Download February 17

REVIEW
Economic Concepts
and Analysis
Benjamin Franklin, London,
September 19, 1772
In the affair of so much importance to you, wherein you ask my advice, I cannot, for want of sufficient
premises, advise you what to determine, but if you please I will tell you how. When those difficult cases
occur, they are difficult, chiefly because while we have them under consideration, all the reasons pro an
d con are not present to the mind at the same time; but sometimes one set present themselves, and at other
times another, the first being out of sight. Hence the various purposes or inclinations that alternately prevail,
and the uncertainty that perplexes us. To get over this, my way is to divide half a sheet of paper by a line
into two columns; writing over the one Pro, and over the other Con. Then, during three or four days
consideration, I put down under the different heads short hints of the different motives, that at different times
occur to me, for or against the measure. When I have thus got them all together in one view, I endeavor to
estimate their respective weights; and where I find two, one on each side, that seem equal, I strike them
both out. If I find a reason pro equal to some two reasons cons, I strike out three. If I judge some two
reasons con, equal to some three reasons pro, I strike out five; and thus proceeding I find at length where
the balance lies; and if, after a day or two of further consideration, nothing new that is of importance
occurs on either side, I come to a determination accordingly. And, though the weight of reasons cannot
be taken with the precision of algebraic quantities, yet when each is thus considered, separately and
comparatively, and the whole lies before me, I think I can judge better, and am less liable to take a rash
step, and in fact I have found great advantage from this kind of equation, in what may be called
moral or prudential algebra.
CONCEPTUALLY BCA IS
SIMPLE
1. Decide whose benefits and costs count (standing).
2. Select the portfolio of alternative projects.
3. Catalogue potential (physical) consequences and select
measurement indicators.
4. Predict quantitative consequences over the life of the project.
5. Monetize (attach dollar values to) all consequences .
6. Discount for time to find present values.
7. Sum: Add up the benefits and costs.
8. Perform sensitivity analysis.
9. Recommend the alternative with the largest net benefit
THE REALITIES OF DOING
BCA
•
•
•
Decide whose benefits and costs count.
Contentious whether global, national, state, or local
perspective is appropriate.
Select the portfolio of alternative projects.
Potentially infinite, the analyst must select a reasonable
subset.
Catalogue potential (physical) consequences and select
measurement indicators.
Difficult to identify specific consequences where
unresolved scientific or biological processes are involved.
True consequences may be unobservable.
THE REALITIES OF DOING
BCA
• Predict quantitative consequences over the life of the
project.
Prediction is difficult, especially over long periods for
complex systems.
• Monetize (attach dollar values to) all consequences
(W2P).
Where there are no appropriate market values, one
needs “catalogues” that rarely exist.
Often the most important benefits are the most
difficult to measure.
• Discount for time to find present values.
Different theories suggest different social discount
rates.
THE REALITIES OF DOING
BCA
•
•
•
Sum: Add up the benefits and costs.
Perform sensitivity analysis.
Potentially infinite—analyst has to choose a reasonable
subset.
Recommend the alternative with the largest net social
benefits.
This is usually easy! It normally does not present any
practical analytical difficulties, just political ones.
The one exception is where sensitivity analysis shows that
NPV estimates are very uncertain.
Linear function
Nonlinear function
Law of Demand
● Law of Demand: the inverse relationship
between the price of a good and the
quantity consumers are willing to
purchase.
● As price of a good rises, consumers buy
less.
● The availability of substitutes (goods with
similar functions) explains this negative
relationship.
Market Demand Schedule
Price
(monthly bill)
Cell phone
service price
Cell phone
subscribers
(monthly bill)
(millions)
$ 124
$ 92
$ 73
$ 58
$ 46
$ 41
3.5
7.6
16.0
33.7
55.3
69.2
120
100
80
60
Demand
40
Quantity
0
10
20
30
40
50
60
70
(millions of
subscribers)
Market Demand Schedule
Price
(monthly bill)
• Notice how the law of
demand is reflected by the
shape of the demand curve.
• As the price of a good
rises …consumers buy less.
120
100
80
60
Demand
40
Quantity
0
10
20
30
40
50
60
70
(millions of
subscribers)
Market Demand Schedule
Price
(monthly bill)
• The height of the demand
curve at any quantity shows
the maximum price that
consumers are willing to pay
for that additional unit.
• Here, for the 16th unit …
consumers are only willing
to pay up to $73 for it.
• While they would be willing
to pay up to $92 for the
7.6 (millionth) unit.
120
100
80
60
Demand
40
Quantity
0
10
20
30
40
50
60
70
(millions of
subscribers)
Market Demand Schedule
• Consider the market for cellular
phones service again. This time
we will assume that the demand
for cell service is more linear
and that the market price is $100.
• If the market price is $100, then
the 30th unit will not sell
because those who demand it are
only willing to pay $60 for
cellular phone service.
• At $100, the 17th unit will sell
because those who demand it are
willing to pay up to $100 for
cellular phone service.
• At $100, the 5th unit will sell
because those who demand it are
willing to pay up to $133 for
cellular phone service.
Price
(monthly bill)
140
120
Market price = $100
100
80
60
Demand
Quantity
5
10 15 20 25 30
(millions of
subscribers)
Market Demand Schedule
Price
(monthly bill)
• For all those goods under 17
units, people are willing to
pay more than $100 for service.
• The area, represented by the
distance above the actual price
paid and below the demand
curve, is called consumer
surplus.
• This area represents the net
gains to buyers from market
exchange.
Consumer
surplus
140
120
Market price = $100
100
80
60
Demand
Quantity
5
10 15 20 25 30
(millions of
subscribers)
Summing Demand for a
Private Good
Summing Demand for a
Private Good
Qa = 20 – P
Qb = 25 – P
Qc = 15 – .5P
Summed Qa + Qb + Qc = 60 – 2.5P
Elastic and Inelastic Demand
• When the market price for
gasoline rises from $1.25 to
$2.00 a gallon, the quantity
demanded in the market
falls insignificantly from 8 to 7
million units per week.
• In contrast, when the market
price for tacos rises from $1.25
to $2.00, quantity demanded in
the market falls significantly
from 8 to 4 million units per
week.
• As taco demand is highly
sensitive to price changes, taco
demand is described as elastic;
as petrol demand is relatively
insensitive to price changes,
gasoline demand is described
as inelastic.
Price
Gasoline
market
$2.00
$1.25
$1.00
D
Quantity
(gasoline)
1 2 3 4 5 6 7 8 9
Price
Taco
market
$2.00
$1.25
$1.00
D
Quantity
1 2 3 4 5 6 7 8 9
(tacos)
Elasticity
Various Kinds of Demand
Schedules
Demand for Stuff
The Law of Supply
● Law of Supply:
there is a positive relationship between
the price of a product and the amount of
it that will be supplied.
● As the price of a product rises,
producers will be willing to supply a
larger quantity.
Market Supply Schedule
Price
Cell phone
Cell phone service supplied
to market
service price
(monthly bill)
$ 60
$ 73
$ 80
$ 91
$ 107
$ 120
(monthly bill)
Supply
120
(millions)
5.0
11.0
15.1
18.2
21.0
22.5
100
80
60
40
Quantity
0
10
20
30
40
50
60
70
(millions of
subscribers)
Market Supply Schedule
Price
(monthly bill)
• Notice how the law of
supply is reflected by the
shape of the supply curve.
• As the price of a good
rises …producers supply
more.
Supply
120
100
80
60
40
Quantity
0
10
20
30
40
50
60
70
(millions of
subscribers)
Market Supply Schedule
Price
(monthly bill)
• The height of the supply
curve at any quantity shows
the minimum price necessary
to induce producers to supply
that next unit to market.
• Here, for the 11th unit …
producers require $73 to
induce them to supply it.
• While they would require
$91 to supply the 18.2
(millionth) unit.
• The height of the supply
curve at any quantity also
shows the opportunity cost
of producing that next unit
of the good.
Supply
120
100
80
60
40
Quantity
0
10
20
30
40
50
60
70
(millions of
subscribers)
Market Supply Schedule
• Consider the market for cellular
phones service again. This time
we will assume that the supply
for cell phones is more linear
and that the market price is $100.
Price
(monthly bill)
Supply
140
120
• If the market price is $100, then
the 30th unit will not be produced
100
because the cost of supplying it
exceeds the market price of $140.
• At $100, the 17th unit will be
80
produced because those who
supply it are willing to do so for
at least $100.
60
• At $100, the 5th unit will be
produced because those who
supply it are willing to do so for
at least $60.
Market price = $100
Quantity
5
10 15 20 25 30
(millions of
subscribers)
Market Supply Schedule
Price
(monthly bill)
• For market outputs of less then
17 units, producers are willing
to supply the good for $100.
• The area represented by the
distance above the supply
curve but below the actual sales
price is called producer surplus.
• This area is the difference
between the minimum amount
required to induce producers to
supply a good and the amount
they actually receive.
Supply
140
120
Market price = $100
100
80
Producer
surplus
60
Quantity
5
10 15 20 25 30
(millions of
subscribers)
Elastic and Inelastic Supply
Price
Soft drink
market
• When the market price for
$2.00
soft drinks increases from
S
$1.00 to $1.50 a six-pack, the
$1.50
quantity supplied to the market
$1.00
rises from 100 to 200 million
units per week.
• When the market price for
Quantity
(million
physician services rises from
6-packs)
50
200
100 150
$100 to $150 an office visit,
the quantity supplied rises from
Physician
Price
S
10 to 12 million visits per week.
Services
$200
market
• As soft drink supply is very
sensitive to price changes, soft
$150
drink supply is described as
$100
elastic; as physician services
supply is relatively insensitive
to price changes, physician
Quantity
services supply is described as
(million
2 4 6 8 10 12 14 16 18 20 visits)
inelastic.
Market Equilibrium
• This table & graph indicate demand and supply
conditions of the market for pocket calculators.
• Equilibrium will occur where the quantity
demanded equals the quantity supplied. If the
price in the market differs from the equilibrium
level, market forces will guide it to equilibrium.
• A price of $12 in this market will result in a
quantity demanded of 450 … quantity supplied
of 600 … resulting in an excess supply.
• With an excess supply present, there will be
downward pressure on price to clear the market.
Price
(dollars) (per day)
12
600
10
550
8
(per day)
Condition
in the
market
Direction
of pressure
on price
450
Excess
supply
Downward
Quantity Quantity
supplied demanded
500
>
Price ($)
S
13
12
11
10
9
8
7
D
Quantity
450 500 550 600 650
Quantity supplied
= 600
550
650
Quantity demanded
= 450
Market Equilibrium
• A price of $8 in this market will result in quantity
supplied of 500 … and quantity demanded of
650 … resulting in excess demand.
• With an excess demand present, there will be
upward pressure on price to clear the market.
Price ($)
S
13
12
11
10
9
8
7
D
Quantity
Price
(dollars) (per day)
12
600
10
550
8
(per day)
Condition
in the
market
Direction
of pressure
on price
450
Excess
supply
Downward
Quantity Quantity
supplied demanded
500
>
450 500 550 600 650
Quantity supplied
= 500
550
<
650
Excess
demand
Upward
Quantity demanded
= 650
Market Equilibrium
• A price of $10 in this market results in a quantity
supplied of 550 … and quantity demanded of
550 …resulting in market balance.
• With market balance present, there will be an
equilibrium present and the market will clear.
Price ($)
S
13
12
11
10
9
8
7
D
Quantity
Price
(dollars) (per day)
12
600
10
550
8
(per day)
Condition
in the
market
Direction
of pressure
on price
450
Excess
supply
Downward
Quantity Quantity
supplied demanded
500
>
=
<
550
650
Balance Equilibrium
Excess
Upward
demand
450 500 550 600 650
Quantity supplied
= 550
Quantity demanded
= 550
Market Equilibrium
S
Price ($)
• At every price above market equilibrium there
is excess supply and there will be downward
pressure on the price level.
• At every price below market equilibrium there
is excess demand and there will be upward
pressure on the price level.
• It is at equilibrium that prices will rest.
13
12
11
10
9
8
7
Excess
supply
Equilibrium
price
Excess
demand
D
Quantity
Price
(per day)
Condition
in the
market
Direction
of pressure
on price
450
Excess
supply
Downward
Quantity Quantity
supplied demanded
(dollars) (per day)
12
600
10
550
8
500
>
=
<
550
650
Balance Equilibrium
Excess
Upward
demand
450 500 550 600 650
Net Gains to Buyers and
Sellers
Price
(monthly bill)
• Return again to the market for cell
phone service. When the market is
in equilibrium – where supply just
equals demand – price equals $100.
• If the area above the market price
and below the demand curve is
called consumer surplus … and
the area above the supply curve
but below the market price is called
producer surplus … then the
combined area is the net gains to
buyers and sellers. It is here that
all potential gains from production
and exchange are realized.
Net gains to
buyers and
sellers
140
Supply
120
Market price = $100
Equilibrium
100
80
60
Demand
Quantity
5
10 15 20 25 30
(millions of
subscribers)
Natural Monopoly I
Natural Monopoly II
Monopoly Revenue
Natural Monopoly III
Benefits from a Subway
Fare
Old revenue = $224K
Old consumers’ surplus = $98K
New revenue = $200K
New consumers’ surplus = $50K
$2
DWL change = $50K -$18K =-$32K
$1.60
SUBWAY OPTION
Consumers gain =
+$150K
$1
140K
100K
200K
Riders per Day
Benefits from a Subway
Fare
Old net operating revenue = $224K - $140K =
$84K + old CS ($98K) = $182K
New NOR = $100K + new CS ($50K) = $150
$2
DWL change = $50K -$18K =-$32K
$1.60
SUBWAY OPTION
Consumers gain =
+$150K
$1
140K
100K
200K
Riders per Day
Benefits from a Subway
Fare
Old net operating revenue = $224K - $140K =
$84K + old CS ($98K) = $182K
New NOR = $100K + new CS ($50K) = $150
$2
DWL change = $50K -$18K =-$32K
$1.60
SUBWAY OPTION
Consumers gain =
+$150K
$1
140K
100K
200K
Riders per Day
Benefits from a Subway
Fare
Bus Fixed Cost = $60K per day
Subway Fixed Cost = $75K per day
Old net revenue = $224K - $140K - fixed
costs ($60K) = $24K + old CS ($98K) =
$122K
New OR = $40K + new CS ($50K) = $90K
$2
DWL change = $50K -$18K =-$32K
SUBWAY OPTION
$1.60
Consumers gain = $150K
Taxpayers lose = $75 K
Bus’ owners lose = $40K
NET GAIN = $35K
$1
140K
100K
200K
Riders per Day
Benefits from a Subway
Fare
Bus Fixed Cost = $60K per day
Subway Fixed Cost = $75K per day
Assume the Bus Company’s
Owners Could be Bribed to
Set the Fare at $1
@ $105K
$2
SUBSIDIZED BUS OPTION
$1.60
Consumers gain = $150K
Taxpayers lose = $105 K
Bus’ owners gain = $5K
NET GAIN = $50K
$1
140K
100K
200K
Riders per Day
Benefits from a Subway
Fare
Old revenue = $224
New revenue = $200K
DWL change = approx $32K
$2
$1.60
SUBWAY OPTION
Consumers gain =
+$150K
$1
140K
100K
200K
Riders per Day
300K
Private Good
Q = 60 - 2.5P
Public Good I
Summing Demand for a
Public Good
Q a = 20 – P, Pa = 20 – Q
Q b = 25 – P, Pb = 25 – Q
Q c = 15 – .5P, Pc = 30 – 2Q
Summed Pa + Pb + Pc = 75 - 4Q
Public Good II
P = 75 - 4Q
Public Good III
What Is a FAIR Tax/Price?
IF THE
IF THE
LIGHTHOUSE
LIGHTHOUSE
COST $12000 & A
COST $12000?
+
B
EACH
HAD
A
● Equal share?
BENEFIT LEVEL
● Equal net benefit?
OF $2000 AND C’s
● Equal ratio of MC to
BENFIT WAS
MB
$2750?