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JEM081 ADVANCED ECONOMICS OF EUROPEAN INTEGRATION: Microeconomic Aspects Lecture 2 Topic 2a, Welfare Effects of Trade MEASURING WELFARE: MARSHALLIAN SURPLUS Dr. Wadim Strielkowski IES FSV CUNI October 1, 2013 Contents • • • • • Measuring market effects Marshallian surplus Consumers’ surplus Producers’ surplus Welfare in closed economy. 2 Reading Turnovec, F.: Political Economy of European Integration. Karolinum, Charles University Press, Prague, 2003, chapter 3, pp. 30-52. Strielkowski, W. and F. Turnovec,: Labour Migration and Welfare Effects of Free Mobility of Labour in the Common Market. In: Mejstřík M. et al., SocioEconomic Models and Policies to Support Active Citizens: Czech Republic and Europe. Matfyzpress, Prague 2008, pp. 105-120. 3 Measuring market effects • To be able to evaluate effects of different positions of a country in an international division of labour we need a measure, a way how to assess a quality of changes • Economic theory provides us with a concept of welfare. 4 Demand and supply functions • market for one commodity • demand curve q = D(p) as a decreasing function of the price p, or inverse demand function as a decreasing function p = D(q) of the quantity q • supply curve as an increasing function q = S(p) of the price p, or inverse supply curve as an increasing function p = S(q) of the quantity q 5 Inverse demand function p D F inverse demand function p = D(q) p* how much to pay for q* p*q* = q*D(q*) 0 q* q 6 Inverse supply function p inverese supply function p=S(q) S p* revenues from q* p*q* = q*S(q*) 0 q* q 7 Equilibrium in a closed economy • no trade assumed • the intersection of supply and demand function defines an equilibrium point E • equilibrium price p* and equilibrium quantity q* of the given commodity clearing the market) 8 Equilibrium in a closed economy p D Market equilibrium S(q) = D(q) S E p* 0 q* q 9 Measuring welfare of consumers • Demand function: for any quantity q demand function provides price p = D(q) for which this quantity will find buyers • for example, a person is willing to pay a tremendous amount for water which represents a basic measure of survival, however since there are competing suppliers of water on the market the water is available for less than a consumer is willing to pay 10 Nash Equilibrium • Preplay Communication – Before the game, discuss their options. Note only NE are suitable candidates for coordination as one player could profitably violate any agreement. • Rational Introspection – Based on what each player knows about the other players, reason what the other players would do in its own best interest. (Best Response - tomorrow) Points where everyone would be playing “correctly” are the NE. • Focal Point – Some distinguishing characteristic of the tuple causes it to stand out. The NE stands out because it’s every player’s best response. • Trial and Error – Starting on some tuple which is not a NE a player “discovers” that deviating improves its payoff. This continues until no player can improve by deviating. Only guaranteed to work for Potential 11 Games (couple weeks) How much consumers are ready to pay? p p0 D how much consumers are ready to pay E p* 0 q* S equilibrium q 12 Individual consumer’s surplus • an individual consumer’s surplus is the difference between the price a consumer is ready to pay for a product and the actual price of the product • if a consumer is ready to pay more than the actual price of the product, her benefit from the eventual transaction is how much she saved when she did not pay that price but the price prevailing on the market 13 Aggregate consumers’ surplus • the difference between the price a consumer is willing to pay and the price she pays is the individual consumer’s surplus. • consequently, the aggregate consumers' surplus is the sum of all individual consumer’s surpluses. 14 Consumers’ surplus p D consumers' surplus CS S E p* 0 q* equilibrium q 15 Measuring producers welfare • an individual producer‘s surplus is used to measure the welfare of a group of firms selling a particular product at a particular price • an individual producer‘s surplus is defined as the difference between what the producer actually receives for selling her product and the amount she would be ready to accept for the product unit. 16 For how much producers are ready to produce p D S E p* equilibrium for how much producers are ready produce 0 q* q 17 Aggregate producers’ surplus • Summing up all individual producer‘s surpluses we get aggregate producers’ surplus • difference between what producers get in equilibrium and for what they are ready to produce 18 Producers’ surplus p D producers' surplus PS E p* 0 q* S equilibrium q 19 In the case of no mobility of the factor we have equilibrium EH in country H and EP in country P and different equilibrium factor prices in H and P, namely rH* and rP* Interpretation of the graph Definite integral! Why do we have to use definite integral? 20 The Area Problem Find the area of the following region: 21 22 23 24 25 Definite integral 26 27 Properties of the Definite integral Reversing the limits f x dx f x dx changes the sign. b a a b a If the upper and lower limits are equal, then the integral is zero. b b a f x dx 0 a b a k f x dx k f x dx a c dx c(b a ), b Constant multiples can be moved outside. where c is any constant b b f x g x dx f x dx g x dx a a a Integrals can be added (or subtracted). b c c a b a f x dx f x dx f x dx Intervals can be added (or subtracted.) 28 29 Marshallian surplus • The idea to measure economic welfare that is based on the concepts of consumers´ and producers´ surplus was introduced by Alfred Marshall • Marshall originally applied this idea to the analysis of effects of taxes and price shifts on market equilibrium • that is why an aggregate of two components of welfare, consumers´ and producers´ surplus, is called “Marshallian surplus” 30 Graphics of Marshallian surplus p D Marshallian surplus MS MS=CS+PS S CS E p* equilibrium PS 0 q* q 31 Alfred Marshall • Alfred Marshall (1842–1924), born in London, England, became one of the most influential economists of his time. • His book, Principles of Economics (1890), brings the ideas of supply and demand, of marginal utility and of the costs of production into a coherent whole 32 What is it good for? • Comparing two different market situations, or equilibrium positions, we can say: – the higher consumers' surplus is, the better for consumers, the higher producers' surplus is, the better for producers, – the higher Marshallian surplus is, the better for the community. 33 What is it good for? • Changes in regimes of international trade and international economic cooperation, including different forms of economic integration, affect the equilibrium situations at the markets. • To evaluate economic implications and desirability of these changes we can use the welfare measures and ask about welfare effects. 34 What is it good for? • Arrangements that increase welfare we shall assess as economically positive, while arrangements that decreases welfare we shall consider economically negative. • To be able to do that, we have to be able to “calculate” welfare effects 35 Shift of equilibrium, does it increase or decrease welfare? p Shift of equilibrium to E2 S CS E2 p* 2 p* 1 E1 PS D2 D1 0 q*1 q* 2 q 36 How to calculate welfare? Area below the curve from calculus: let y = f(x) be continuously differentiable function, then b f ( x)dx a is equal to the shaded area. y=f(x) y a b x 37 Area below the curve Definite integral Let u(x) is a function such that du ( x) f ( x) dx then du ( x) f ( x ) dx dx u ( x ) const dx (integral of a function is a function such that its derivative is equal to the function we are integrating) then b f ( x)dx u (b) u (a) a 38 How to calculate welfare? Consumers’ surplus a) find function e(x) such that This image cannot currently be display ed. de ( q ) D (q ) dq where D(q) is an inverse demand function b) then consumers surplus is equal to q* CS D(q)dq p*q* e(q*) e(0) p*q * 0 39 How to calculate welfare? Producers’ surplus a) find function r(q) such that This image cannot currently be display ed. dr(q) S(q) dq where S(q) is an inverse supply function b) then producers’ surplus is equal to q* PS p * q * S (q)dq p * q * r(q*) r(0) 0 40 Marshallian surplus MS CS PS e( q*) r ( q*) r (0) e(0) Marshall’s original motivation was to study of welfare effects of taxation. Some authors (see for example Viner, 1950) used concepts of consumers’ and producers’ surplus to analyse welfare effects of customs unions. In the 1950s and 1960s Marshallian surplus became one of the instruments of economics of international trade and economics of integration (Johnson, 1965; Molle, 1994; Pelkmans, 1997; Hansen and Nielsen, 1997; Svendsed, 41 2003; Turnovec, 2003). Problems? Questions? • CS and PS • Marshallian surplus • Calculus and definite integral 42 Simple quizz (1): • • Pleas list six founding member states of the EU. Ger, Fr, It, Be, Ne, Lux • List all recent member states of the EU that are the members of European Monetary Union 17 countries (Be, Est, Fin etc.) and 11 non-Euro states • • • How many members have been elected to the European Parliament in 2009 elections? 736 • • What is the total size of population of the EU? 503 mil. 43 Simple quizz (2): • Please calculate: ∫(3x2+5x+8 )dx • x3+5/2x2+8x+c • Please calculate: ∫((2x+3 )/4)dx • 1/4x2+3/4x+c • Please derive: 12x5-2x2+x+7 • 60x4-4x+1 44 Problems? Questions? 45