Part I. Principles
A.
B.
C.
D.
E.
F.
Markets
Market failure
Discounting & PV
Markets 2
Dynamic efficiency
Pollution solutions
First topic
• Competitive markets vs. monopolies
Competitive market
$
S = MC
p*
D = MB = MR
q*
Quantity
Competitive market: Price = MR
TR  p * q
ΔTR
MR 
Δq
• In competitive market, firm price-taker (lots of
firms in market), each additional unit sold same
price,
p= MR
Example P = MR
Price
Quantity
TR
MR
5
0
0
5
5
1
5
5
5
2
10
5
5
3
15
Monopoly
$
S = MC
pm
p*
D = MB(c)
MR = MB(p)
qm
q*
Quantity
Monopoly: P > MR
Why?
• In a monopoly, firm is price maker (only
firm in market). Because they face
downward sloping demand curve, in order
to sell 1 more unit, they must lower price
• Therefore, price > MR
• Pink shaded area social cost resulting from
restricted output & higher price
(“deadweight loss,” “excess burden”)
Example P > MR
Price
Quantity
TR
MR
5
0
0
4
4
1
4
2
3
2
6
0
2
3
6
Second topic
• Solving for consumer, producer, and total
surplus (CS, PS, TS)
Consumer surplus (CS)
• CS: area under demand curve, above
equilibrium price
Producer surplus (PS)
• PS: area below price, above MC (or TR-TC)
Total surplus = social welfare =
CS + PS
Solving for CS and PS
• Remember how to find the area of a
triangle?
• CS = ½ *base*height = ½* Q*(max p – p)
• PS = ½ *base*height = ½* Q*(p – min p)
Example – solve for CS, PS, TS
$
20
S
P* = 10
5
D
Q
Q* = 15
Solution?
• CS = ½ * 15 * 10 = $75.00
• PS = ½ * 15 * 5 = $37.50
• Total surplus (social welfare)
= CS + PS = $112.50