Review of Results from Double Auctions

• 20 different markets

• 10 buyers and 10 sellers in each market– the 5 buyers and 5 sellers on page 178-179

plus their clones– Prediction: P = $13 and Q = 26– results were very close to prediction

• For $6 increase in MC, the equilibrium price P = $16 and equilibrium Q = 20

Properties of Competitive Markets

• One price in the market which is the equilibrium price P

• Each firm produces a quantity such that MC equals the equilibrium price P– Hugo, Mimi,...

• Each consumer buys a quantity such that MB equals the equilibrium price P– Maria, Ken,...

Are Competitive Markets Efficient

• Definition (need to be careful)

• Pareto efficiency:– a situation where it is impossible to make one

person better off without hurting another person

Conditions for Pareto Efficiency

• marginal benefit equals marginal cost (for last item produced)

• marginal cost of each good should be the same for all producers

• marginal benefit of each good should be the same for all consumers

Are the conditions satisfied for a competitive market? Check ‘em

– first: MC = MB because equilibrium occurs at the intersection of the demand (MB) curve and the supply (MC) curve

– second: MB = P for each consumer, because each consumer sets MB = P and because there is a single equilibrium price P in the market equilibrium

– third: MC = P for each firm, because each firm sets MC = P and because there is a single equilibrium price P in market equilibrium

Answer: YES! ALL THREE CONDITIONS ARE

SATISFIED

07_06

QUANTITY

PRICE

Market supply(derived from firms'marginal costs)

Market demand(derived fromconsumers'marginal benefits)

FED

EfficientToo little Too much

We can measure how well the market works:

• Use producer and consumer surplus

• in an equilibrium of a competitive market the sum of producer surplus and consumer surplus is as large as possible

• OR, the marginal benefit less the marginal cost of all items produced is as large as possible

• Or, Deadweight Loss is eliminated

07_07

Too little

Efficient

QUANTITY

PRICE

Too much

Demand

Supply

C

D

Negative producer surplus and negative consumer surplus: area C + D

QUANTITY

PRICE

Demand

Supply

A

B

QUANTITY

PRICE

Demand

Supply

Deadweight loss: area A + B

Market price

Market price

Market price

Deadweight Loss from a Tax

• A tax on firms raises the marginal cost for each firm

• Supply curve shifts up by the amount of the tax

• Quantity produced falls

• Price rises, but by less than the tax

• Deadweight loss is created

07_08A

New supply curve

Old supply curve

Demand curve

QUANTITY

PRICE

Quantity declines by this amount.

New quantity Old quantity

New price

Old price

Price rises by this amount.

Price received by sellers after sending tax to government

Deadweight loss

Amount of sales tax

Deadweight Loss from a Sales Tax