SLIDE 1
Gains from trade
- In a voluntary transaction, both parties become better
- ff: win-win situation
- Much of the value in an economy is created by trade,
EFFICIENCY AND THE FUNDAMENTAL THEOREM Gains from trade In a - - PowerPoint PPT Presentation
EFFICIENCY AND THE FUNDAMENTAL THEOREM Gains from trade In a - - PowerPoint PPT Presentation
EFFICIENCY AND THE FUNDAMENTAL THEOREM Gains from trade In a voluntary transaction, both parties become better off: win-win situation Much of the value in an economy is created by trade, no necessarily by production Consumer and
SLIDE 2
SLIDE 3
Consumer and producer surplus
D
p′ q′ p q
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SLIDE 4
Consumer and producer surplus
S
p′ q′ p q
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SLIDE 5
Consumer and producer surplus
D S
p′ q′ p q
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SLIDE 6
Consumer and producer surplus
D S
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q∗
Optimal output level
p∗ p q
SLIDE 7
Consumer and producer surplus
D S
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q′
Under production
p∗ p q
SLIDE 8
Consumer and producer surplus
D S
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q′′
Over production
p∗ p q
SLIDE 9
The Fundamental Theorem
- Also known as Fundamental Theorem of Welfare Economics
- Exchange generates surplus:
− Sellers sell for more than marginal cost: producer surplus − Buyers pay less than willingness to pay: consumer surplus
- If markets are competitive, then markets are efficient: total gains
from trade (surplus) are maximized
SLIDE 10
The Fundamental Theorem (cont)
- Consumers who have a valuation higher than price buy
- Producer sells units with marginal cost lower than price
- Hence, all trades such that willingness to pay is higher
than marginal cost take place
- Price indicates whether consumer should buy and
whether producer should sell: the invisible hand
SLIDE 11
The Fundamental Theorem (cont)
- A second, less talked about, element of the theorem
- Survival of the fittest: only the best firms survive
competition
- Charles Darwin vs Adam Smith
SLIDE 12
Allocative and productive efficiency
- If q = q∗, then: allocative inefficiency (area C)
- If S = SL, then: productive inefficiency (area D)
- Market competition minimizes allocative and productive efficiency
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D S p′ q′ q∗ p q A B C
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
D SL SH p′ q′ p q A B D
SLIDE 13
The Fundamental Theorem (cont)
Critical assumptions underlying competitive markets assumption:
- No market power; free entry and exit; level playing field
- Well defined property rights (including externalities, IP)
- Perfect information
SLIDE 14