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6 Shortage

7 150 gallons = 568 liters

8 San Diego =.5cents per gallon = 1.427$US/Kilolitre = 1.86AUD/Kilolitre

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16 Elasticity of Demand Tells us how responsive consumers are to changes in price η = % Change in Quantity Demand % Change in Price (This is a negative number but is often expressed as a positive number.) Demand is elastic when η is greater than 1 Demand is inelastic when η is less than 1 Demand is unit elastic when η =1 George Mason University School of Law Law & Economics Center

17 Elasticity of Demand P η > 1 (elastic range, MR > 0) η < 1 (inelastic range, MR < 0) MR D If demand is elastic, a 1% decrease in the price will result in a greater than 1% increase in quantity. George Mason University School of Law Law & Economics Center Q

18 Lerner Index P η > 1 (elastic range, MR > 0) MC P* P*-MC η < 1 (inelastic range, MR < 0) Q* MR D Q George Mason University School of Law Law & Economics Center

19 Demand Elasticity and Market Power An important result in economics says that the markup of the monopoly price p* over marginal cost is higher, the less elastic is demand. Lerner Index: P* MC = -1 P* η This formula is basis for critical loss analysis and diversion analysis for implementing the SSNIP test. George Mason University School of Law Law & Economics Center

20 Lerner Index P MC P* P*-MC P*-MC D Q* MR Q* D MR Q George Mason University School of Law Law & Economics Center

21 First Law of Demand: The lower the price at which one can buy a good, the more will one purchase, have, use, or consume (Demand Curves slope downwards). Alchian and Allen, Exchange and Production: Competition, Coordination, & Control, 3d ed, Wadsworth, Stigler s Law of Demand and Supply Elasticities: All demand curves are inelastic, and all supply curves are inelastic too. George J. Stigler, 1982 Nobel Prize winner for Economics, from The Intellectual and the Marketplace, enlarged edition, Harvard University Press (1984) at 75.

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23 Consumer and Social Welfare Consumer welfare is the difference between the value each individual places on a good or service they purchase (measured by their maximum they are willing to pay) and the price they pay for it. Social welfare is the difference between the value each individual places on a good or service they purchase (measured by their maximum willingness to pay) the cost to society of the scarce resources that went into providing that good or service. Roughly speaking the difference between social welfare and consumer welfare goes to firms as profits which then get distributed to their shareholders George Mason University School of Law Law & Economics Center

24 P Consumer Welfare Based on Willingness to Pay MC Consumer Surplus P c Producer Surplus Q c Q George Mason University School of Law Law & Economics Center

25 The Monopoly Pricing Problem P Transfer from Consumers to Producers MC P* Deadweight Loss P c Q* Q c Q George Mason University School of Law Law & Economics Center

26 Application to cartels P Transfer from Consumers to Producers MC P* Deadweight Loss P c Q* Q c When firms collude to raise price consumer welfare decreases for two reasons: (1) some consumers who valued the product don t get it anymore (quantity declines) and (2) other consumers pay more for the product and get less consumer surplus. 60 Q

27 Excess of Market Price over Sellers Value of Home

28 Alchian-Allen Hypothesis: [A] larger proportion of good-quality California Oranges and grapes is shipped for sale to New York while a larger proportion of the poorer quality fruit remains in California? Why is the quality ratio higher, even If the poor districts of New York than California? Armen A. Alchian & William R. Allen, Exchange & Production, Competition Coordination and Control, p.36-7

29 Suppose high quality oranges cost $24 a dozen and low quality Oranges cost $12 a dozen in California. Suppose it costs $8 to ship a dozen oranges to New York. With shipping costs, the Price of high quality oranges will be $32 and the low quality oranges will be $20. In CA, the relative price of a high to low quality orange will be 2 In NY, the relative price of a high to law quality orange will be 1.6

30 Y = Lower Quality Oranges P X The Slope of the CA Budget line is P X /P Y = $24/$12 = 2 X = High Quality Oranges

31 Y = Lower Quality Oranges P X The Slope of the CA Budget line is P X /P Y = $24/$12 = 2 The Slope of the NY Budget line is (P X +S)/(P Y +S) = ($24+$8)/($12+$8) = $32/$20 = 1.6 X = High Quality Oranges

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