Microeconomics 2
Lecture 2
Gains from exchange
Who will win the Nobel Prize in economics in 2013?
In 2012 - below
Lloyd Shapley
Al Roth
See the Guardian video
What did I ask you to do?
• Recall/find the definition of a reservation price
for a buyer (perhaps you used a different expression for it?).
• Recall/find the definition of a reservation price
for a seller(perhaps you used a different expression for it?).
• Assume a discrete good – single units.
• You might also have done this below:
• Recall/find the definition of surplus for a buyer.
• Recall/find the definition of surplus for a seller.
Today’s lecture
• We are going to study some different
exchange/market mechanisms; is there a
‘best’?
• In the olden days, when there were not many
students, I used to get the students to play a
little game.
• I cannot do it here as there are too many of
you, but you can imagine it.
• And you could do it with your friends tonight.
An imaginary market/an experiment
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Buyers and Sellers, a discrete good.
Each Buyer wants to buy at most one unit.
Each Seller wants to sell at most one unit.
Each Buyer has a reservation price for the one
unit – this is the maximum that he or she will
pay for that one unit.
• Each Seller has a reservation price for the one
unit – this is the minimum that he or she will
accept for that one unit.
Profit/Surplus
• The profit/surplus of a buyer is the difference
between the reservation price and the price
paid.
• The profit/surplus of a seller is the difference
between the price received and the
reservation price.
• We will formalise this later.
• Both want to maximise their surplus.
A Particular Market Mechanism
• Bilateral Trades
• Buyers and Sellers negotiate individually and see if
they can agree on a price.
• I asked students to pretend that this was a real
experiment and I would pay them their surpluses.
• So for the buyers I would pay the difference between
the reservation price and the price paid; and for the
buyers I would pay the difference between the price
recieved and the reservation price.
What do you think of this exchange mechanism?
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What do you think of it?
Do you think it might be efficient?
Do you think that it might be fair?
There are lots of other market mechanisms.
Is there a ‘best’?
Let us study a particular mechanism – a
competitive market – in which a price is chosen
such that the demand equals the supply.
• What are the properties of this mechanism?
• Let us go to the html file.
Properties of Competitive Market Mechanism
• Total surplus is maximised.
• With any other single price (not a competive
equilibrium price) the total surplus is less.
• So this mechanism maximises the total surplus
extracted from the market.
• Note however that it says nothing about the
distribution of the surplus or whether it is a fair
mechanism.
• You should also think of other exchange mechanisms
and see if they are efficient and/or fair.
Goodbye!!
• See you next week.