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0:11
okay why don't we get started today we're gonna come full circle back to the first lecture so we in the first lecture we talked by we started by drawing a supply and demand graph we've now spent the last few weeks explaining where supply and demand curves come from and now we're gonna talk about the supply and demand curves you know what do they know did they know things let's find out so no one no one on that okay thank you alright so let's start by talking about
0:44
shocking the supply and demand curves
0:50
shocking the supply and demand curves that was a Bojack horseman reference for those who missed that okay let's let's talk about shocking the supply and demand curves so let's start with a review of the supply and demand framework that we introduced in the first lecture so let's go back to figure 9 1 we've got the market for gasoline okay on the x-axis is big Q quantity of gases is a market level diagram on the y-axis the price of gas and as we said the first lecture to supply curve that's
1:23
upward sloping representing the fact that higher prices call forth more supply we now know where that comes from we know that what happens is when there's a higher price firms can now afford to move up the marginal cost curve which is a supply curve so we know where that comes from we've demand curve which is downward sloping higher prices lead to less demand we know where that comes from we know that it's the price of a good Rises through both income and substitution effects for normal goods
1:52
good sumers who want less of it so whenever that comes from so we now have derived these and we're back where we started in equilibrium so let's actually start by asking what happens let's say I start by asking as we move forward how do I want to think about these curves and the way I think about them is we want to think about the demand curve want to think about these as willingness to play pay and willingness to supply curse so think about the demand curve as
2:17
a willingness to pay curve how much are you willing to pay to get the next unit of doors how much is the market willing to pay to get the next unit of the good okay and the supply curve is willing to supply okay an equilibrium is the point where consumers willingness to pay for the next unit of the good meets the suppliers willing to supply the next unit of the good when those are equal we're in equilibrium so that's kind of where we start now let's asking now
2:49
let's ask what happens as these cars shift so for example let's take this market and imagine the tastes change suddenly everyone wants to drive big cars everyone's to drive SUVs okay what does this do to the market for gas well so what does this do well what it does yeah go ahead yes SUVs are what we call a complement a complement as opposed to substitute our complement for gasoline when demand for SUVs goes up demand for gas goes up so the demand curve would shift out so we would end up in a
3:31
situation like figure 9 - but let's talk through the dynamics all you would see in the market is quantity of gas sold would go up from q1 to q2 and price of gas would go up from p1 to p2 well let's talk about underneath how we get there what happens is demand shifts up people want more gas because they want to drive these gas-guzzling cars so she demand shifts from d1 to d2 what does that mean that means that at the previous equilibrium price if the price didn't
4:05
change if the price stayed at p1 what would happen well we'd no longer be in equilibrium because people firms would still be happy to supply q1 units of gas but people would want way more than that we would have excess demand if the price didn't change there would be excess demand people would want more than the q1 units of gas suppliers will recognize this and say well if people want more we're happy to produce more but remember we have to respect the marginal cost curve and marginal costs
4:40
of rising if we're gonna produce more we're gonna have to charge more we're gonna have to move up the supply curve so a shift in the demand curve makes firms move along the supply curve we want to keep shifts and movement along curves separate a shift in the demand curve meaning people are saying to gas producers we want more gas gas firms like great we want to give you more gas but we're gonna have to charge you more to do it because our marginal cost curve is upward sloping which is our supply
5:07
curve as we learned so the price rises and we need to reach a new equilibrium at e2 so we don't see these steps in practice in the end we just see the price change but think about it as two steps demand shifts out creating excess demand providers to meet that excess demand have to produce more and to produce more they're gonna charge a higher price and that moves you from e1 to e2 okay so we have a shift in demand which cause to slide up the supply curve okay now let's think about a different
5:40
example imagine war breaks out in the Middle East not too hard to imagine unfortunately and as a result the quantity so suppliers need to pay more to get the oil that they used to make gasoline okay what does that do we see that in Figure 9 3 now what happens is for every you for every unit of gas suppliers need to charge more their underlying marginal costs have gone up because they have to pay more to get the oil that's a variable cost of production of gas so their marginal costs have gone
6:18
up their marginal costs going up meaning their supply curve has shifted upwards okay for every unit of production their marginal cost is higher because they're variable costs have gone up therefore they're gonna need to charge a higher price to break-even okay we're still in perfectly competitive markets where nobody's making any profit okay they're gonna charge more to break-even so now let's once again talk with that dynamics of what's happening that I nameks are the cost of and the input to
6:48
the suppliers went up Oh okay they're marginal cost serve shifts up to s2 so they want to charge a higher price so if we kept the price the same as it was before supplies would say we don't want to sell q1 anymore what I ain't shouldn't selling q1 anymore at that old price okay that doesn't interest us could sue there for consumers want more than providers are willing to sell and we once again have access to mant so we in both cases we get excess demand in the first case we
7:22
got excess demand because consumers wanted more the lower the consumers taste shifted so they wanted more gas at every price now we have excess demand not cuz taste shift but because costs go up so providers don't wanna provide as much gas at every price so what happens is providers are gonna say fine we're gonna charge a higher price okay and we'll slide up the demand curve because as providers charge a higher price people want less gas at a higher price you want less gas through the
7:52
substitution effect because you'll buy other things instead it's the income effect because you're effectively poorer because the price of gas went up for those reasons you're gonna shift up the demand curve and reach a new equilibrium and e2 so that's the underlying dynamics of how shifts in supply and demand lead to changes in quantity and price okay so that's basically what we're seeing questions about that yeah
8:27
great great question so what's the answer how do you what's the substitution effect with gas well even it's yourself it's not driving it's taking the bus it's driving less it's walking or taking your bike so once again when everything about substitute eviction I think about the the opportunity the next opportunities you could use instead okay good question other questions okay so here's an interesting point look at figure 92 and 93 in both cases the price went up okay
9:00
in both case the price went up so we can't tell if a price goes up you can't tell from that alone whether there was a shift in demand or supply so if I for example asks you on an exam or your mom came home and your mom asks you hey umm if the price goes up does that mean demand shift or supply shifted you say to your mom I don't know I can't tell with just that information I knew what happened to quantity - okay and then you save your mom good question okay so
9:29
let's go through the reasons why the supply and demand curve shift so why the curve shift okay well in the demand side there's at least six reasons why demand curves would shift so why do why do you demand curve shift okay one reason is taste change I just use that reason taste change okay people want different things okay a second reason is that income changes Zachary's could people are richer or poorer and so that makes them want different quantities even with the
10:08
same tastes a third reason is the change the change in the price of a complimentary or substitutable good okay now that's different I should separate the actually example unifor was this taste change is slightly different so change in price so come buy substitute ago is what I talked about taste change would be literally for everything held in equal I just wake up on morning like to drive that be it takes change okay so really this the example I used was to
10:44
change the price of complementary no no please didn't change no I go back I go back the example I used was at exchange people wanted more you SUVs but at the same time imagine different a different change imagine that we're looking at the demand for babysitters and the price of movies goes up okay well movies are complementary with babysitters you guys know what about the scene of kids yet but trust me movies are complement babysitters that basically the more you go to the movies
11:15
the more you need babysitters so if the price of movies goes up that's gonna lower my demand for babysitter's or vice-versa imagine that how the change in the price of movies affects the demand for Netflix well those are substitutable as the price of movies goes up I'm gonna want more Netflix and less babysitters so change in price of competent or substitutable goods will also affect my domain curve another thing that could affect the demand curve is a change in the market size so we
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will talk in a couple lectures about international trade if suddenly you're selling goods to a much larger market that will affect the demand for your good so preference I haven't changed price haven't change you just got to suddenly got a bunch of new customers that will affect demand for your good okay and the last thing that could change the most subtle way demand could change is expectations of the future so for example imagine you expect the price of gas to go up tomorrow you might buy
12:24
more gas today and that'll be weird for the next day you say look nothing changed today your tastes didn't change prices nothing change but people buy more gas what's going on it's that they expect the price to change in the future so expectations the future can actually drive demand today okay we've all experienced this in very various aspects of our lives okay so those are the reasons why the demand curve can shift so a lot of reasons why the demand curve could shift for the supply curve wise
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supply curve shifts is sort of much simpler there's really only two reasons okay one reason is changes in input costs and the second reason changes in input costs and the second is a shift in the technology and production so the production function changes or input costs change that's pretty much why supply curve shift okay so that sort of gives you a catalog of how to think about these curve shifting I have a fun example in the videos that go with this class um which is that we
13:33
all know Kim Kardashian is you may you may or may not know she has more Instagram followers and there are people in France she got eighty million about eight it's up to about a hundred and plus million Instagram followers Kim Kardashian a few years ago tweeted out a picture of herself in an exercise corset she called it she basically claimed of course it is this thing nice to wear like back like when we didn't care about women much at all and we just made them wear these
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incredibly constrictive things to make them look skinnier okay they're basically like a like a brace you'd wear to make you look skinnier back in the old days and Kim Kardashian said actually if you were a corset when you exercise it helps you lose weight well actually she's totally wrong okay it doesn't okay there is no it does not help you lose weight but she tweeted this out and there was a massive increase in demand for exercise corsets okay and the one company that made them
14:26
made scads of money there was a huge demand shift based on this Kim Kardashian tweet okay so tell me what happened next yeah more companies entered okay so what happened was profits were being made on exercise corsets so more companies started making exercise corsets and they came in and drove those profits down okay so that's a classic example of how demand shift and how the market the long-run will respond to return us to zero profits see her profits the long
14:59
when the short runs of course that money companies made a lot of money they should they owe Kim okay but in the long run profits go to zero yeah yeah anything where you basically well no but once that's on that's a price change a limited time sale for a good is literally just a standard the price changed okay it's sort of you think the sales go up in the future so you buy less today that's so the expectations okay so that's shifts in demand supply curse let's now talk about what
15:36
determines the shapes of supply and demand curve then what determines the shapes of supply and demand curse okay so basically the effect not what term is the shape so we're talking about determines the shape so one talk about the role the shapes the supply demand curves play let me rephrase that we know what determines the shapes we covered that the last ten lectures or whatever now we're talking about the role that shapes play as demand curve shift so for example let's think about a Stan word
16:10
figure nine three shows what happens with a supply the figure we're just looking at okay figure would just look at that figure nine three shows what happens when the supply shift with the standard downward sloping demand curve okay which is that the price goes up quantity Falls however imagine instead we had perfectly inelastic demand so for example for insulin then what would happen well figure nine four shows if demands perfectly inelastic quantity won't change so if there's a supply if
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there's a shock that shifts up the supply curve like war in the Middle East so this is the question here why wouldn't gas just be perfectly inelastic Allah demand in fact in the short-run gases actually pretty you know elastically demanded okay it's not perfectly inelastic but it's pretty inelastic okay so in that case you would see just prices going up and quantities wouldn't change now in the long run do we think the elasticity for gas will be higher or lower than the short-run the demand
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elasticity for gas hi somebody somebody graze their hand tell me why so every second tell me why somebody else besides people always answer questions yeah people can shift towards electric cars exactly in the short-run all you can do is drive less and we got to drive to work and stuff like that in the long run I can buy a different car so it's an example of long run versus short run how it can affect these elasticity's okay now let's think instead about a perfectly perfectly elastic demand the
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demand for I don't know you know tchotchkes in a market or something like that okay perfectly elastic demand in figure 9 it's always hard to think of markets with probably lasted man it's easy to think about firms having perfect elastic demand it's hard to think about markets but think about a market for a certain kind of candy okay well there's another kind of cane that's just as good okay so those are markets which are fairly elastically demanded okay there you see when the supply ships price
18:01
doesn't change only quantity does and why is that that's when the demand is perfectly elastic you can't change the price if you try to raise price by one penny you'll lose the entire market if you lower the price by one penny you gain the entire market and then you'll your profits will go away because your marginal cost will be through the roof okay so with perfectly elastic demand okay you're gonna get prices fixed but only quantity changes okay so basically
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that's sort of how we think about these extremes the bottom line is that's how the shapes of supply and demand will affect the response to shocks okay the more elastically the more elastic is demand the more price shock will come through in quantity and lessen prices the more inelastic is demand the more supply shock will come through in prices in nom in quantity okay any questions about that okay so now let's go on to what we can do with the supply and demand curve so now we're where the
19:01
Masters is applying two-man curves we know where they come from we know why they shape the way they do we what happens when they shift and we know what happens how that shift depends on their shapes so we own supply and demand curves now let's say what can we do with them and what we can do with them is use them to take the next step in this class from positive to normative economics so far this class has been completely focused on positive economics why do firms behave the way they do
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why do consumers behave the way they do and we haven't talked at all about whether it's a good thing or a bad thing well we need a new set of tools if we're gonna move from positive economics about why things the way things are turn or what if he connects about the way they should be okay and those set of tools were going to derive from supply and demand curves and this is critically important because for example let's take where we ended the last lecture or the
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lectures last lecture I think talking about how with perfectly or middle last lecture talking about on a perfectly competitive market under a set of assumptions all firms as you're a profit in the long run okay so we you buy that that's but you have to ask tough is that a good thing or a bad thing it's zero profits long run good or bad well on the one hand firms are cost minimizing that's good on the other hand why would anyone start a business in the long run
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they're gonna make no money that's bad so how do we think about trading those things off how do we think about whether it's a good idea or bad to have long run zero profits okay this is the question these this set of questions is what we turn to with with the notion of welfare economics welfare now welfare what's going to be used in two senses in this class mostly when I say welfare I'll mean as a measure of well-being most what I say welfare I mean welfare is
20:54
well-being sometimes we say welfare we mean cash payments to poor people that's like welfare payments that's not what I mean usually when I say welfare I'll try to distinguish I mean the other thing when I say welfare I don't mean the way it's used in a political debate meaning cash payments to poor people I mean welfare is a measure of well-being and welfare economics is the tools of normative analysis the tools of well freakin dogs the tools of measuring well being and we're gonna start by
21:21
talking about the concept of consumer surplus it's gonna be the first thing we're gonna use when we talk about welfare economics is consumer surplus okay now if we want to measure well-being however we have a problem which is how do you measure how happy I am my noodles but you don't exist so I've got a fundamental challenge here which is our indicator of well-being as utility function which isn't a real thing okay we use it to derive decisions but we don't actually have a measure of
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well-being that gives real meaningful inputs so what do we do we you a clever thing economists thought of a long time ago which is to use the concept of compensating variation the concept of compensating variation was that concept means that means that instead of asking you how happy you are I ask you how much would I have to pay you to become less set to become sadder or how much would you be willing to pay to be happier so I can't measure margin jillion dollars but
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I can measure how many dollars you would pay to buy the next good or how many dollars you pay me not to be punched or whatever okay I can basically measure those things by essentially ask asking you how much would you pay to be better off or how much would you be willing to pay not to be worse off and those are what we call dative compensating variation we measure your well-being by the money equivalent that you give to us okay in expressing your preferences and
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what we can then define consumer surplus will define consumer surplus which is our first measure of normative welfare economics as the benefit that it consumer gets from consuming a good above and beyond the price of that good the benefit that a consumer gets from consuming a good above and beyond what they for that good that's consumer surplus surplus means extra right so it's your extra it's how much more you get that when you had what you actually had to pay to get the good in the first place
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okay so basically um consider my daughter's demand for songs by Kendrick Lamar okay um let's and let's to make life easy let's say this is pre streaming and songs cost a dollar okay so she wants songs by Kendrick Lamar it's actually so let's actually yeah see what sort of icons Lamar and there's no streaming and she and the songs cost a dollar so if my daughter's willing to pay a dollar for Kendrick Lamar song and it costs a dollar then her consumer surplus is zero
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she's will heard the benefit she gets from the song as a dollar it costs a dollar her zero but if she was willing to pay two dollars for Kendrick Lamar song and all it cost a dollar then she's got a dollar in surplus okay so basically the key thing is to define consumer surplus we need two things the price and the willingness to pay well how the hell do we get willingness to pay where does that come from some raise their head and tell me yeah the demand curve we are defined it we are defined
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what will is toupees it's the demand curve so consumer surplus is simply defined as the area below the demand curve above the price because that tells you the demand curve tells you how much you're willing to pay for each unit the price new face tells you how much you had to pay so any gap between them is consumer surplus okay so let's go to figure nine six let's do my daughter's demand for Kendrick Lamar songs okay let's say that her demand is such that now once again the trick here is we've
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drawn a continuous demand curve it's a discrete decision so sort of bear with me the numbers you know bear with me as you think about this but roughly speaking she's willing to pay for the first Kendrick Lamar song between four and five dollars okay for the next Kendrick Lamar song's gonna pay between three and four dollars for the-- and so on so this gives you so let's to make life easy let's imagine willing to pay four dollars for the first Kendrick Lamar song three dollars for the second
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Kendrick Lamar song two dollars for the third Kendrick Lamar song and four dollars for the first country and four I'm sorry in one dollar for the fourth Kendrick Lamar song okay so imagine that's basically her demand curve it's not quite that discreet but we could make it stepwise if you want just be ugly-looking okay so that's her demand curve so what does that mean that means that when she buys the fourth Kendrick Lamar song okay when she buys King or whatever that is
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zero surplus okay zero surplus she was willing to pay a dollar for King Kunta and she and it cost a dollar so she's done okay however what does that mean that means when she bought Humble which was her first chor song okay she gained a surplus because she paid a dollar for that but she was willing to pay four dollars for it so she gained a surplus and the surplus is the difference between what she paid which is represented by the horizontal line and a dollar and what
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she was willing to pay which is a demand curve which is four dollars so she gained that surplus yeah it's a great question is a famous article about that I'll come back to that in one minute let me finish this the bottom line is the surplus there's been what she was willing to pay and what she had to pay which in the continuous example is this entire triangle think of by being able to buy fractions of songs okay little little bits ringtones or whatever okay fractions of songs okay
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then this entire area under the curve above the price is her surplus she was willing to pay the points on the curve she only had to pay the flat line at a dollar so the entire difference is her surplus okay the key point is this is all driven by diminishing marginal utility that is the reason her surplus goes to zero or eventually is because eventually gets tired of Kendrick Lamar songs so it goes down we have diminishing margin Chile for the songs and that's why we get
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consumer surplus as a triangle it's the difference between the downward sloping demand curve and the flat price line that the consumer faces okay so the individual consumer surplus individual consumer surplus okay it's hurt him as an individual graph okay individual graph per demand is downward sloping and therefore her surplus difference between is the area under the demand curve above the price line yeah let's talk about that let's let's talk about um actually
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I don't have it here if the man was Hurley inelastic you're absolutely right the consumer surplus would be infinite because the area under the demand curve above the price line would be infinity to be a rectangle go up to infinity why is that why is the consumer surplus infinite if demands inelastic because they pay anything for it so at any price it's a bargain in theory if you're if you're incredibly rich diabetic you would pay an infinite amount to have insulin so at any price
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you're getting huge surplus you're getting infinite circles infinity minus anything is infinity likewise what's the consumer surplus if demand is perfectly elastic same person what zero why that's graphically why but intuitively why why do you get no surplus from a good where demands fairly elastic what what makes a perfectly elastic demand curve because why as their substitutes that you're indifferent towards that's what gets a perfectly last demand so if I'm indifferent between jujyfruits
29:54
god you got spot-on jujyfruits if I'm a different between god only know what candy is anymore whatever I mean everything candy and candy be okay and then I get no surplus from consuming candy a why because I'm equally happy with candy B so candy a gives me no surplus what is the candy people eat what do people eat what Jolly ranks I love Jolly Ranchers okay yeah well no but that's that's irrelevant cuz skittles are just disappointing M&Ms let's be honest when you get skittles
30:27
you just pissed off the non M&Ms am i right I mean skittles is 220 M&Ms so we can't do that one let's do sort of you know Jolly Ranchers versus skittles maybe those are more comparable cuz M&Ms are better than everything so basically Jolly rationed skittles since I get since I'm indifferent Jolly Ranchers and skittles I get no surplus trimming the skittles cuz I would Etha happy having a jolly rancher so surplus is zero for a perfectly lastly demand good it's
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infinite for a perfectly inelastic they demand a good okay now let's go back to the question there's a famous article in economics called the deadweight loss of Christmas we're such an awful profession based about how terrible gift giving is and wise gift giving terrible because if you gave people cash they could get what they want the most but if you give them a gift it's by definition lower surplus than the cash because they could always go out and buy that good with the cash
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so by definition giving someone a gift makes them worse off they giving them that same amount of cash so this guy does the interview to all the students I think was at Penn State and he asked them how much their parents presents really worth to them and he found the deadweight loss of Christmas like hundreds of billions of dollars but like he would way rather have cash than the parents but what did he get wrong what did he get wrong why is that not why is that nicely a bad thing yeah you ask the
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first question so go ahead maybe but even ignoring that what else did he get wrong yeah that's um like the surprise there's emotional connections that's all well and good but that's not very big okay what's really big that he missed yeah he missed the fact the person who gave it gets utility from giving it so in fact the package may be efficient because you're like the surprising because the person gets utility but if you compared to dollars it's inefficient so it's kind of a
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clever clever little exercise he did um okay so basically that's individual consumer surplus but in this course we don't care about individual consumer surplus we care about market consumer surplus so let's turn to figure nine seven and think about a market listen about the market for gas now the mechanics is the same here but we're actually now thinking not about the individual buying one gallon versus two gallons but the market for gas how many gallons in aggregate will be bought
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but the analysis is the same okay that basically the willingness to pay for gas is the demand curve for gas the market demand curve for gas the price is the price so the difference is the area under the demand curve above the price the idea here is for consumers all the way to the left they have to drive to work they have to drive to have to drive a lot they're truck drivers or whatever they've drive a lot so for them they have a huge willingness to pay for gas so they make
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a huge surplus the more you want something you've given price the more circles you get where's you move to the right that's who will need to drive less and less once you pass point a why does surplus go away to the right of point a wise to know more consumer surplus yeah didn't happen because
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your willingness to pay is below the price right so transaction so consumer surplus can't go negative but when negative just wouldn't buy it so let's see his negative consumer surplus okay when negative you just wouldn't buy it okay but but as you get closer and closer to a then you actually do end up with consumer surplus going to zero okay so that's the UM that sort of mark consumer surplus so let's ask what let's let's talk about um a couple of aspects of our consumer surplus first
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question what happens to consumer surplus when the price changes let's show that in Figure nine eight let's say the price of gas goes up from $3 to 350 a gallon consumer surplus shrinks by consumer surplus shrinks by a trapezoid consumer surplus used to be the entire area below the demand curve it used to be the entire area below the demand curve and above $3 so used to be that whole triangle now it's just the empty triangle above the new price curve and below the demand curve so the new
34:47
consumer surplus is just the area above 350 on demand curves does the area not shaded in what you've lost is the trapezoid that goes that on the y-axis goes between 3 and 350 and then along the along the line goes from A to B you've lost that trapezoid why is it a trapezoid why have you lost why why is the lost consumer surplus a trapezoid because two things have happened what are the two things that have happened that have reduced your consumer surplus get some more folks involved folks you
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know good doctors quantity supplied quantity sold goes down because you want less supply because you are so the first thing is because the price gone up you want less that's the triangle you lost you have given up units that you used to get surplus on used to derive surplus on all the units from 900 to a thousand so what happened here is the price goes up and a hundred fewer people buy gas that's the way I've ladies that could be people buy less gas let's make it easy
35:45
hundred people buy gas so hundred people used to buy gas no longer buy gas they're out of gasps market.they bike instead okay now they clearly were not that sad to bike or they would've had huge surplus from gas but they're little sad to bike gets crappy day out they ravage driving and so they lost surplus from the fact that now at the higher price they have to bike instead but it's a little bit of surplus it's just a little triangle okay so it's a little bit of surplus loss
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because some people who are close to and different now have to bike instead of driving but why the big what the big what's the big rectangle same person what caused a big rectangle increase in price for who for the people who are already buying it anyway so the big losers are the people are going to drive anyway and now just have to pay more for it because they because here's the key point the people between a and B people the last hundred people they were pretty close to indifferent
36:39
they didn't lose that much surplus I'm not driving all the people to the left of person nine hundred they get big surplus from driving so their surplus simply went down by this rectangle they used to get the difference between the demand curve and three dollars not leaders to demand curve in 350 it's just a pure loss so when you raise a price the existing the people whose behavior doesn't change are worse off sometimes behavior change they're a little worse off but not that much so the triangle
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small the rectangles big the big loss is the people who like gas a lot but not to pay more for it okay point one point two what determines whether consumer surplus is large or small well we cover this it's elasticity of demand determines whether consumer surplus is large or small so for example figure nine nine takes the gas market with a price of three and a thousand people buying gas and uses two shows two different demand curves both of which go through point a so both demand curves yield the
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equilibrium price of three and the equilibrium quantity of a thousand okay so these two different Amman curves are just two different sets of preferences both of which yield the same equilibrium outcome and yet under the steeper demand curve the consumer surplus is larger that under the flatter cut man kerf and that's for the reason we talked about that's for the reason that's because with the steeper demand curve the more inelastic demand people want the good more they basically
38:17
they're less willing to give it up as the price goes up therefore at any price they're making more surplus often with the flatter demand curve people are basically closer to indifferent with some other good so they're not so sad if the price goes up their surplus is smaller from getting this good there's even what that we're willing to pay and what they have to pay is smaller okay so that's how we think about consumer surplus it's basically the excess of your willingness to pay above what you
38:49
have to pay so the price goes up your surplus goes down and surplus is larger the more inelastic is is the demand curve yeah great question when we talk about monopolies right now why can't producers do that why can't producers exploit that because perfectly yeah exactly cuz there that's a perfect answer to a perfectly competitive question cuz their price takers okay so they can't do an exploiting of consumers they don't have that choice mmm starting next lecture one lecture
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after we'll talk about monopolies then their price setters then they'll start thinking about that but right now they can't because the price takers I mean ultimately that's with it yeah ultimately they'd like the cert the surplus is just extra money somebody's got if you're a business owner why should consumers have it there you know you want it okay so that's um so that's consumer surplus any other questions about consumer surplus okay now let's move on and let's talk about producer surplus
40:04
let's talk about producer surplus okay now the idea here is the same consumer surplus was the difference between the willingness to pay for a good and its price producer surplus is the difference between the willingness supply a good and its price and how do we measure willing to supply the supply curve so figure as figure 9/10 shows the producer surplus for any given firm for any given firm okay firms have an upward sloping supply curve and the market is delivering them
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some price so let's think about this firm when they produce the first unit this think this is a gas production firm okay a gas refiners say when they refine that first gallon of gas okay that costs them almost nothing because marginal costs upward sloping they've already paid the fixed costs they don't care in the short-run so I like ever this variable costs okay so in the end of the day this is not expensive they are willing to prove that first gallon really cheaply they've already invested
41:10
in this giant refinery plant marginal costs are tiny so they get a huge but at the same time you pay them you don't differentiate what you pay per gallons you go to you plug the thing into your car and you get the gas okay so they're getting three bucks a gallon but they're not paying much to make that gallon however as they make more gallons their marginal cost increases so the surplus they earn on each gallon produced shrinks the surplus they earn at each gallon produced shrinks and so
41:40
eventually they get to a point where they are essentially indifferent about producing the next unit of gasoline that's at a price of $3 and a quantity of should be little Q okay that's the point at which they are indifferent okay between producing producing gas and a producing gas therefore their surplus is zero so producer surplus is the difference between the price line and the upward sloping supply curve is pretty surplus now in the long run we have a name for that it's called profits
42:14
okay so while consumer surplus is this sort of abstract weird theoretical concept pretty surplus you can get your hands around its profits basically in the long run remember in the long run marginal cost equals average cost right because in the long run you produce until marginal cost equals average cost therefore the supply curve is the average cost curve price minus average cost as profits therefore producer surpluses profits let me say it again little three line proof
42:42
for you okay in the long run marginal cost equals average costs second the supply curve is the marginal cost curve therefore it's the average cost curve third profits is defined as price minus average cost fourth profits is the shaded area now in the short-run that's not quite right because there's the whole shutdown decision which makes things awkward but roughly speaking it's not terrible to think about producer surplus as being profits that's a shorthand that largely
43:13
works if it ever doesn't work we'll let you know but that's a shorthand should largely work okay now of course once again we don't care about individual firms producer surplus we care about the market briefs or surplus so let's go to figure 911 figure 911 is basically the market surplus curve and the idea here is that essentially to the left you you have a market supply curve where basically remember the individual firms supply curve is always flat but the market supply curve doesn't have to be
43:45
it doesn't have to be flat okay the market supply curve well note let me back up a market supply curve is flat under certain set of conditions but now let's imagine that those conditions aren't true for example let's go back to I talked at the end of last lecture about heterogeneous firms when we took the cotton example some firms are more efficient producers than others if all firms are identical it's hardly competitive of course the market supply curve is flat since this graph
44:10
would be uninteresting but in fact imagine that firms aren't identical some firms are more efficient producers than others okay for example in that case what you'll see is the most efficient producer will earn the most surplus EE ie the most profit there all the way to the left as you move to the right you're getting to less and less efficient producers okay so profit is shrinking so under the conditions we started with last time then price would always equal supply be
44:44
a flat supply curve at the price and therefore profits are zero that is producer surplus is zero so we we derived towards the end of the last election we said in the long run a perfectly competitive market profit is zero that's the same as saying producer surplus is zero and why is that that's because in that case the price line is on top of the supply curve therefore there's no gap between them so in the long run in a perfectly competitive market there's zero producer
45:07
surplus means zero profit in reality we talked about conditions why there would be an upward sloping long run supply curve like firms different how efficient they are or where there's barriers to entry which means some firms can't come in and drive profits to zero or there's an upward sloping input price curve meaning that basically the more you want to produce the more you have to pay workers for all those reasons the supply curve slopes up and therefore you can
45:31
get a producer surplus you can get some profits even the long-run okay so basically what we have here is a situation where as long as the supply curve slopes up you get a long-run producer surplus which is the difference between the price and the supply curve okay and that is the same as profits questions about that okay let me cover one last point going back to last lecture didn't have time to get to a last lecture remember we talked about three reasons why in the long run even
46:01
even in a competitive market supply could give slope up we talked about heterogeneous firms that is firms with different levels of efficiency of production we talked about barriers to entry that is reasons why firms can't enter and drive profits to zero because it's not costless to enter and we talked about upward sloping input supply curves we talked about the fact that as you produce more you might have to pay more for your inputs and therefore you can't just charge one you have to charge the
46:40
you have to charge higher prices as you produce more I want to highlight so they said quickly last time difference between these two and this one in these two there are profits and these two there are profits okay because then each of these their reasons why the market will not drive every firm to zero profit some furs will remain in much like Pakistan made profits on their cotton sales some froze Romanian likewise with the barriers to entry the firm's that have that are in the market
47:08
that have gotten over those barriers will make money okay in this case the firm doesn't necessarily make money okay what it does here is it just pays it takes that extra money and pays it out to workers okay so whether or not an upward sloping supply curve doesn't necessarily mean the firm makes profit it could just be upward sloping because their input costs are rising okay so that's sort of an important distinction to keep in mind so let's stop there with that mind-blowing insight let's stop
47:37
there and we will come back and we'll talk more about welfare economics
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