Christopher Makler
Stanford University Department of Economics
Econ 50: Lecture 15
What can go wrong?
Model 2: two consumers, two firms
Model 1: one consumer, one firm
The "social planner's problem"
Market Power
Externalities
Taxes
Suppose you were in charge of the economy.
How would you answer the fundamental economic questions about a particular good?
How to produce it?
Want to produce any given quantity Q
at the lowest possible cost
Who gets to consume it?
How much to produce?
Want to distribute any given quantity Q
to the people who value it the most
Want to choose the quantity Q*
to maximize total surplus
(benefit to consumers minus costs of production)
FIRM
CONSUMER
Quasilinear utility function:
Good 2 is "dollars spent on other goods"
Total benefit (in dollars)
from \(x_1\) units of good 1:
Total cost function:
Note: variable costs only
GROSS CONSUMER'S SURPLUS
(total benefit, in dollars)
Marginal benefit,
in dollars per unit:
(also MRS, marginal willingness to pay)
TOTAL VARIABLE COST
(dollars)
Marginal cost,
in dollars per unit:
FIRM
CONSUMER
Total benefit:
Total cost:
Total welfare:
Marginal welfare from producing another unit:
TOTAL WELFARE
(dollars)
Marginal welfare,
in dollars per unit:
Total benefit to consumers minus total cost to firms
Marginal benefit to consumers minus marginal cost to firms
FIRM
CONSUMER
Maximize net consumer surplus
Maximize profits
FIRM
CONSUMER
Net benefit from buying \(Q\) units at price \(P\):
Net benefit from selling \(Q\) units at price \(P\):
Total welfare:
Marginal welfare from producing another unit:
FIRMS: SUBWAY AND TOGO'S
CONSUMERS: ADAM AND EVE
A = number of sandwiches for Adam
S = number of sandwiches produced by Subway
E = number of sandwiches for Eve
T = number of sandwiches produced by Togo's
How can we choose A, E, S, and T to maximize total benefit minus total cost
subject to the constraint that the total amount produced is the total amount consumed?
If there is a single price in the market that all consumers pay, and all producers receive, and all consumers and producers are “price takers,” then:
Every consumer sets MB = p:
Every firm set MC = p:
Every firm’s MC from the last unit produced is the same.
Cannot reduce total costs by reallocating production from one firm to another
The MB of the last unit consumed by some person
equals the MC of the last unit produced by some firm