1、Chapter OneThe MarketThe Theory of Economics does notfurnish a body of settled conclusionsimmediately applicable to policy.It isa method rather than a doctrine,anapparatus of the mind,a technique ofthinking which helps its possessor todraw correct conclusions-John Maynard KeynesEconomic ModelinguWha
2、t causes what in economic systems?uAt what level of detail shall we model an economic phenomenon?uWhich variables are determined outside the model(exogenous)and which are to be determined by the model(endogenous)?Modeling the Apartment MarketuHow are apartment rents determined?uSuppose apartments ar
3、e close or distant,but otherwise identicaldistant apartments rents are exogenous and knownmany potential renters and landlordsModeling the Apartment MarketuWho will rent close apartments?uAt what price?uWill the allocation of apartments be desirable in any sense?uHow can we construct an insightful m
4、odel to answer these questions?Economic Modeling AssumptionsuTwo basic postulates:Rational Choice:Each person tries to choose the best alternative available to him or her.Equilibrium:Market price adjusts until quantity demanded equals quantity supplied.Modeling Apartment DemanduDemand:Suppose the mo
5、st any one person is willing to pay to rent a close apartment is$500/month.Thenp=$500 QD=1.uSuppose the price has to drop to$490 before a 2nd person would rent.Thenp=$490 QD=2.Modeling Apartment DemanduThe lower is the rental rate p,the larger is the quantity of close apartments demandedp QD .uThe q
6、uantity demanded vs.price graph is the market demand curve for close apartments.Market Demand Curve for ApartmentspQDModeling Apartment SupplyuSupply:It takes time to build more close apartments so in this short-run the quantity available is fixed(at say 100).Market Supply Curve for ApartmentspQS100
7、Competitive Market Equilibriumu“low”rental price quantity demanded of close apartments exceeds quantity available price will rise.u“high”rental price quantity demanded less than quantity available price will fall.Competitive Market EquilibriumuQuantity demanded=quantity available price will neither
8、rise nor falluso the market is at a competitive equilibrium.Competitive Market EquilibriumpQD,QS100Competitive Market EquilibriumpQD,QSpe100Competitive Market EquilibriumpQD,QSpe100People willing to pay pe for close apartments get closeapartments.Competitive Market EquilibriumpQD,QSpe100People willi
9、ng to pay pe for close apartments get closeapartments.People not willing to pay pe for close apartments get distant apartments.Competitive Market EquilibriumuQ:Who rents the close apartments?uA:Those most willing to pay.uQ:Who rents the distant apartments?uA:Those least willing to pay.uSo the compet
10、itive market allocation is by“willingness-to-pay”.Comparative StaticsuWhat is exogenous in the model?price of distant apartmentsquantity of close apartmentsincomes of potential renters.uWhat happens if these exogenous variables change?Comparative StaticsuSuppose the price of distant apartment rises.
11、uDemand for close apartments increases(rightward shift),causingua higher price for close apartments.Market EquilibriumpQD,QSpe100Market EquilibriumpQD,QSpe100Higher demandMarket EquilibriumpQD,QSpe100Higher demand causes highermarket price;same quantitytraded.Comparative StaticsuSuppose there were m
12、ore close apartments.uSupply is greater,so uthe price for close apartments falls.Market EquilibriumpQD,QSpe100Market EquilibriumpQD,QS100Higher supplypeMarket EquilibriumpQD,QSpe100Higher supply causes alower market price and alarger quantity traded.Comparative StaticsuSuppose potential renters inco
13、mes rise,increasing their willingness-to-pay for close apartments.uDemand rises(upward shift),causinguhigher price for close apartments.Market EquilibriumpQD,QSpe100Market EquilibriumpQD,QSpe100Higher incomes causehigher willingness-to-payMarket EquilibriumpQD,QSpe100Higher incomes causehigher willi
14、ngness-to-pay,higher market price,andthe same quantity traded.Taxation Policy AnalysisuLocal government taxes apartment owners.uWhat happens topricequantity of close apartments rented?uIs any of the tax“passed”to renters?Taxation Policy AnalysisuMarket supply is unaffected.uMarket demand is unaffect
15、ed.uSo the competitive market equilibrium is unaffected by the tax.uPrice and the quantity of close apartments rented are not changed.uLandlords pay all of the tax.Imperfectly Competitive MarketsuAmongst many possibilities are:a monopolistic landlorda perfectly discriminatory monopolistic landlorda
16、competitive market subject to rent control.A Monopolistic LandlorduWhen the landlord sets a rental price p he rents D(p)apartments.uRevenue=pD(p).uRevenue is low if p 0uRevenue is low if p is so high that D(p)0.uAn intermediate value for p maximizes revenue.Monopolistic Market EquilibriumpQDLowprice
17、Low price,high quantitydemanded,low revenue.Monopolistic Market EquilibriumpQDHighpriceHigh price,low quantitydemanded,low revenue.Monopolistic Market EquilibriumpQDMiddlepriceMiddle price,medium quantitydemanded,larger revenue.Monopolistic Market EquilibriumpQD,QSMiddlepriceMiddle price,medium quan
18、titydemanded,larger revenue.Monopolist does not rent all theclose apartments.100Monopolistic Market EquilibriumpQD,QSMiddlepriceMiddle price,medium quantitydemanded,larger revenue.Monopolist does not rent all theclose apartments.100Vacant close apartments.Perfectly Discriminatory Monopolistic Landlo
19、rduImagine the monopolist knew everyones willingness-to-pay.uCharge$500 to the most willing-to-pay,ucharge$490 to the 2nd most willing-to-pay,etc.Discriminatory Monopolistic Market EquilibriumpQD,QS100p1=$5001Discriminatory Monopolistic Market EquilibriumpQD,QS100p1=$500p2=$49012Discriminatory Monop
20、olistic Market EquilibriumpQD,QS100p1=$500p2=$49012p3=$4753Discriminatory Monopolistic Market EquilibriumpQD,QS100p1=$500p2=$49012p3=$4753Discriminatory Monopolistic Market EquilibriumpQD,QS100p1=$500p2=$49012p3=$4753peDiscriminatory monopolistcharges the competitive marketprice to the last renter,a
21、ndrents the competitive quantityof close apartments.Rent ControluLocal government imposes a maximum legal price,pmax pe,the competitive price.Market EquilibriumpQD,QSpe100Market EquilibriumpQD,QSpe100pmaxMarket EquilibriumpQD,QSpe100pmaxExcess demandMarket EquilibriumpQD,QSpe100pmaxExcess demandThe
22、100 close apartments areno longer allocated bywillingness-to-pay(lottery,lines,large families first?).Which Market Outcomes Are Desirable?uWhich is better?Rent controlPerfect competitionMonopolyDiscriminatory monopolyPareto EfficiencyuVilfredo Pareto;1848-1923.uA Pareto outcome allows no“wasted welf
23、are”;ui.e.the only way one persons welfare can be improved is not to lower another persons welfare.Pareto EfficiencyuJill has an apartment;Jack does not.uJill values the apartment at$200;Jack would pay$400 for it.uJill could sublet the apartment to Jack for$300.uBoth gain,so it was Pareto inefficien
24、t for Jill to have the apartment.Pareto EfficiencyuA Pareto inefficient outcome means there remain unrealized mutual gains-to-trade.uAny market outcome that achieves all possible gains-to-trade must be Pareto efficient.Pareto EfficiencyuCompetitive equilibrium:all close apartment renters value them
25、at the market price pe or moreall others value close apartments at less than peso no mutually beneficial trades remainso the outcome is Pareto efficient.Pareto EfficiencyuDiscriminatory Monopoly:assignment of apartments is the same as with the perfectly competitive marketso the discriminatory monopo
26、ly outcome is also Pareto efficient.Pareto EfficiencyuMonopoly:not all apartments are occupiedso a distant apartment renter could be assigned a close apartment and have higher welfare without lowering anybody elses welfare.so the monopoly outcome is Pareto inefficient.Pareto EfficiencyuRent Control:
27、some close apartments are assigned to renters valuing them at below the competitive price pesome renters valuing a close apartment above pe dont get close apartmentsPareto inefficient outcome.Harder QuestionsuOver time,willthe supply of close apartments increase?rent control decrease the supply of apartments?a monopolist supply more apartments than a competitive rental market?
