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1. Demand Willingness to Pay (WTP) A buyer’s willingness to pay for a good is the maximum amount the buyer will pay for that good. WTP measures how much the buyer values the good. name Flea WTP Example: 4 buyers’ WTP for an iPod $300 Anthony 250 Chad 175 John 125 1 WTP and the Demand Curve Q: If price of iPod is $200, who will buy an iPod, and what is quantity demanded? A: Flea & Anthony will buy an iPod, Chad & John will not. name Flea WTP $300 Anthony 250 Chad 175 John 125 2 Hence, Qd = __ when P = $200. 2 WTP and the Demand Curve Derive the demand schedule: name Flea who buys Qd $301 & up nobody 0 WTP 251 – 300 Flea 1 $300 176 – 250 Anthony, Flea 2 Chad, Anthony, 126 – 175 Flea 3 John, Chad, 0 – 125 Anthony, Flea 4 Anthony 250 Chad 175 John P (price of iPod) 125 3 WTP and the Demand Curve P $350 $300 Qd=0 P Qd $301 & up 0 251 – 300 1 176 – 250 2 126 – 175 3 0 – 125 4 Qd=1 $250 $200 Qd=2 $175 Qd=3 $150 $125 $100 $50 Qd=4 $0 Q 0 1 2 3 4 4 About the Staircase Shape… P This D curve looks like a staircase with 4 steps. $350 $300 If there were a huge # of buyers, as in a competitive market, $250 $200 there would be a huge # of very tiny steps, $150 and it would look more like a smooth curve. $100 $50 $0 Q 0 1 2 3 4 5 2. Supply Cost and the Supply Curve • Cost is the value of everything a seller must give up to produce a good (i.e., opportunity cost). • Includes cost of all resources used to produce good, including value of the seller’s time. • Example: Costs of 3 sellers in the lawn-cutting business. A seller will only produce and name cost sell the good if the price Angelo $10 exceeds his/her cost. Hunter 20 Hence, cost is a measure of Kitty 35 willingness to sell. 6 Cost and the Supply Curve Derive the supply schedule from the cost data: name P Qs $0 – 9 0 10 – 19 1 20 – 34 2 35 & up 3 cost Angelo $10 Hunter 20 Kitty 35 7 Cost and the Supply Curve P $40 $35 $30 $20 $10 $0 P Qs $0 – 9 0 10 – 19 1 20 – 34 2 35 & up 3 Q 0 1 2 3 8 3. Welfare measures—CS and PS (1) Consumer Surplus (CS) Consumer surplus is the amount a buyer is willing to pay minus the buyer actually pays. name Flea WTP Suppose P = $260. $300 Flea’s CS = $300 – 260 = $40 __. Anthony 250 Chad 175 The others get no CS because they do not buy an iPod at this price. John 125 40 . Total CS = $___ 9 CS and the Demand Curve P P = $260 Flea’s WTP $350 $300 Flea’s CS = $300 – 260 = $40 $250 $200 Total CS = $40 $150 $100 $50 $0 Q 0 1 2 3 4 10 CS and the Demand Curve P Flea’s WTP $350 $300 Anthony’s WTP Instead, suppose P = $220 Flea’s CS = $250 $200 $300 – 220 = $80 $150 $250 – 220 = $30 $100 $50 Total CS = $110 Anthony’s CS = $0 Q 0 1 2 3 4 11 CS and the Demand Curve P The lesson: Total CS equals the area below the demand curve & above the price. $350 $300 $250 $200 $150 $100 $50 $0 Q 0 1 2 3 4 12 CS with Lots of Buyers & a Smooth D Curve Price per pair Q: P = $30, CS=? P The Demand for Shoes $ 60 50 A: CS is the area h below the D curve 40 and above the P. 30 Recall: area of 20 a triangle equals 10 ½ x base x height 0 So, CS=½ x 15 x $30 = _____ 1000s of pairs of shoes D Q 0 5 10 15 20 25 30 13 (2) Producer Surplus P $40 Producer surplus (PS): the amount a seller is paid for a good minus the seller’s cost. $30 $20 $10 $0 Q 0 1 2 3 14 Producer Surplus and the S Curve P Suppose P = $25 $40 Kitty’s cost $30 $25 Hunter’s cost $20 Angelo’s cost $10 $0 Q 0 1 2 3 Angelo’s PS = $15 Hunter’s PS = $5 Total PS = $20 Total PS equals the area below the price and above the supply curve. 15 PS with Lots of Sellers & a Smooth S Curve Price per pair Q: P=$40, PS=? A: PS is the area below the P and above the S curve. The height of this triangle is $40 – 15 = $25. P The supply of shoes 60 S 50 40 30 h 20 x 25 x $25 So,PS=½ _____________ = $312.5 $15 1000s of pairs of shoes 10 Q 0 0 5 10 15 20 25 30 16 4. Profit profit per unit = P – ATC = $10 – $6 = $4 Costs and Revenue Total profit = TR-TC =P ________________ x Q – ATC x Q = $10 _________________ x 50 - $6 x 50 = _____ $200 MC P = $10 profit MR ATC $6 Total profit = (P – ATC) x Q = $4 x 50 = $200 Greg Mankiw: CHAPTER 14 50 FIRMS IN COMPETITIVE MARKETS Q 17