Microeconomics
Lecture 2
Gains from exchange
Attention!
• I am giving each of you a piece of
paper.
• On it is written information useful
to you and private.
• Do NOT show it to anyone else!!!
An Imaginary Market
•
•
•
•
Buyers and Sellers.
Each Buyer wants to buy one unit.
Each Seller wants to sell 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.
• 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.
• Pretend that this is a real experiment and I will pay
you your surpluses:
• So for the buyers I will pay the difference between
the reservation price and the price paid; and for the
buyers I will pay the difference between the price
recieved and the reservation price.
Are you ready?
• You should find someone who will
trade with you and you should
agree on the price.
• OK: GO!!!
• If you agree a trade with someone,
come to me and we will write the
details on the computer here.
Buyer
Reservation Seller
price of
buyer
Reservation Price
price of
agreed
seller
Profit of Profit of
buyer
seller
Information not normally available
•
•
•
•
•
Imagine that there are
10 buyers with a reservation price of £10
10 buyers with a reservation price of £20
...
10 buyers with a reservation price of £100
•
•
•
•
10 sellers with a reservation price of £10
10 sellers with a reservation price of £20
...
10 sellers with a reservation price of £100
We have studied a particular
mechanism
• What do you think of it?
• Is it efficient?
• Is it fair?
• Let us now study another mechanism – a
competitive market – in which a price is chosen
such that the demand equals the supply.
• What are the properties of this mechanism?
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.
Goodbye!!
• See you tomorrow.