The Market Mechanism

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# The Market Mechanism
## EC 201: Principles of Microeconomics
### Kyle Raze
### Winter 2020

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# Prologue

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# Agenda

## Pit Market Activity

1. Read instructions handout

2. Join a team

3. Make trades and earn extra participation points

## The Market Mechanism

- Activity debrief and discussion

## Midterm 1 Overview

- One week from today!

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# Pit Market Activity

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.center[**Pit Market Results**]

.pull-left[
<img src="05-Market_Mechanism_files/figure-html/price-1.svg" style="display: block; margin: auto;" />
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.pull-right[
<img src="05-Market_Mechanism_files/figure-html/quantity-1.svg" style="display: block; margin: auto;" />
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# The Market Mechanism

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# Pit Market

.less-right[
## .pink[Buyers]

.pink[Maximum willingness to pay:]
.pull-left[
10 of .red[♦️] 
9 of .red[♦️] 
8 of .red[♦️] 
7 of .red[♦️] 
6 of .red[♦️] 
5 of .red[♦️] 
4 of .red[♦️]
]
.pull-right[
10 of .red[♥️] 
9 of .red[♥️] 
8 of .red[♥️] 
7 of .red[♥️] 
6 of .red[♥️] 
]
]

.more-left[
<img src="05-Market_Mechanism_files/figure-html/unnamed-chunk-1-1.svg" style="display: block; margin: auto;" />
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# Pit Market

.less-right[
## .purple[Sellers]

.purple[Minimum willingness to accept:]
.pull-left[
2 of ♠️ 
3 of ♠️ 
4 of ♠️ 
5 of ♠️ 
6 of ♠️ 
7 of ♠️ 
8 of ♠️
]
.pull-right[
2 of ♣️ 
3 of ♣️ 
4 of ♣️ 
5 of ♣️ 
6 of ♣️
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<img src="05-Market_Mechanism_files/figure-html/unnamed-chunk-2-1.svg" style="display: block; margin: auto;" />
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# Pit Market

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## .purple[Sellers]

The tax increases each seller's cost by .mono[$]2.

]

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<img src="05-Market_Mechanism_files/figure-html/unnamed-chunk-3-1.svg" style="display: block; margin: auto;" />
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# Pit Market

.less-right[
## Equilibrium

Theory predicts that a price of .mono[$]6 clears the market..super[.pink[&#8224;]]

**Q:** Who trades? Who doesn't?

]

.more-left[
<img src="05-Market_Mechanism_files/figure-html/unnamed-chunk-4-1.svg" style="display: block; margin: auto;" />
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.footnote[.pink[&#8224;]: *Clears the market* .mono[<=>] Q.sub[D] .mono[=] Q.sub[S].]

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# Pit Market

.less-right[
## Equilibrium

Theory predicts that a price of .mono[$]6 clears the market..super[.pink[&#8224;]]

**Q:** Who trades? Who doesn't?

]

.more-left[
<img src="05-Market_Mechanism_files/figure-html/unnamed-chunk-5-1.svg" style="display: block; margin: auto;" />
]

.footnote[.pink[&#8224;]: *Clears the market* .mono[<=>] Q.sub[D] .mono[=] Q.sub[S].]

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# Pit Market

.less-right[
## Equilibrium

Theory predicts that a price of .mono[$]6 clears the market..super[.pink[&#8224;]]

**Q:** Who trades? Who doesn't?

]

.more-left[
<img src="05-Market_Mechanism_files/figure-html/unnamed-chunk-6-1.svg" style="display: block; margin: auto;" />
]

.footnote[.pink[&#8224;]: *Clears the market* .mono[<=>] Q.sub[D] .mono[=] Q.sub[S].]

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# Pit Market

.less-right[
## Equilibrium

Theory predicts that a price of .mono[$]6 clears the market..super[.pink[&#8224;]]

**Q:** Who trades? Who doesn't?

]

.more-left[
<img src="05-Market_Mechanism_files/figure-html/unnamed-chunk-7-1.svg" style="display: block; margin: auto;" />
]

.footnote[.pink[&#8224;]: *Clears the market* .mono[<=>] Q.sub[D] .mono[=] Q.sub[S].]

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# Pit Market

.less-right[
## Market Surplus

Theory predicts that prices above .mono[$]6 create a market surplus..super[.pink[&#8224;]]

]

.more-left[
<img src="05-Market_Mechanism_files/figure-html/unnamed-chunk-8-1.svg" style="display: block; margin: auto;" />
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.footnote[.pink[&#8224;]: *Market surplus* .mono[<=>] Q.sub[D] .mono[<] Q.sub[S].]

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# Pit Market

.less-right[
## Market Surplus

Theory predicts that prices above .mono[$]6 create a market surplus..super[.pink[&#8224;]]

]

.more-left[
<img src="05-Market_Mechanism_files/figure-html/unnamed-chunk-9-1.svg" style="display: block; margin: auto;" />
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.footnote[.pink[&#8224;]: *Market surplus* .mono[<=>] Q.sub[D] .mono[<] Q.sub[S].]

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# Pit Market

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## Shortage

Theory predicts that prices below .mono[$]6 create a shortage..super[.pink[&#8224;]]

]

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<img src="05-Market_Mechanism_files/figure-html/unnamed-chunk-10-1.svg" style="display: block; margin: auto;" />
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.footnote[.pink[&#8224;]: *Shortage* .mono[<=>] Q.sub[D] .mono[>] Q.sub[S].]

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# Pit Market

.less-right[
## Shortage

Theory predicts that prices below .mono[$]6 create a shortage..super[.pink[&#8224;]]

]

.more-left[
<img src="05-Market_Mechanism_files/figure-html/unnamed-chunk-11-1.svg" style="display: block; margin: auto;" />
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.footnote[.pink[&#8224;]: *Shortage* .mono[<=>] Q.sub[D] .mono[>] Q.sub[S].]

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# Pit Market

.less-right[
## Tax

The tax increases each seller's cost by .mono[$]2:

1. Supply curve shifts.
2. Market adjusts to a new equilibrium.

**Q:** By how much does the equilibrium price increase?

]

.more-left[
<img src="05-Market_Mechanism_files/figure-html/unnamed-chunk-12-1.svg" style="display: block; margin: auto;" />
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# Pit Market

.less-right[
## Tax

The tax increases each seller's cost by .mono[$]2:

1. Supply curve shifts.
2. Market adjusts to a new equilibrium.

**Q:** By how much does the equilibrium price increase?

]

.more-left[
<img src="05-Market_Mechanism_files/figure-html/unnamed-chunk-13-1.svg" style="display: block; margin: auto;" />
]

---
count: false
# Pit Market

.less-right[
## Tax

The tax increases each seller's cost by .mono[$]2:

1. Supply curve shifts.
2. Market adjusts to a new equilibrium.

**Q:** By how much does the equilibrium price increase?

]

.more-left[
<img src="05-Market_Mechanism_files/figure-html/unnamed-chunk-14-1.svg" style="display: block; margin: auto;" />
]

---
count: false
# Pit Market

.less-right[
## Tax

The tax increases each seller's cost by .mono[$]2:

1. Supply curve shifts.
2. Market adjusts to a new equilibrium.

**Q:** By how much does the equilibrium price increase?

]

.more-left[
<img src="05-Market_Mechanism_files/figure-html/unnamed-chunk-15-1.svg" style="display: block; margin: auto;" />
]

---
count: false
# Pit Market

.less-right[
## Tax

The tax increases each seller's cost by .mono[$]2:

1. Supply curve shifts.
2. Market adjusts to a new equilibrium.

**Q:** By how much does the equilibrium price increase?

]

.more-left[
<img src="05-Market_Mechanism_files/figure-html/unnamed-chunk-16-1.svg" style="display: block; margin: auto;" />
]

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# Mutual Gains from Trade

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.pink[Consumer surplus] .mono[=] sum of buyers' earnings.

.purple[Producer surplus] .mono[=] sum of sellers' earnings.

.green[Total surplus] .mono[=] .pink[consumer surplus] .mono[+] .purple[producer surplus].

]

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<img src="05-Market_Mechanism_files/figure-html/unnamed-chunk-17-1.svg" style="display: block; margin: auto;" />
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# Mutual Gains from Trade

.less-right[

.pink[Consumer surplus] .mono[=] sum of buyers' earnings.

.purple[Producer surplus] .mono[=] sum of sellers' earnings.

.green[Total surplus] .mono[=] .pink[consumer surplus] .mono[+] .purple[producer surplus].

]

.more-left[
<img src="05-Market_Mechanism_files/figure-html/unnamed-chunk-18-1.svg" style="display: block; margin: auto;" />
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# Mutual Gains from Trade

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## Market Surplus

P .mono[=].mono[$]7.50 .mono[==>] TS .mono[=] .mono[$]36.

]

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<img src="05-Market_Mechanism_files/figure-html/unnamed-chunk-19-1.svg" style="display: block; margin: auto;" />
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# Mutual Gains from Trade

.less-right[
## Shortage

P .mono[=].mono[$]4.50 .mono[==>] TS .mono[=] .mono[$]36.

]

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<img src="05-Market_Mechanism_files/figure-html/unnamed-chunk-20-1.svg" style="display: block; margin: auto;" />
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# Mutual Gains from Trade

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## Equilibrium

P .mono[=].mono[$]6 .mono[==>] TS .mono[=] .mono[$]40.

]

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<img src="05-Market_Mechanism_files/figure-html/unnamed-chunk-21-1.svg" style="display: block; margin: auto;" />
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# Mutual Gains from Trade

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## Intervention

**Q:** True or false? The government can increase TS by mandating 12 trades.

> **A.** True

> **B.** False

]

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# Mutual Gains from Trade

.less-right[
## Intervention

**Q:** True or false? The government can increase TS by mandating 12 trades.

> **A.** True

> .pink[**B.** False]

]

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<img src="05-Market_Mechanism_files/figure-html/unnamed-chunk-23-1.svg" style="display: block; margin: auto;" />
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# Mutual Gains from Trade

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## Intervention

**Q:** True or false? The government can increase TS by mandating 12 trades.

> **A.** True

> .pink[**B.** False]

TS would decrease from .mono[$]40 to .mono[$]34

]

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**Q:** What is the source of mutual benefits from voluntary trade?

**A:** .pink[Differences in marginal values.]

**Example:** You own a pair of sneakers. You value them at .mono[$]20. I value them at .mono[$]50. Could we benefit from trade?

- **A:** Yes! Marginal value differential of .mono[$]30 .mono[=] .mono[$]30 in mutual benefits!.super[.pink[&#8224;]]

.footnote[.pink[&#8224;]: The distribution of the benefits depends on the price we negotiate.]

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**Q:** What role do "middlemen".super[.pink[&#8224;]] play?

.footnote[.pink[&#8224;]: *e.g.,* real estate agents, stock brokers, grocers, retailers, *etc.*]
--

**A:** .pink[They play match-maker in exchange for part of the marginal-value differential.]

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# Efficiency

## Definition 1 (market-specific)

> The outcome that maximizes mutual benefits from voluntary trade (*i.e.,* total surplus).

## Definition 2 (more general)

> The absence of waste.

## Definition 3 (.pink[*Pareto Efficiency*])

> The state in which no person can be made better off without harming someone else.

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**Podcast Question:** What problem(s) did Alaska's food bank have before *Feeding America* established an auction market?

> **A.** It received too few pickles.

> **B.** It received so much fresh produce that it would rot before people could eat it.

> **C.** It received too many potatoes.

> **D.** It received too few potatoes.

> **E.** It received too many pickles.

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**Podcast Question:** What problem(s) did Alaska's food bank have before *Feeding America* established an auction market?

> **A.** It received too few pickles.

> **B.** It received so much fresh produce that it would rot before people could eat it.

> **C.** It received too many potatoes.

> **D.** It received too few potatoes.

> .pink[**E.** It received too many pickles.]

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**Podcast Question:** Which food banks received the most "fake money" to use in the auction market?

> **A.** Those in relatively affluent areas.

> **B.** Those in relatively poor areas.

> **C.** Those with the most donors.

> **D.** Those most willing to pay.

> **E.** Those with the most food stockpiled.

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**Podcast Question:** Which food banks received the most "fake money" to use in the auction market?

> **A.** Those in relatively affluent areas.

> .pink[**B.** Those in relatively poor areas.]

> **C.** Those with the most donors.

> **D.** Those most willing to pay.

> **E.** Those with the most food stockpiled.

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**Q:** What problems did the *Feeding America* auction market solve?

1. .pink[Local information problem:] Food bank directors knew exactly what they wanted, but *Feeding America* executives had to make guesses.

2. .pink[Shortages and surpluses:] Food banks had insufficient quantities of sought-after items but abundant quantities of unwanted items.

**Q:** Are food banks and their clients better off now than they were before?

**A:** Yes.

- Less food waste .mono[-->] more food for people in need.

- .pink[*Pareto improving:*] More mutually beneficial transactions..super[.pink[&#8224;]]

.footnote[.pink[&#8224;]: *Pareto improvement* .mono[=] A transaction that makes at least one person better off without harming others.]

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# Efficient Markets

## Conditions

1. Well-defined property rights.

2. No market power.

3. *Symmetric* information.

## Result

> If all three conditions hold, then an *unregulated* market maximizes total surplus.

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# Efficient Markets

## Result

> If all three conditions hold, then an *unregulated* market maximizes total surplus.

## Implications

1. When all three conditions hold, government intervention in a market can generate inefficient outcomes.

2. When at least one condition fails, an *unregulated* market can generate inefficient outcomes.

- Well-designed government intervention *can* redress inefficiencies.

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# Efficient Markets

**Q:** What kinds of markets are most likely to yield efficient outcomes?

**A:** Markets that feature

1. Transactions that don't hurt or help those outside the transaction.

2. Many buyers and sellers.

3. Goods with easily observable quality.

Examples?

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# Midterm 1

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# Midterm Topics

.green[Anything from the lectures, discussions, or podcasts] .hi-green[is fair game!]

1. What is Economics?

2. Motivating the Economic Problem

3. Consumer Theory I

4. Consumer Theory II

5. The Market Mechanism

6. Demand and Supply

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# Midterm Structure

## Multiple Choice

- 50 questions
- 1 point per question

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# Midterm Protocol

## Materials

- Writing utensil
- 3-inch-by-5-inch note card
- Basic or scientific calculator (no graphing or programming capabilities)
- .hi[Nothing else]

## Procedure

- **Randomized** seating chart
- 80 minutes from *"you may begin"* to *"pencils down"*
- First 30 minutes: .hi[quiet period] (no questions, no getting up)
- Last 50 minutes: ask lots of questions
- Show your UO ID card as you turn-in your exam

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# Midterm Preparation

1. Lecture slides

2. Discussion worksheets

3. Practice midterm questions

- No solutions posted, but you can ask about the questions in office hours.

4. Extended office hours

- M 14:00-15:00 and T 14:30-17:30 in **412 PLC**
    
5. Textbook (additional practice problems)

6. Prepare your note card