applications. .80 •Consumer surplus = (1/2)(3,000)(.60) = $900/day 1. Costs of price ceilings

Price ($/gallon) Price •Producer surplus = (1/2)(3,000)(.6) = 900/day •Economic surplus = $1,800/day

12345 8 Quantity (1,000s of gallons/day)

MB MC The Cost of Preventing MB MC The Waste Caused by Price Controls Price Adjustments

Price Ceiling set at $1.00 S 2.00 Price Ceilings: Do They Help the Poor? 1.80 Consumer surplus z An Example 1.60 1.40 A Price Ceiling for Home Heating Oil 1.20

1.00 Producer surplus = D (1/2) (0.2) (1000) = .80 $100/day Price ($/gallon) Price

12345 8 Quantity (1,000s of gallons/day)

MB MC MB MC The Waste Caused by Price Controls

Price Ceiling set at $1.00 S 2.00 Area of trapezoid = (1/2) x (base_1 + 1.80 Consumer surplus = (1/2) (1 + 0.8) (1000) base_2) x (height) 1.60 = $900/day 1.40 1.20

1.00 Producer surplus = D (1/2) (0.2) (1000) = .80 $100/day Price ($/gallon) Price

12345 8 Quantity (1,000s of gallons/day)

8 MB MC MB MC The Cost of Preventing The Waste Caused by Price Controls Price Adjustments

Price Ceiling set at $1.00 S 2.00 1.80 Consumer surplus = The reduction in economic surplus from $900/day 1.60 Lost economic a price ceiling will be underestimated 1.40 surplus = (1/2) (0.8) (2000) = $800/day when 1.20 z 1.00 Producer surplus = The consumers who receive the product D $100/day .80 are not the consumers who value it the With price controls: most.

Price ($/gallon) Price •Producer surplus = (1/2)(1,000)(.20) = $100/day or a loss of $800/day z Consumers take costly actions to enhance •Economic surplus = $1,000 or a loss of $800/day their chances of being served.

12345 8 Quantity (1,000s of gallons/day)

MB MC When the Pie Is Larger, MB MC The Cost of Preventing Everyone Can Have a Bigger Slice Price Adjustments

Surplus with price controls Surplus with income transfers and no price controls What types of programs could be used to help the poor get heating oil that R R would be more efficient than a price ceiling? P Is housing different? P

With price controls set at $1.00 the Without price controls & with income economic surplus is $1,000/day transfers economic surplus is $1,800/day *R = economic surplus received by *R & P have the same share and a rich people much larger economic surplus *P = economic surplus received by poor people Copyright c 2004 by The McGraw-Hill Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Companies, Inc. All rights reserved.

MB MC MB MC Chapter 7: Efficiency and The Market for Potatoes Without Taxes Exchange

S A. Producer surplus Total economic 6 surplus = $9 B. million/month Consumer surplus 5

C. Total economic surplus 4

D. Applications. 3

1. Costs of price ceilings Price ($/pound) 2

2. Effects of taxes 1 D 12345

Quantity (millions of pounds/month)

9 MB MC The Effect of a $1 per MB MC Pound Tax on Potatoes Taxes and Efficiency

S + tax S Deadweight Loss 6 z The reduction in total economic surplus 5 that results from the adoption of a policy 4 How a tax collected 3.50 from a seller affects 3 economic surplus 2.50

Price ($/pound) 2

1 D 12345 2.5 Quantity (millions of pounds/month)

MB MC The Effect of a $1 per MB MC The Deadweight Loss Caused by a Tax Pound Tax on Potatoes

S + tax S + tax S S 6 6

5 5

4 How a tax collected 4 3.50 from a seller affects 3.50 Deadweight loss 3 economic surplus 3 caused by tax 2.50 2.50

Price ($/pound) 2 Price ($/pound) 2

1 1 D D 12345 12345 2.5 2.5 Quantity (millions of pounds/month) Quantity (millions of pounds/month)

MB MC Elasticity of Demand and MB MC Elasticity of Supply and the the Deadweight Loss from a Tax Deadweight Loss from a Tax

Deadweight loss Deadweight loss Deadweight Loss Deadweight Loss

S1 + T S2 + T S + T S + T S2 2.60 2.65 S1 2.40 S S 2.35 2.00 2.00 2.00 2.00 1.60 1.65 1.40 1.35 D D1 Price ($/unit) Price ($/unit) Price Price ($/unit) Price ($/unit) Price D

19 24 21 24 57 72 63 72 Quantity (units/day) Quantity (units/day) Quantity (units/day) Quantity (units/day) The greater the elasticity of demand, the The greater the elasticity of supply, the greater the deadweight loss from a tax greater the deadweight loss from a tax

10 MB MC MB MC The Effect of a Tax on Sellers of a Taxes and Efficiency Good with Infinite Price Elasticity of Supply

Assume a tax levy of $100 tax/car Who Pays A Tax Imposed On Sellers of a Good? z Answer depends on the elasticity of S + $100 demand and supply $20,100 $20,000 S

Price ($/car) Price • Supply shifts to $20,100 • The burden of the tax falls entirely on the consumer

1.9 2.0 Quantity (millions of cars/month)

MB MC MB MC The Effect of a Tax on the Chapter 7: Efficiency and Equilibrium Quantity and Price of Potatoes Exchange Without a tax P = $3/lb S + tax and Q = 3 million lbs/month S A. Producer surplus 6 B. 5 Consumer surplus With a tax of $1/lb C. 4 • MC increases by $1/lb Total economic surplus 3.50 • Supply shifts up by $1 3 • P = $3.50; Q = 2.5 million D. Applications. 2.50 • Consumers and producers share

Price ($/pound) 2 the burden of the tax equally 1. Costs of price ceilings • Producers receive $2.50/lb • Consumers pay $3.50/lb 1 2. Effects of taxes D 3. Effects of subsidies 12345 2.5 Quantity (millions of pounds/month)

MB MC The Cost of Preventing MB MC Economic Surplus in a Price Adjustments Bread Market Without Subsidy

Economic surplus Price Subsidies: Do They Help the Poor? 5.00 maximized where MC($2) = MB($2) at 4 million loaves z By how much do subsidies reduce total Consumer surplus economic surplus in the market for bread? 4.00 = $4,000,000/month

z Assume a small nation imports all its bread 3.00 Price of bread ($/loaf) of bread Price at the world price of $2.00 World price = $2.00 S

1.00 D

2468 Quantity (millions of loaves/month)

11 MB MC The Reduction in Economic MB MC The Cost of Preventing Surplus from a Subsidy Price Adjustments

•The cost of the subsidy = $6 million •The benefit of the subsidy = $5 million 5.00 •Loss of economic surplus = $1 million Price Subsidies

Consumer surplus z How could we provide assistance to low 4.00 = $9,000/month Reduction in total income consumers more efficiently? economic surplus = 3.00 $1,000,000/month Price of bread ($/loaf) of bread Price World price = $2.00 S

1.00 D

2468 Quantity (millions of loaves/month

MB MC The Cost of Preventing MB MC Equilibrium in the Market Price Adjustments for Seats on Oversold Flights

Demand for remaining on the flight z First-Come, First-Served Policies Supply of seats 60 Movie Theatres Restaurants Hotels 24 Airlines Price ($/seat) Price

33 37 Seats

MB MC Equilibrium in the Market MB MC The Marginal Cost Pricing of for Seats on Oversold Flights Public Services

First-come, First-served •Reservation prices = (60+59+…+24)/37 = $42/passenger Example •4 bumped @ $42 each or $168 loss in economic surplus Supply of seats z How much should a city charge for water, 60 electricity, or some other service?

27 24 Price ($/seat) Price

33 37 Seats

12 MB MC MB MC The Marginal Cost Curve for Water The Marginal Cost Curve for Water

Ocean Ocean

4.0 4.0

Three sources of water Assume •Spring: 1 million gallons/day •If P = 4 cents/gallon, Q = 4 Lake .02 cents/gallon Lake million gallons •Lake: 2 million gallons/day Spring @ .08 cents/gallon Spring Question •Ocean: 4 cents/gallon •Why should all residents Cost (cents/gallon) Cost (cents/gallon) 0.8 0.8 pay 4 cents per gallon

0.2 0.2 13 13

Water supplied (millions of gallons/day) Water supplied (millions of gallons/day)

MB MC MB MC Market Equilibrium and Efficiency Market Equilibrium and Efficiency

Are markets always efficient and A market equilibrium is efficient equitable? z If price and quantity take any other than their equilibrium values, a transaction that will make at least some people better off without harming others can always be found. z This definition is often referred to as Pareto efficiency

MB MC How Excess Demand Creates an Opportunity MB MC How Excess Supply Creates an Opportunity for a Surplus-Enhancing Transaction for a Surplus-Enhancing Transaction

S S 2.50 2.50

• If P = $1 then QS = 2,000 •If P = $2 then QD = 2,000 2.00 gallons/day 2.00 gallons/day • At 2,000 gallons the consumer is 1.75 •Additional output costs only $1 willing to pay $2 and the MC = $1 •This is $1 less than a buyer would 1.50 • If the buyer pays $1.25 for an 1.50 pay extra gallon, producer is $.25 1.25 •If the buyer pays the seller $1.75, better off, and the consumer is the buyer gains an economic 1.00 $.75 better off, or economic 1.00 surplus of $0.25 then the seller

Price ($/gallon) Price surplus increases by $1.00 ($/gallon) Price gains an economic surplus of • At $1, the market is not efficient $0.75 .50 .50 D D

12345 12345 Quantity (1,000s of gallons/day) Quantity (1,000s of gallons/day)

13 MB MC MB MC Market Equilibrium and Efficiency Market Equilibrium and Efficiency

Observations on Efficiency Markets will be efficient when z When price is above or below the z Buyers and sellers are well informed. equilibrium, the quantity exchanged will be z Markets are perfectly competitive. below the equilibrium. z Supply measures all relevant costs. z The vertical value on the demand curve z Demand measures all relevant benefits. (marginal benefit) is greater than the vertical value on the supply curve (MC). z Only the equilibrium will maximize economic surplus.

MB MC Centrally Planned Economies

Government determines what quantity of each good should be produced Government sets price for each good

Questions z Are the government’s desired quantity and price always realized? z Why is it impossible to control both? z How do markets achieve equilibrium in a centrally planned economy?