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PROFESSOR: We want to turn
this course to now start

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00:00:25,830 --> 00:00:28,270
talking about some normative
economics, which is how do we

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00:00:28,270 --> 00:00:31,030
feel about the actions firms
and consumers take.

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00:00:31,030 --> 00:00:33,640
And to do that we need to
pause, and starting last

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00:00:33,640 --> 00:00:36,970
lecture now through this
lecture, talk about welfare.

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00:00:36,970 --> 00:00:37,980
Well-being.

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00:00:37,980 --> 00:00:41,530
How do we measure the well-being
implications of

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00:00:41,530 --> 00:00:44,910
individual and firm actions?

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00:00:44,910 --> 00:00:48,770
Now, we talked last time about
the first concept of this,

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00:00:48,770 --> 00:00:51,010
which was consumer surplus.

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00:00:51,010 --> 00:00:57,840
Consumer surplus was the amount
of utility consumers

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00:00:57,840 --> 00:01:00,640
derived above and beyond
the price they had

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00:01:00,640 --> 00:01:01,670
to pay for the good.

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00:01:01,670 --> 00:01:03,285
Now, since it's utility,
remember, it's not ordinal,

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00:01:03,285 --> 00:01:04,569
it's cardinal.

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00:01:04,569 --> 00:01:06,130
We redefine that.

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00:01:06,130 --> 00:01:09,680
That is the consumer's
willingness to pay above the

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00:01:09,680 --> 00:01:11,490
price that they pay
for a good.

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00:01:11,490 --> 00:01:14,380
So, anything a consumer's
willing to pay that was higher

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00:01:14,380 --> 00:01:18,730
than the price they actually
paid is consumer surplus.

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00:01:18,730 --> 00:01:20,050
And that was at the
individual level.

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00:01:20,050 --> 00:01:22,180
That was the individual
consumer surplus.

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00:01:22,180 --> 00:01:24,810
Now what we want to do is move
on and talk about market

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00:01:24,810 --> 00:01:26,060
consumer surplus.

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00:01:29,250 --> 00:01:33,110
So for an individual, consumer
surplus is a willingness to

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00:01:33,110 --> 00:01:35,490
pay above the price
actually paid.

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00:01:35,490 --> 00:01:38,510
At the market level, it's
the same thing.

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00:01:38,510 --> 00:01:43,850
It's just the aggregation of
individual consumer surpluses.

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00:01:43,850 --> 00:01:46,870
So let's think about
a simple example.

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00:01:46,870 --> 00:01:50,630
Let's think about the case of
the consumer surplus that you

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00:01:50,630 --> 00:01:53,270
derive from my lectures.

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00:01:53,270 --> 00:01:54,420
Let's think about the
consumer surplus you

40
00:01:54,420 --> 00:01:56,120
derive from my lectures.

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00:01:56,120 --> 00:01:58,180
So we have some demand curve
for my lectures.

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00:01:58,180 --> 00:02:00,410
Let's look at figure 13-1.

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00:02:00,410 --> 00:02:03,910
Let's say this is the demand
curve for my lectures.

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00:02:03,910 --> 00:02:07,040
So basically, this is a
willingness to pay.

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00:02:07,040 --> 00:02:10,600
So the notion is that there's
some student who's willing to

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00:02:10,600 --> 00:02:12,740
pay a large amount because they
recognize the brilliance

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00:02:12,740 --> 00:02:14,020
of what they're hearing here.

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00:02:14,020 --> 00:02:16,890
And they're willing to pay a
large amount for my lectures.

49
00:02:16,890 --> 00:02:18,990
Then the next student's willing
to pay slightly less.

50
00:02:18,990 --> 00:02:22,220
All the way down to the student
who falls asleep every

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00:02:22,220 --> 00:02:25,050
time who's not willing to pay
anything for my lectures.

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00:02:25,050 --> 00:02:26,770
So you've got some demand
curve for my lectures.

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00:02:26,770 --> 00:02:29,320
And, once again, the key to
all this, the key to the

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00:02:29,320 --> 00:02:31,820
welfare analysis, is to remember
what this demand

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00:02:31,820 --> 00:02:32,390
curve represents.

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00:02:32,390 --> 00:02:34,370
It's a willingness
to pay curve.

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00:02:34,370 --> 00:02:36,260
But in this case, it's
not an individual's

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00:02:36,260 --> 00:02:36,962
willingness to pay.

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00:02:36,962 --> 00:02:38,620
It's the market's willingness
to pay.

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00:02:38,620 --> 00:02:41,220
Where each point is
a unit of demand.

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00:02:41,220 --> 00:02:44,350
So in this case, one unit
equals one person.

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So each point represents
the willingness

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00:02:45,900 --> 00:02:47,430
to pay of that person.

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00:02:47,430 --> 00:02:49,995
So the point on the y-axis
represents the willingness to

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00:02:49,995 --> 00:02:53,450
pay of the person who most
enjoys my lectures.

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Or derives the most
value out of them.

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00:02:55,320 --> 00:02:58,470
The intersection of that line
with the x-axis is a

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00:02:58,470 --> 00:02:59,910
willingness to pay of zero,
someone who's not willing to

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00:02:59,910 --> 00:03:02,130
pay anything for the lectures.

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00:03:02,130 --> 00:03:03,150
Obviously, could go negative.

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00:03:03,150 --> 00:03:05,600
People could be willing to pay
not have to come to the

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00:03:05,600 --> 00:03:07,170
lecture, but we won't
consider that.

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00:03:07,170 --> 00:03:10,000
We'll just say zero's
the minimum.

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00:03:10,000 --> 00:03:13,900
So, basically, what is the
key determinant of

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00:03:13,900 --> 00:03:15,950
the equilibrium outcome?

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00:03:15,950 --> 00:03:20,270
It is the point where,
equilibrium is the point,

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where the price is set equal to
the willingness to pay of

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00:03:24,870 --> 00:03:26,450
the marginal consumer.

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00:03:26,450 --> 00:03:30,610
So if you think about typical
supply-demand diagram, and we

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00:03:30,610 --> 00:03:32,760
get some equilibrium price.

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00:03:32,760 --> 00:03:35,260
So here's our equilibrium
quantity, Q-star.

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00:03:35,260 --> 00:03:37,690
And here's our program
price, P-star.

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00:03:37,690 --> 00:03:40,090
Now, let's focus in on
this demand curve.

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00:03:40,090 --> 00:03:43,690
With that price P-star,
it represents--

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00:03:43,690 --> 00:03:46,770
it's on the demand curve, so
it's a willingness to pay.

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00:03:46,770 --> 00:03:48,670
Whose willingness
to pay is it?

87
00:03:48,670 --> 00:03:51,450
It's the willingness to
pay of person Q-star.

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00:03:51,450 --> 00:03:54,420
It's the willingness to pay of
the person who's exactly

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00:03:54,420 --> 00:03:56,740
willing to pay the price.

90
00:03:56,740 --> 00:04:00,290
That is, the equilibrium in a
perfectly competitive market,

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00:04:00,290 --> 00:04:05,620
of the kind we've discussed so
far, the price represents the

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00:04:05,620 --> 00:04:08,900
willingness to pay of the
marginal consumer.

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00:04:08,900 --> 00:04:13,410
The willingness to pay of the
consumer who exactly is

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00:04:13,410 --> 00:04:16,640
indifferent between consuming
and not consuming the good.

95
00:04:16,640 --> 00:04:20,839
So this consumer, Q-star, this
person Q-star in our example,

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00:04:20,839 --> 00:04:22,980
is the person who's
indifferent.

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00:04:22,980 --> 00:04:27,040
Who derives, what, zero
consumer surplus.

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00:04:27,040 --> 00:04:30,170
This person, since their
willingness to pay equals the

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00:04:30,170 --> 00:04:36,550
price, equilibrium is achieved
where the price is set--

100
00:04:36,550 --> 00:04:39,950
In equilibrium, you have that
the marginal consumer, the

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last person consuming,
is deriving

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00:04:42,240 --> 00:04:44,190
zero consumer surplus.

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00:04:44,190 --> 00:04:47,470
They're indifferent between
consuming the good and not

104
00:04:47,470 --> 00:04:49,550
consuming the good
at that price.

105
00:04:49,550 --> 00:04:51,780
If it was free, they'd be happy
to consume it, but at

106
00:04:51,780 --> 00:04:54,090
the price, at that equilibrium
price P-star, they're

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00:04:54,090 --> 00:04:55,950
indifferent.

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00:04:55,950 --> 00:04:59,270
So basically, looking at the
diagram, what this is saying

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00:04:59,270 --> 00:05:03,170
is that the price was
$100 a lecture.

110
00:05:03,170 --> 00:05:07,530
Then person 100, that hundredth
person, would be the

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00:05:07,530 --> 00:05:11,460
marginal consumer who's
indifferent between paying the

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00:05:11,460 --> 00:05:13,710
$100 and hearing my lecture
or paying nothing

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00:05:13,710 --> 00:05:15,860
and skipping my lecture.

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00:05:15,860 --> 00:05:19,180
So that person 100 is the
person who's indifferent

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00:05:19,180 --> 00:05:22,375
between paying $100 and hearing
my lecture or paying

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00:05:22,375 --> 00:05:23,880
zero and not hearing
my lecture.

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00:05:23,880 --> 00:05:27,670
That person drives no
consumer surplus.

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00:05:27,670 --> 00:05:30,290
Because their willingness
to pay equals the price.

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00:05:30,290 --> 00:05:34,550
What that means is that every
consumer up to the first 100,

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00:05:34,550 --> 00:05:36,740
by definition, must be deriving

121
00:05:36,740 --> 00:05:38,570
some consumer surplus.

122
00:05:38,570 --> 00:05:41,770
As long as the demand curve
is downward sloping.

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00:05:41,770 --> 00:05:44,270
As long as the demand curve is
downward sloping, every person

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00:05:44,270 --> 00:05:46,800
to the left of person
100 must be deriving

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00:05:46,800 --> 00:05:48,690
some consumer surplus.

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00:05:48,690 --> 00:05:51,340
In particular, the first person
is driving enormous

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00:05:51,340 --> 00:05:52,450
consumer surplus.

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00:05:52,450 --> 00:05:53,200
How can we prove that?

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00:05:53,200 --> 00:05:54,180
Well, the proof is simple.

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00:05:54,180 --> 00:05:59,590
We know their willingness to pay
is higher than person 100.

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00:05:59,590 --> 00:06:02,810
And we know person 100 is
willing to pay $100.

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00:06:02,810 --> 00:06:05,470
Therefore, by definition anyone
to the left is deriving

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00:06:05,470 --> 00:06:07,860
consumer surplus from this.

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00:06:07,860 --> 00:06:10,070
Because we know they like it
more than person 100, and

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00:06:10,070 --> 00:06:11,990
person 100 is willing
to pay $100.

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00:06:11,990 --> 00:06:15,000
They only have to pay $100, it's
one price to everybody.

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00:06:15,000 --> 00:06:18,540
So by definition, they're
deriving consumer surplus.

138
00:06:18,540 --> 00:06:24,910
So the first guy, he or she gets
a big consumer surplus.

139
00:06:24,910 --> 00:06:26,915
Then it dwindles and dwindles
and dwindles until the

140
00:06:26,915 --> 00:06:28,670
hundredth person derives zero.

141
00:06:28,670 --> 00:06:32,250
But, if you integrate, and the
entire consumer surplus for

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00:06:32,250 --> 00:06:35,020
the market is that entire
triangle, that

143
00:06:35,020 --> 00:06:36,570
entire shaded triangle.

144
00:06:36,570 --> 00:06:40,080
So market consumer surplus is
defined the same as individual

145
00:06:40,080 --> 00:06:41,330
consumer surplus, as
the difference

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00:06:41,330 --> 00:06:42,420
between the demand curve.

147
00:06:42,420 --> 00:06:44,675
It's the area under the demand
curve above the price.

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00:06:44,675 --> 00:06:47,490
So it's the integral of that
area, under the demand curve,

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00:06:47,490 --> 00:06:49,250
above the price.

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00:06:49,250 --> 00:06:51,220
But here we're thinking of it
not in terms of a person's

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00:06:51,220 --> 00:06:52,770
decision but the market's
decision.

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00:06:52,770 --> 00:06:54,870
And when you think about that,
it is the last unit be

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00:06:54,870 --> 00:06:56,730
representing the person
who's indifferent.

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00:06:56,730 --> 00:07:00,730
And everybody else deriving
surplus from it.

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00:07:00,730 --> 00:07:03,540
Questions about that?

156
00:07:03,540 --> 00:07:06,870
Now, let's ask what, then would
happen if the price of

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00:07:06,870 --> 00:07:08,750
my lecture rate rose.

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00:07:08,750 --> 00:07:11,010
So let's say I was charging
$100 boxes at the door.

159
00:07:11,010 --> 00:07:13,550
You guys are all the guys to
the left of person 100.

160
00:07:13,550 --> 00:07:14,930
Those people who were here for
the first lecture and don't

161
00:07:14,930 --> 00:07:16,620
show up any more, they're
the people to the

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00:07:16,620 --> 00:07:19,880
right of person 100.

163
00:07:19,880 --> 00:07:21,540
And now let's say I change.

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00:07:21,540 --> 00:07:23,580
Instead of charging $100
at the door, I

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00:07:23,580 --> 00:07:25,570
charge $110 at the door.

166
00:07:25,570 --> 00:07:29,350
So let's look at figure 13-2.

167
00:07:29,350 --> 00:07:31,630
What happens there?

168
00:07:31,630 --> 00:07:39,070
Well, in that case, if I charge
$110, the hundredth guy

169
00:07:39,070 --> 00:07:41,190
is no longer willing
to come to lecture.

170
00:07:41,190 --> 00:07:44,550
Remember, the hundredth guy,
he or she was indifferent

171
00:07:44,550 --> 00:07:46,480
between paying $100 and hearing
my lecture and paying

172
00:07:46,480 --> 00:07:47,840
nothing and missing
my lecture.

173
00:07:47,840 --> 00:07:50,125
Well at $110, clearly, they'll
say forget it, it's not worth

174
00:07:50,125 --> 00:07:50,900
it any more.

175
00:07:50,900 --> 00:07:52,450
They'll drop out.

176
00:07:52,450 --> 00:07:55,560
Likewise, the way I've drawn
this diagram, everybody above

177
00:07:55,560 --> 00:07:58,960
person 90 will no
longer attend.

178
00:07:58,960 --> 00:08:01,830
That is, person 90 is now the
person, where at a price of

179
00:08:01,830 --> 00:08:04,820
$110 they're indifferent between
paying and attending

180
00:08:04,820 --> 00:08:07,640
or not paying and
not attending.

181
00:08:07,640 --> 00:08:09,830
Everybody to the left
of person 90 still

182
00:08:09,830 --> 00:08:10,760
gets consumer surplus.

183
00:08:10,760 --> 00:08:12,990
It's not shaded, but if you
shade the triangle above the

184
00:08:12,990 --> 00:08:16,230
$110 dashed line, the triangle
under the demand curve and

185
00:08:16,230 --> 00:08:18,980
above with a dashed line
at $110, that's the

186
00:08:18,980 --> 00:08:22,140
new consumer surplus.

187
00:08:22,140 --> 00:08:23,670
That's the new consumer
surplus.

188
00:08:23,670 --> 00:08:25,280
Those people still derive
consumer surplus because they

189
00:08:25,280 --> 00:08:29,250
love me so much that they're
willing to pay more than $110.

190
00:08:29,250 --> 00:08:31,990
So even $110, and they
prefer to pay $100.

191
00:08:31,990 --> 00:08:34,070
But even $110 they'll still
come and they'll still be

192
00:08:34,070 --> 00:08:35,340
happy about it.

193
00:08:35,340 --> 00:08:37,940
But now 10 people have dropped
out because they're not

194
00:08:37,940 --> 00:08:39,320
willing to pay $110.

195
00:08:39,320 --> 00:08:41,750
They were only willing
to pay $100.

196
00:08:41,750 --> 00:08:44,540
So what we see is
that the total

197
00:08:44,540 --> 00:08:46,450
consumer surplus has shrunk.

198
00:08:46,450 --> 00:08:51,910
It's shrunk by this trapezoid,
by this shaded trapezoid.

199
00:08:51,910 --> 00:08:55,010
And it's shrunk for
two reasons.

200
00:08:55,010 --> 00:08:59,180
One reason is that some people
who used to derive consumer

201
00:08:59,180 --> 00:09:01,480
surplus now are out
of the market.

202
00:09:01,480 --> 00:09:02,840
That's the triangle.

203
00:09:02,840 --> 00:09:05,240
That's the shaded triangle.

204
00:09:05,240 --> 00:09:08,730
It's also shrunk because even
people staying in the market

205
00:09:08,730 --> 00:09:10,570
are now sadder.

206
00:09:10,570 --> 00:09:11,960
They've lost consumer surplus.

207
00:09:11,960 --> 00:09:14,010
The consumer surplus
is still positive.

208
00:09:14,010 --> 00:09:16,400
They're still coming to the
lecture, but it's smaller than

209
00:09:16,400 --> 00:09:18,860
it was, and that's
the rectangle.

210
00:09:18,860 --> 00:09:22,530
So the triangle is the people
who drop out of the market.

211
00:09:22,530 --> 00:09:27,210
The rectangle is the reduced
consumer surplus, the reduced

212
00:09:27,210 --> 00:09:29,290
consumer surplus of people who
stay in the market but now

213
00:09:29,290 --> 00:09:31,200
have to pay $10 more.

214
00:09:31,200 --> 00:09:33,100
The consumer surplus is still
positive, but it's smaller.

215
00:09:35,960 --> 00:09:38,170
So, a question to you.

216
00:09:38,170 --> 00:09:44,170
What is the key economic
concept that's going to

217
00:09:44,170 --> 00:09:48,360
determine, for a given market,
whether the consumer surplus

218
00:09:48,360 --> 00:09:49,910
is large or small?

219
00:09:49,910 --> 00:09:50,760
Yeah?

220
00:09:50,760 --> 00:09:51,210
AUDIENCE: Elasticity.

221
00:09:51,210 --> 00:09:51,950
PROFESSOR: The elasticity.

222
00:09:51,950 --> 00:09:53,080
And why is that?

223
00:09:53,080 --> 00:09:56,890
AUDIENCE: Because it changes
how steeply--

224
00:09:56,890 --> 00:09:57,700
PROFESSOR: Exactly.

225
00:09:57,700 --> 00:10:04,820
So if we look at figure 13-3,
now here is a case with a

226
00:10:04,820 --> 00:10:06,360
steeper elasticity
of demand, where

227
00:10:06,360 --> 00:10:08,780
consumers are more inelastic.

228
00:10:08,780 --> 00:10:11,810
If you compare it to figure
13-1, you'll see the consumer

229
00:10:11,810 --> 00:10:15,660
surplus triangle
is much bigger.

230
00:10:15,660 --> 00:10:20,030
Likewise, if we drew a flatter
demand curve, a more elastic

231
00:10:20,030 --> 00:10:25,630
demand, the consumer surplus
would be much smaller.

232
00:10:25,630 --> 00:10:27,450
So hopefully you can see
graphically what will

233
00:10:27,450 --> 00:10:31,050
determine consumer surplus is
the elasticity of demand.

234
00:10:31,050 --> 00:10:33,650
Now, can someone give me the
intuition for why that's true?

235
00:10:33,650 --> 00:10:34,990
Graphically, I hope you
can see it's true.

236
00:10:34,990 --> 00:10:38,030
The triangle will be smaller
as that curve is flatter.

237
00:10:38,030 --> 00:10:40,010
Can someone give me the
intuition for why that's true?

238
00:10:40,010 --> 00:10:42,890
Why is it that consumer surplus
is larger the more

239
00:10:42,890 --> 00:10:45,575
inelastic is demand, and
consumer surplus is smaller

240
00:10:45,575 --> 00:10:48,510
the more elastic is demand.

241
00:10:48,510 --> 00:10:50,294
Want to give it a try?

242
00:10:50,294 --> 00:10:52,754
AUDIENCE: I guess if it's more
inelastic, then consumers

243
00:10:52,754 --> 00:10:56,200
don't have--

244
00:10:56,200 --> 00:10:57,180
PROFESSOR: They don't
have what?

245
00:10:57,180 --> 00:10:58,160
[UNINTELLIGIBLE]

246
00:10:58,160 --> 00:11:00,120
What determines it?

247
00:11:00,120 --> 00:11:00,420
AUDIENCE: As many choices,
I would say.

248
00:11:00,420 --> 00:11:02,040
PROFESSOR: They don't have
as many substitutes.

249
00:11:02,040 --> 00:11:05,500
So with inelastic demand is when
consumers don't have as

250
00:11:05,500 --> 00:11:06,840
many substitutes.

251
00:11:06,840 --> 00:11:09,460
In that case they get a
lot of surplus from

252
00:11:09,460 --> 00:11:10,850
consuming this good.

253
00:11:10,850 --> 00:11:14,310
So think about insulin
versus McDonald's.

254
00:11:14,310 --> 00:11:17,980
The consumer surplus from
insulin is very, very high.

255
00:11:17,980 --> 00:11:21,170
Because regardless of the
price, I die without it.

256
00:11:21,170 --> 00:11:23,520
And there's no substitute.

257
00:11:23,520 --> 00:11:27,970
So it's a very inelastically
demanded good, and as a

258
00:11:27,970 --> 00:11:31,670
result, at any price, I derive
a huge consumer surplus

259
00:11:31,670 --> 00:11:33,730
because as long as that price
is less than the value of my

260
00:11:33,730 --> 00:11:37,660
life, I derive a big
consumer surplus.

261
00:11:37,660 --> 00:11:39,600
Now let's take McDonald's.

262
00:11:39,600 --> 00:11:42,780
I can always go to Burger King
and be equally happy.

263
00:11:42,780 --> 00:11:44,280
Maybe not quite equally
happy, the curve

264
00:11:44,280 --> 00:11:44,950
isn't perfectly elastic.

265
00:11:44,950 --> 00:11:46,160
I like McDonald's a
little bit more.

266
00:11:46,160 --> 00:11:48,960
I like the prizes in their
Happy Meals better.

267
00:11:48,960 --> 00:11:51,580
So it's a little bit elastic,
but the point is, if

268
00:11:51,580 --> 00:11:55,320
McDonald's raises the price,
I'm not that much sadder

269
00:11:55,320 --> 00:11:57,340
because I just go to Burger
King where I was perfectly

270
00:11:57,340 --> 00:11:58,500
happy as well.

271
00:11:58,500 --> 00:12:00,830
So there's not much lost
consumer surplus if McDonald's

272
00:12:00,830 --> 00:12:01,490
raises the price.

273
00:12:01,490 --> 00:12:05,710
There's not much consumer
surplus arising.

274
00:12:05,710 --> 00:12:07,410
There's not that much
consumer surplus--

275
00:12:07,410 --> 00:12:08,120
forget the loss.

276
00:12:08,120 --> 00:12:08,990
Go back.

277
00:12:08,990 --> 00:12:10,270
That's a different issue.

278
00:12:10,270 --> 00:12:12,020
I'm talking the sides of
the consumer surplus.

279
00:12:12,020 --> 00:12:14,480
There's not much consumer
surplus arising from consuming

280
00:12:14,480 --> 00:12:16,890
at McDonald's.

281
00:12:16,890 --> 00:12:18,330
Not much consumer surplus
arises from consuming

282
00:12:18,330 --> 00:12:19,200
McDonalds because I
can always just go

283
00:12:19,200 --> 00:12:20,640
to Burger King instead.

284
00:12:20,640 --> 00:12:23,310
So what determines consumer
surplus is the elasticity of

285
00:12:23,310 --> 00:12:29,060
demand, which is fundamentally
about your willingness to pay.

286
00:12:29,060 --> 00:12:33,930
Inelastic goods have higher
willingness to pay.

287
00:12:33,930 --> 00:12:37,660
And so as a result, the
consumer surplus is

288
00:12:37,660 --> 00:12:41,030
essentially inversely related
to the elasticity of demand.

289
00:12:41,030 --> 00:12:43,535
The higher the elasticity, the
smaller the consumer surplus.

290
00:12:48,970 --> 00:12:52,230
Now, let's shift and talk
about producers.

291
00:12:52,230 --> 00:12:56,810
The analysis for producer
surplus is exactly the same

292
00:12:56,810 --> 00:12:58,320
type of analysis, just
flipped to the

293
00:12:58,320 --> 00:13:01,320
other side of the market.

294
00:13:01,320 --> 00:13:07,160
Now, here the question is, what

295
00:13:07,160 --> 00:13:08,650
determines my producer surplus?

296
00:13:08,650 --> 00:13:10,720
Well, what determines
consumer surplus?

297
00:13:10,720 --> 00:13:13,330
It's the difference between my
marginal willingness to pay

298
00:13:13,330 --> 00:13:14,820
and the price.

299
00:13:14,820 --> 00:13:17,540
What determines producer
surplus, that's going to be

300
00:13:17,540 --> 00:13:20,880
the difference between the
firm's marginal willingness to

301
00:13:20,880 --> 00:13:24,160
supply, and the price.

302
00:13:24,160 --> 00:13:28,140
So my marginal willingness to
pay as a consumer is what

303
00:13:28,140 --> 00:13:30,190
determines my consumer
surplus.

304
00:13:30,190 --> 00:13:32,890
Producer surplus will be
determined by my marginal

305
00:13:32,890 --> 00:13:34,140
willingness to supply.

306
00:13:36,630 --> 00:13:39,730
My marginal is supply, which is
simply represented by the

307
00:13:39,730 --> 00:13:41,820
supply curve.

308
00:13:41,820 --> 00:13:43,380
A little bit easier for
producer surplus.

309
00:13:43,380 --> 00:13:46,970
The supply curve represents the
price at which I'm willing

310
00:13:46,970 --> 00:13:48,350
to supply a good.

311
00:13:48,350 --> 00:13:49,820
That's what a supply curve is.

312
00:13:49,820 --> 00:13:53,440
As we learned a couple lectures
ago, in the context

313
00:13:53,440 --> 00:13:57,580
of competitive firms that's my
marginal cost. So the supply

314
00:13:57,580 --> 00:14:02,950
curve is my marginal cost. That
says that is how much it

315
00:14:02,950 --> 00:14:05,490
costs me to produce
the next unit.

316
00:14:05,490 --> 00:14:08,255
In a perfectly competitive
long-run equilibrium, or short

317
00:14:08,255 --> 00:14:13,870
run equilibrium, that is
basically what I'll

318
00:14:13,870 --> 00:14:17,240
set my price to.

319
00:14:17,240 --> 00:14:23,900
So if we go to figure
13-4, now let's look

320
00:14:23,900 --> 00:14:26,090
at my producer surplus.

321
00:14:26,090 --> 00:14:28,510
My surplus from delivering
lectures.

322
00:14:28,510 --> 00:14:30,140
Let's say that--

323
00:14:30,140 --> 00:14:31,290
this is a bit harder
to imagine--

324
00:14:31,290 --> 00:14:35,250
but imagine that I prefer
deliver smaller lectures.

325
00:14:35,250 --> 00:14:38,310
Maybe because as the number of
kids gets smaller I can learn

326
00:14:38,310 --> 00:14:38,745
your names.

327
00:14:38,745 --> 00:14:40,760
I don't have to look around as
much, I don't have to pace as

328
00:14:40,760 --> 00:14:42,690
much, whatever.

329
00:14:42,690 --> 00:14:44,950
So imagine that I'm most
happy delivering a

330
00:14:44,950 --> 00:14:47,010
lecture to one student.

331
00:14:47,010 --> 00:14:50,080
And that's the lowest cost
to me, the lowest effort.

332
00:14:50,080 --> 00:14:52,320
I can just come in and sit down,
and we have coffee and I

333
00:14:52,320 --> 00:14:54,020
just riff, and I don't have to
worry about notes or any of

334
00:14:54,020 --> 00:14:55,080
that stuff.

335
00:14:55,080 --> 00:14:57,160
But when there's two students
I feel a little bit guilty

336
00:14:57,160 --> 00:14:59,200
doing that, so I make some
notes to myself.

337
00:14:59,200 --> 00:15:01,030
When there's three students
I make some more notes.

338
00:15:01,030 --> 00:15:03,070
By the time there's all you
students, I have to type up

339
00:15:03,070 --> 00:15:04,780
all these notes.

340
00:15:04,780 --> 00:15:08,520
So every student that adds to
my lecture, imagine, is a

341
00:15:08,520 --> 00:15:09,130
marginal cost.

342
00:15:09,130 --> 00:15:10,200
Now, you know that's not
true, of course.

343
00:15:10,200 --> 00:15:12,680
I wouldn't change my notes if
six more students walked in.

344
00:15:12,680 --> 00:15:15,950
But let's just imagine
that it's linear.

345
00:15:15,950 --> 00:15:19,000
Imagine with every student that
comes in here, I have to

346
00:15:19,000 --> 00:15:21,580
put in a little more effort
in my lecture.

347
00:15:21,580 --> 00:15:25,200
So it's a marginal cost to me
with the additional students.

348
00:15:25,200 --> 00:15:27,680
So that delivers the supply
curve, this upward sloping

349
00:15:27,680 --> 00:15:30,450
supply curve.

350
00:15:30,450 --> 00:15:34,040
Now let's say at a given price,
P, I'm willing to

351
00:15:34,040 --> 00:15:37,100
lecture-- so that, given the
supply curve, if the price is

352
00:15:37,100 --> 00:15:41,910
equal to p, I'm willing to
lecture to Q students.

353
00:15:41,910 --> 00:15:45,940
That is, if you're going to give
me a price of P, at that

354
00:15:45,940 --> 00:15:51,010
price my marginal willingness to
supply is that I'll supply

355
00:15:51,010 --> 00:15:52,260
Q lectures.

356
00:15:54,800 --> 00:15:57,260
So another way to say it is that
if you want me to supply

357
00:15:57,260 --> 00:16:00,880
Q lectures, you've got to pay me
a price P. That's the point

358
00:16:00,880 --> 00:16:03,950
where I derive no producer
surplus.

359
00:16:03,950 --> 00:16:06,080
I'm indifferent at that point.

360
00:16:06,080 --> 00:16:11,010
If at that point you said,
would you want the Q-th

361
00:16:11,010 --> 00:16:12,910
student or not, I'd say
I don't really care.

362
00:16:12,910 --> 00:16:14,750
I'm indifferent.

363
00:16:14,750 --> 00:16:16,300
I get zero producer surplus.

364
00:16:16,300 --> 00:16:18,770
But, I got a huge surplus
on that first student.

365
00:16:18,770 --> 00:16:20,650
Because I was willing to work
with them and it wouldn't have

366
00:16:20,650 --> 00:16:21,790
cost me anything.

367
00:16:21,790 --> 00:16:24,560
But I'm getting paid P to
work with all of you.

368
00:16:24,560 --> 00:16:26,710
So I make a producer
surplus on that.

369
00:16:26,710 --> 00:16:31,470
So producer surplus is made on
every unit to the left of Q,

370
00:16:31,470 --> 00:16:36,250
because those are units with a
positive producer surplus.

371
00:16:36,250 --> 00:16:39,810
They're the units above
the supply curve

372
00:16:39,810 --> 00:16:42,200
and below the price.

373
00:16:42,200 --> 00:16:44,610
They're the units where it's
above the supply curve, so I'm

374
00:16:44,610 --> 00:16:47,430
willing to supply, but below the
price which means that I'm

375
00:16:47,430 --> 00:16:51,320
getting paid more than I would
have to to supply that unit.

376
00:16:51,320 --> 00:16:52,850
Can anyone think of
another name for

377
00:16:52,850 --> 00:16:54,130
this triangle, roughly?

378
00:16:54,130 --> 00:16:55,535
How else you might think
about that triangle.

379
00:16:58,400 --> 00:16:59,770
Well, I can talk about
producer surplus.

380
00:16:59,770 --> 00:17:02,340
And I said, what's the
difference between the price

381
00:17:02,340 --> 00:17:05,819
producers receive and the cost
that they have to produce it.

382
00:17:05,819 --> 00:17:06,359
AUDIENCE: Profit.

383
00:17:06,359 --> 00:17:07,720
PROFESSOR: Profit.

384
00:17:07,720 --> 00:17:10,750
Roughly speaking, producer
surplus is profit.

385
00:17:10,750 --> 00:17:13,910
Now, technically, in the short
run, that's not true.

386
00:17:13,910 --> 00:17:15,770
Because in the short run there's
fixed costs and you

387
00:17:15,770 --> 00:17:17,740
might lose money on fixed costs
and still make a long

388
00:17:17,740 --> 00:17:18,359
run profit.

389
00:17:18,359 --> 00:17:20,599
So in the short run it's
not technically true.

390
00:17:20,599 --> 00:17:22,410
In the long run it is
technically true, and for the

391
00:17:22,410 --> 00:17:24,780
purpose of this course we'll
say it's technically true.

392
00:17:24,780 --> 00:17:26,440
So producer surplus is profit.

393
00:17:26,440 --> 00:17:28,010
It's a lot easier
to think about.

394
00:17:28,010 --> 00:17:30,850
Consumer surplus is this vague
concept we have to measure my

395
00:17:30,850 --> 00:17:33,300
willingness to pay versus
what I pay.

396
00:17:33,300 --> 00:17:36,590
Producer surplus is
easy, it's profit.

397
00:17:36,590 --> 00:17:41,070
So producer surplus is profit,
it's the difference between

398
00:17:41,070 --> 00:17:43,160
the price at which I'm willing
to produce the good and the

399
00:17:43,160 --> 00:17:46,150
price you actually
pay me for it.

400
00:17:46,150 --> 00:17:48,400
So that's producer surplus.

401
00:17:48,400 --> 00:17:51,230
Questions about that?

402
00:17:51,230 --> 00:17:52,110
OK.

403
00:17:52,110 --> 00:17:55,950
Putting this together, we can
now measure the total welfare

404
00:17:55,950 --> 00:17:56,970
of society.

405
00:17:56,970 --> 00:17:57,763
We now have it.

406
00:17:57,763 --> 00:18:00,650
We can measure the entire
happiness of all of society.

407
00:18:00,650 --> 00:18:07,300
And we define social welfare of
society as consumer surplus

408
00:18:07,300 --> 00:18:10,520
plus producer surplus.

409
00:18:10,520 --> 00:18:13,100
Now, that doesn't have to be.

410
00:18:13,100 --> 00:18:16,130
You could say, gee, Jon, don't
you care more about consumers

411
00:18:16,130 --> 00:18:17,230
than firms?

412
00:18:17,230 --> 00:18:18,730
Or gee, Jon, don't
you care more

413
00:18:18,730 --> 00:18:19,260
about firms than consumers.

414
00:18:19,260 --> 00:18:20,770
I'm going to leave that
alone for now.

415
00:18:20,770 --> 00:18:23,380
We're just going to do the
simplest thing and just say,

416
00:18:23,380 --> 00:18:27,670
we're going to define social
welfare as simply the sum of

417
00:18:27,670 --> 00:18:30,300
how much surplus consumers
get plus how much surplus

418
00:18:30,300 --> 00:18:32,730
producers get.

419
00:18:32,730 --> 00:18:33,420
OK?

420
00:18:33,420 --> 00:18:34,610
This is a particular
representation.

421
00:18:34,610 --> 00:18:36,835
When we talk about efficiency
and equilibrium, we're talking

422
00:18:36,835 --> 00:18:37,560
about efficiency--

423
00:18:37,560 --> 00:18:38,400
I'm sorry--

424
00:18:38,400 --> 00:18:41,260
versus equity, which we'll talk
about towards the end of

425
00:18:41,260 --> 00:18:41,870
the course.

426
00:18:41,870 --> 00:18:45,080
We'll talk about alternative
definitions, and how we weigh

427
00:18:45,080 --> 00:18:46,390
different definitions of this.

428
00:18:46,390 --> 00:18:48,760
But for now, this is the
standard economic definition.

429
00:18:48,760 --> 00:18:50,460
Which is, let's not draw
a judgment about

430
00:18:50,460 --> 00:18:51,910
who's better than who.

431
00:18:51,910 --> 00:18:53,230
Let's just talk about
the total amount

432
00:18:53,230 --> 00:18:55,670
of surplus in society.

433
00:18:55,670 --> 00:18:58,940
So the amount of social welfare,
is the total amount

434
00:18:58,940 --> 00:19:00,320
of surplus in society.

435
00:19:00,320 --> 00:19:03,440
And here's the key result.

436
00:19:03,440 --> 00:19:08,880
That the competitive
equilibrium, where demand

437
00:19:08,880 --> 00:19:13,010
equals supply, in competitive
equilibrium, is the welfare

438
00:19:13,010 --> 00:19:15,890
maximizing outcome.

439
00:19:15,890 --> 00:19:18,910
The competitive equilibrium of
the market, which is where

440
00:19:18,910 --> 00:19:21,620
demand equals supply,
is also the

441
00:19:21,620 --> 00:19:23,350
welfare maximizing outcome.

442
00:19:26,310 --> 00:19:29,220
And that's the key thing we want
to go to now, which is

443
00:19:29,220 --> 00:19:32,700
that basically moving away from
that equilibrium point,

444
00:19:32,700 --> 00:19:36,310
where demand equals supply, will
by definition lower the

445
00:19:36,310 --> 00:19:38,490
amount of social welfare.

446
00:19:38,490 --> 00:19:45,430
So to see this, let's
go to Figure 13-5.

447
00:19:45,430 --> 00:19:47,313
And we've got some supply
and demand curves.

448
00:19:47,313 --> 00:19:48,280
This is from the book now.

449
00:19:48,280 --> 00:19:50,880
We've got some supply
and demand curves.

450
00:19:50,880 --> 00:19:55,880
And we're initially in
equilibrium at P1 Q1,

451
00:19:55,880 --> 00:19:57,520
at the point E1.

452
00:19:57,520 --> 00:20:01,350
So we're initially at
equilibrium at E1.

453
00:20:01,350 --> 00:20:06,840
At E1, at that initial
equilibrium point, consumer

454
00:20:06,840 --> 00:20:12,190
surplus is equal to R. Now,
going by the letters that

455
00:20:12,190 --> 00:20:17,680
label the areas, R plus S plus
V. That's the amount of

456
00:20:17,680 --> 00:20:18,020
consumer surplus.

457
00:20:18,020 --> 00:20:20,590
The amount under the demand
curve, above the price.

458
00:20:23,110 --> 00:20:24,120
That's consumer surplus.

459
00:20:24,120 --> 00:20:27,120
Stop me if this is not clear,
this is important stuff.

460
00:20:27,120 --> 00:20:29,560
So under the demand curve above
the price, R plus S plus

461
00:20:29,560 --> 00:20:36,880
V. The producer surplus is T
plus U. The profit is the

462
00:20:36,880 --> 00:20:40,800
amount above the supply curve
and below the price.

463
00:20:40,800 --> 00:20:44,930
And so total social welfare
is the sum of all these.

464
00:20:44,930 --> 00:20:50,170
R plus S plus V plus T plus U.
That's our starting point.

465
00:20:50,170 --> 00:20:54,370
That's our competitive
equilibrium starting point.

466
00:20:54,370 --> 00:20:56,400
Now, let's see.

467
00:20:56,400 --> 00:20:58,530
You should be able to
immediately see, those of you

468
00:20:58,530 --> 00:21:01,160
who are good with your geometry,
that there is no

469
00:21:01,160 --> 00:21:04,100
point you could choose
which can make

470
00:21:04,100 --> 00:21:05,930
social welfare larger.

471
00:21:05,930 --> 00:21:08,840
As a simple comparative statics
exercise, imagine I

472
00:21:08,840 --> 00:21:10,950
had the government come in and
say, we're going to raise the

473
00:21:10,950 --> 00:21:13,210
prices in the market to P2.

474
00:21:13,210 --> 00:21:15,260
We decide that producers
aren't making enough.

475
00:21:15,260 --> 00:21:17,770
Look, the consumers get three
letters, the producers only

476
00:21:17,770 --> 00:21:20,460
get two letters,
that's unfair.

477
00:21:20,460 --> 00:21:22,040
So we're going to raise the
price to give the produces

478
00:21:22,040 --> 00:21:23,700
more letters and the consumer
fewer letters.

479
00:21:23,700 --> 00:21:25,500
That sounds like about the
rational basis for government

480
00:21:25,500 --> 00:21:27,770
policy making these days.

481
00:21:27,770 --> 00:21:29,870
So we're going to do that.

482
00:21:29,870 --> 00:21:32,460
And so we're going to raise
the price to P2.

483
00:21:32,460 --> 00:21:37,160
With a price of P2, we'll
have a new equilibrium.

484
00:21:37,160 --> 00:21:39,990
If you force the
price up to P2.

485
00:21:39,990 --> 00:21:44,120
You have a new equilibrium
at little e sub 2, and

486
00:21:44,120 --> 00:21:45,830
a quantity of Q2.

487
00:21:45,830 --> 00:21:46,680
What happens now?

488
00:21:46,680 --> 00:21:48,660
What's happened to
consumer surplus?

489
00:21:48,660 --> 00:21:55,415
Consumer surplus, you've now
lost S and V. Consumer surplus

490
00:21:55,415 --> 00:21:58,820
is now just R. Because at that
new price, P2, that's the area

491
00:21:58,820 --> 00:22:01,620
under the demand curve
above the price.

492
00:22:01,620 --> 00:22:03,150
Producer surplus has
grown, however.

493
00:22:03,150 --> 00:22:10,580
Now, instead of being T plus
U, it's now T plus S. So

494
00:22:10,580 --> 00:22:15,070
what's happened, effectively,
is you've transferred S from

495
00:22:15,070 --> 00:22:18,650
consumers to producers.

496
00:22:18,650 --> 00:22:21,890
And you've lost V
plus U, forever.

497
00:22:24,850 --> 00:22:26,790
So what's involved in
this change is a

498
00:22:26,790 --> 00:22:28,800
transfer and a loss.

499
00:22:28,800 --> 00:22:31,710
The transfer is the area S,
which used to belong to

500
00:22:31,710 --> 00:22:34,240
consumers now belongs
to producers.

501
00:22:34,240 --> 00:22:39,770
But now we have what we call
a dead weight loss.

502
00:22:39,770 --> 00:22:48,340
Dead weight loss, of V plus
U. That's welfare that has

503
00:22:48,340 --> 00:22:49,590
disappeared.

504
00:22:51,470 --> 00:22:53,350
Welfare has disappeared.

505
00:22:53,350 --> 00:22:56,900
And the definition of dead
weight loss is a net reduction

506
00:22:56,900 --> 00:23:01,190
in efficiency from trades
that are not made.

507
00:23:01,190 --> 00:23:02,640
Remember we talked
about efficiency

508
00:23:02,640 --> 00:23:04,040
early on in the course.

509
00:23:04,040 --> 00:23:08,470
We said the efficient outcome is
one where trades that make

510
00:23:08,470 --> 00:23:11,810
both people better
off are made.

511
00:23:11,810 --> 00:23:14,800
Here we have trades, which
absent the government would

512
00:23:14,800 --> 00:23:17,790
have made both parties
better off,

513
00:23:17,790 --> 00:23:19,960
and they're not happening.

514
00:23:19,960 --> 00:23:22,010
That is surplus that's
just gone.

515
00:23:22,010 --> 00:23:24,660
It's into the ether.

516
00:23:24,660 --> 00:23:28,110
That is social surplus that is
now social welfare, that is

517
00:23:28,110 --> 00:23:30,240
now gone because there are
trades that would have made

518
00:23:30,240 --> 00:23:35,390
both parties happier that
are now not happening.

519
00:23:35,390 --> 00:23:39,460
And that's a total waste from
society's perspective.

520
00:23:39,460 --> 00:23:42,390
Because society's best off if
all the trades that make both

521
00:23:42,390 --> 00:23:45,430
parties happier, happen.

522
00:23:45,430 --> 00:23:50,640
So the bottom line is, any price
you would impose other

523
00:23:50,640 --> 00:23:54,060
than the market price of P1, and
you can work this out for

524
00:23:54,060 --> 00:24:01,210
yourself, any price you would
impose would by definition

525
00:24:01,210 --> 00:24:04,110
lead to a lower social
welfare.

526
00:24:04,110 --> 00:24:05,090
It may shift.

527
00:24:05,090 --> 00:24:07,010
It may lead to a bigger or
smaller consumer surplus

528
00:24:07,010 --> 00:24:08,860
relative to producer surplus.

529
00:24:08,860 --> 00:24:11,230
Once again at this point we're
just using the sum of them as

530
00:24:11,230 --> 00:24:12,830
a measure of social welfare.

531
00:24:12,830 --> 00:24:15,940
Social welfare has fallen.

532
00:24:15,940 --> 00:24:19,250
So social welfare is maximized
in this case.

533
00:24:19,250 --> 00:24:23,240
So this gives us a framework
to think about.

534
00:24:23,240 --> 00:24:26,620
We started the course with
supply and demand, and talking

535
00:24:26,620 --> 00:24:29,690
about how things like the
minimum wage reduce

536
00:24:29,690 --> 00:24:30,910
efficiency.

537
00:24:30,910 --> 00:24:33,190
Well, this gives us a welfare
framework, a more formal

538
00:24:33,190 --> 00:24:35,690
welfare framework, for
thinking about that.

539
00:24:35,690 --> 00:24:38,260
I said it reduces efficiency
before because you had less

540
00:24:38,260 --> 00:24:39,450
labor in the market.

541
00:24:39,450 --> 00:24:41,740
But now we can actually more
formally say why does the

542
00:24:41,740 --> 00:24:44,040
minimum wage reduce
efficiency?

543
00:24:44,040 --> 00:24:45,040
We can actually look at that.

544
00:24:45,040 --> 00:24:47,500
Let me just do the always-risky
thing of trying a

545
00:24:47,500 --> 00:24:49,790
freehand diagram.

546
00:24:49,790 --> 00:24:52,380
You remember our market for
labor, you had the amount of

547
00:24:52,380 --> 00:24:58,160
labor on the x-axis, the
wage on the y-axis.

548
00:24:58,160 --> 00:25:02,470
You had some supply of labor
that comes from workers

549
00:25:02,470 --> 00:25:05,340
deciding to work as the
wage goes up, they

550
00:25:05,340 --> 00:25:06,510
want to work more.

551
00:25:06,510 --> 00:25:08,440
You've got demand for labor.

552
00:25:08,440 --> 00:25:11,230
That comes from firms
demanding workers.

553
00:25:11,230 --> 00:25:14,430
As the wage goes up, they
want fewer workers.

554
00:25:14,430 --> 00:25:19,790
And you have some initial
equilibrium, L-star, W-star.

555
00:25:19,790 --> 00:25:22,560
When the government came in with
its minimum wage and the

556
00:25:22,560 --> 00:25:25,060
government said, we're going
to impose a minimum wage of

557
00:25:25,060 --> 00:25:28,890
W-bar, W-super bar.

558
00:25:28,890 --> 00:25:31,200
OK Remember, we said what
happened was, well, of course

559
00:25:31,200 --> 00:25:34,965
then firms are only going
to want L1 workers.

560
00:25:38,250 --> 00:25:41,720
We talked before about how that
led to some unemployment.

561
00:25:41,720 --> 00:25:43,850
What we didn't mention is how
this leads to an efficiency

562
00:25:43,850 --> 00:25:45,910
loss to society.

563
00:25:45,910 --> 00:25:49,540
This area is now dead
weight loss.

564
00:25:49,540 --> 00:25:55,020
These workers, who would have
been happy to work at the

565
00:25:55,020 --> 00:25:58,210
prevailing wage, and firms would
have been happy to hire

566
00:25:58,210 --> 00:26:00,830
the workers at the prevailing
wage, and those trades no

567
00:26:00,830 --> 00:26:03,900
longer happen.

568
00:26:03,900 --> 00:26:06,750
So here's an important question
to help you think--

569
00:26:06,750 --> 00:26:08,580
you're going to have to draw
dead weight loss triangles in

570
00:26:08,580 --> 00:26:09,310
your sleep now.

571
00:26:09,310 --> 00:26:12,970
So here's the trick
with these.

572
00:26:12,970 --> 00:26:16,230
Why is the dead weight loss
triangle smallest here and

573
00:26:16,230 --> 00:26:17,800
grow like that?

574
00:26:17,800 --> 00:26:21,690
Why does the dead weight loss
triangle grow as you move away

575
00:26:21,690 --> 00:26:22,790
from the competitive
equilibrium?

576
00:26:22,790 --> 00:26:23,143
Yeah.

577
00:26:23,143 --> 00:26:26,028
AUDIENCE: There is less amount
of people who are willing to

578
00:26:26,028 --> 00:26:28,850
work at that price.

579
00:26:28,850 --> 00:26:30,129
PROFESSOR: Say it again?

580
00:26:30,129 --> 00:26:33,242
AUDIENCE: So there's less people
that are willing to

581
00:26:33,242 --> 00:26:35,480
work for that smaller price.

582
00:26:35,480 --> 00:26:37,723
PROFESSOR: Well, here we're
imposing a higher-- less

583
00:26:37,723 --> 00:26:39,250
people are willing to
work for, are you

584
00:26:39,250 --> 00:26:40,320
referring to here or here?

585
00:26:40,320 --> 00:26:41,760
AUDIENCE: To all the
way to the right.

586
00:26:41,760 --> 00:26:42,420
PROFESSOR: All the way.

587
00:26:42,420 --> 00:26:45,140
So basically, the point is--
another way to put it is, at

588
00:26:45,140 --> 00:26:49,330
that wage the consumers there
are pretty indifferent.

589
00:26:49,330 --> 00:26:53,770
So in other words, they're
willing to work but barely.

590
00:26:53,770 --> 00:26:59,420
So at this wage, at this point
here, the L*-th worker is

591
00:26:59,420 --> 00:27:01,660
getting no surplus
from working.

592
00:27:01,660 --> 00:27:03,640
It's not a crappy wage,
he's happy to take it.

593
00:27:03,640 --> 00:27:05,290
But he'd also be happy
to sit at home.

594
00:27:05,290 --> 00:27:06,600
He's indifferent.

595
00:27:06,600 --> 00:27:09,960
So for that L*-th worker,
you make him not

596
00:27:09,960 --> 00:27:12,040
work, he doesn't care.

597
00:27:12,040 --> 00:27:14,660
So if you raise the minimum wage
and this guy sits at home

598
00:27:14,660 --> 00:27:16,380
instead of working,
he didn't care.

599
00:27:16,380 --> 00:27:18,610
He was getting no surplus
from working anyway.

600
00:27:18,610 --> 00:27:21,560
Likewise this firm, who's hiring
the L*-th worker, they

601
00:27:21,560 --> 00:27:25,110
were paying this worker exactly
what he was producing.

602
00:27:25,110 --> 00:27:28,990
The marginal cost of that worker
exactly equalled what

603
00:27:28,990 --> 00:27:30,200
they were paying him.

604
00:27:30,200 --> 00:27:31,662
What that worker's producing
was exactly equal to

605
00:27:31,662 --> 00:27:32,170
what they paid him.

606
00:27:32,170 --> 00:27:34,260
They were earning zero profit
on that worker.

607
00:27:34,260 --> 00:27:36,340
So they don't care
if he stays home.

608
00:27:36,340 --> 00:27:39,480
So if the government set a
minimum wage, such that one

609
00:27:39,480 --> 00:27:43,600
guy stayed home, the minimum
wage was so close to market

610
00:27:43,600 --> 00:27:47,000
wage that one guy stayed home,
there would be no social

611
00:27:47,000 --> 00:27:48,380
welfare loss.

612
00:27:48,380 --> 00:27:50,260
Or infinitesimally small.

613
00:27:50,260 --> 00:27:52,870
Because that last guy, there was
indifference on both the

614
00:27:52,870 --> 00:27:55,640
worker's side and
the firm's side.

615
00:27:55,640 --> 00:27:58,160
However once you start
displacing more and more,

616
00:27:58,160 --> 00:27:59,910
these workers aren't indifferent
anymore, right?

617
00:27:59,910 --> 00:28:01,470
These are workers who
were making a lot of

618
00:28:01,470 --> 00:28:02,930
surplus at that wage.

619
00:28:02,930 --> 00:28:05,180
And firms that were earning a
lot of profit at that wage.

620
00:28:05,180 --> 00:28:06,800
Now they're not indifferent.

621
00:28:06,800 --> 00:28:09,030
So as you move farther and
farther from the competitive

622
00:28:09,030 --> 00:28:12,420
equilibrium, the distortion
gets larger and larger.

623
00:28:12,420 --> 00:28:16,780
Very important intuition to
have. That for that last

624
00:28:16,780 --> 00:28:22,150
person, there's no distortion
from moving epsilon away from

625
00:28:22,150 --> 00:28:23,370
the competitive equilibrium.

626
00:28:23,370 --> 00:28:25,240
Because they weren't earning
any surplus anyway.

627
00:28:25,240 --> 00:28:27,450
And the firm wasn't making
any surplus on them.

628
00:28:27,450 --> 00:28:31,880
But as you move away, the loss
in social welfare gets larger

629
00:28:31,880 --> 00:28:35,180
and larger because these are
people who are making all

630
00:28:35,180 --> 00:28:37,070
sorts of surpluses on
these transactions.

631
00:28:37,070 --> 00:28:38,740
And you're stopping them
from happening.

632
00:28:38,740 --> 00:28:40,630
So if the government
interferes with the

633
00:28:40,630 --> 00:28:42,530
transaction--

634
00:28:42,530 --> 00:28:44,710
So imagine, this guy and I
were negotiating over a

635
00:28:44,710 --> 00:28:49,020
baseball card and I ended up
paying him exactly what the

636
00:28:49,020 --> 00:28:50,530
baseball card was
worth to him.

637
00:28:50,530 --> 00:28:51,930
And I ended up paying exactly
what it was worth

638
00:28:51,930 --> 00:28:53,690
to me to have it.

639
00:28:53,690 --> 00:28:56,950
And then my parents come in and
say, you can't do that.

640
00:28:56,950 --> 00:28:59,180
Then it doesn't really matter,
because we weren't making any

641
00:28:59,180 --> 00:29:01,180
surplus of that trade anyway.

642
00:29:01,180 --> 00:29:05,330
But, if he had three of these
cards and was delighted to get

643
00:29:05,330 --> 00:29:08,293
rid of it for $50, and I have
always wanted this card and

644
00:29:08,293 --> 00:29:11,730
valued it at $200, then if my
parents come and sink this

645
00:29:11,730 --> 00:29:14,040
trade, then that's
a real bummer.

646
00:29:14,040 --> 00:29:16,410
That's a huge loss in social
welfare, because the trade

647
00:29:16,410 --> 00:29:20,060
that made both parties better
off is not happening.

648
00:29:20,060 --> 00:29:23,050
Questions about that?

649
00:29:23,050 --> 00:29:26,510
Let's look at a particularly
good example of this.

650
00:29:26,510 --> 00:29:29,060
Of when the government
interferes with trades and the

651
00:29:29,060 --> 00:29:29,480
implications of that.

652
00:29:29,480 --> 00:29:31,340
The TAs on Friday are going
to go through a bunch of

653
00:29:31,340 --> 00:29:32,530
interesting examples.

654
00:29:32,530 --> 00:29:34,000
I'm just going to
do one today.

655
00:29:34,000 --> 00:29:35,560
And then you'll do some more
in section, because this is

656
00:29:35,560 --> 00:29:36,930
hard and important.

657
00:29:36,930 --> 00:29:40,370
I want to today focus on the
example of taxicab medallions.

658
00:29:40,370 --> 00:29:41,620
It's the example in the
book, which is a

659
00:29:41,620 --> 00:29:43,850
particularly good example.

660
00:29:43,850 --> 00:29:47,850
Taxi drivers, we've all taken
taxis, we know how they work.

661
00:29:47,850 --> 00:29:52,210
But taxi drivers in virtually
all cities, you cannot just

662
00:29:52,210 --> 00:29:54,710
start a cab and drive
people around.

663
00:29:54,710 --> 00:29:57,950
In virtually all cities, you
need to get something from the

664
00:29:57,950 --> 00:30:01,660
city that allows you to call
yourself a taxicab.

665
00:30:01,660 --> 00:30:04,080
And that's typically called
a taxicab medallion.

666
00:30:04,080 --> 00:30:06,470
It originally was literally
something you had on the hood

667
00:30:06,470 --> 00:30:07,360
of your car.

668
00:30:07,360 --> 00:30:10,150
Now it's a certificate you have
in the back of your car.

669
00:30:10,150 --> 00:30:12,100
So you see the certificate
whenever you ride in a car,

670
00:30:12,100 --> 00:30:14,700
which says, So-and-so is
licensed by the city of

671
00:30:14,700 --> 00:30:17,760
whatever to drive this cab.

672
00:30:17,760 --> 00:30:20,300
The government issues a certain
amount of these

673
00:30:20,300 --> 00:30:21,390
taxicab medallions.

674
00:30:21,390 --> 00:30:25,570
And almost always issues less
than would be demanded in the

675
00:30:25,570 --> 00:30:27,940
free market for taxicabs.

676
00:30:27,940 --> 00:30:30,510
And let's see what
effect that has.

677
00:30:30,510 --> 00:30:31,750
So go to 13-6.

678
00:30:31,750 --> 00:30:33,130
This is getting kind of
complicated, but this is an

679
00:30:33,130 --> 00:30:36,460
example of the kind of welfare
analysis we can do.

680
00:30:36,460 --> 00:30:39,720
Once we understand
these concepts.

681
00:30:39,720 --> 00:30:43,440
Let's say we start
at point E1.

682
00:30:43,440 --> 00:30:45,670
Big E1 on the right, little
E1 on the left.

683
00:30:45,670 --> 00:30:49,880
So on the right-hand side, this
is like our other profit

684
00:30:49,880 --> 00:30:52,380
diagrams. The right-hand
side is the market.

685
00:30:52,380 --> 00:30:56,890
The left-hand side is an
individual cab firm.

686
00:30:56,890 --> 00:31:01,470
Initially, if the government
doesn't interfere, you are in

687
00:31:01,470 --> 00:31:05,270
equilibrium at point E sub 1.

688
00:31:05,270 --> 00:31:13,110
Which is, that the price is
P1, and the individual cab

689
00:31:13,110 --> 00:31:15,740
firm delivers q sub 1 rides.

690
00:31:15,740 --> 00:31:18,090
And let's assume cab firms
are identical,

691
00:31:18,090 --> 00:31:18,790
just to make it easy.

692
00:31:18,790 --> 00:31:20,280
And that there are n of them.

693
00:31:20,280 --> 00:31:24,230
Well in that case, the total
amount delivered is N1 Q1.

694
00:31:24,230 --> 00:31:29,610
So Q sub 1 is q sub 1, which is
the amount delivered by a

695
00:31:29,610 --> 00:31:32,860
given cab firm at that price,
times the n cab

696
00:31:32,860 --> 00:31:34,190
firms in the market.

697
00:31:34,190 --> 00:31:36,990
N1 cab firms in the market.

698
00:31:36,990 --> 00:31:38,630
So there's N1 firms.
Each delivers

699
00:31:38,630 --> 00:31:40,580
little q sub 1 of rides.

700
00:31:40,580 --> 00:31:44,820
And you can see at that point,
they each make some profit.

701
00:31:44,820 --> 00:31:48,030
So what you can see at that
point is that at E1, at a

702
00:31:48,030 --> 00:31:54,910
price of P1, they're
making some profit.

703
00:31:54,910 --> 00:31:57,850
The price is set equal to
their marginal cost.

704
00:31:57,850 --> 00:31:58,610
I'm sorry, they're not
making a profit.

705
00:31:58,610 --> 00:31:59,150
My bad.

706
00:31:59,150 --> 00:32:01,690
You see at that point they're
not making profit.

707
00:32:01,690 --> 00:32:03,545
Because what you can see is
price is equal to the minimum

708
00:32:03,545 --> 00:32:06,550
of average cost. Remember, the
no-profit condition is where

709
00:32:06,550 --> 00:32:09,980
marginal cost equals average
cost. You can see at that

710
00:32:09,980 --> 00:32:11,630
point, little e1 in
the diagram at the

711
00:32:11,630 --> 00:32:14,960
left, there is no profit.

712
00:32:14,960 --> 00:32:18,440
Because price equals marginal
cost, equals the average cost.

713
00:32:18,440 --> 00:32:20,590
So we're making no profit, and
that's a perfectly competitive

714
00:32:20,590 --> 00:32:21,020
equilibrium.

715
00:32:21,020 --> 00:32:23,510
That's what we derived
last time.

716
00:32:23,510 --> 00:32:24,910
Now, let's say the government
comes in and

717
00:32:24,910 --> 00:32:26,160
says, you know what?

718
00:32:28,840 --> 00:32:29,750
And the welfare here.

719
00:32:29,750 --> 00:32:31,040
Just to do the welfare here.

720
00:32:31,040 --> 00:32:33,550
You see that the welfare
of society is,

721
00:32:33,550 --> 00:32:35,920
producers make no surplus.

722
00:32:35,920 --> 00:32:38,140
There's no producer surplus,
there's no profits.

723
00:32:38,140 --> 00:32:42,720
Consumers have surplus of A
plus B plus C. So consumer

724
00:32:42,720 --> 00:32:45,730
surplus is the area on the
demand curve above the price.

725
00:32:45,730 --> 00:32:48,470
That's A plus B plus C. Producer
surplus is profits,

726
00:32:48,470 --> 00:32:49,660
which are zero.

727
00:32:49,660 --> 00:32:51,440
Because it's perfectly
competitive.

728
00:32:51,440 --> 00:32:55,370
So you end up with a total
social surplus of A plus B

729
00:32:55,370 --> 00:32:59,850
plus C. And it all goes
to consumers.

730
00:32:59,850 --> 00:33:03,360
Now let's say, the taxicab
owners aren't

731
00:33:03,360 --> 00:33:05,210
so happy about this.

732
00:33:05,210 --> 00:33:07,120
They don't like making
zero surplus.

733
00:33:07,120 --> 00:33:10,400
And they manage to get
a restriction.

734
00:33:10,400 --> 00:33:12,480
Such that the government says,
there's only a certain number

735
00:33:12,480 --> 00:33:13,950
of medallions.

736
00:33:13,950 --> 00:33:17,630
And we're only going to let
people drive the cabs if they

737
00:33:17,630 --> 00:33:18,880
have a medallion.

738
00:33:22,110 --> 00:33:25,900
Now, let's say that the taxicab
owners say, we're only

739
00:33:25,900 --> 00:33:29,000
going to limit the number of
medallions to N sub 2.

740
00:33:29,000 --> 00:33:31,530
Instead of there being n sub
1 cab firms-- let's say

741
00:33:31,530 --> 00:33:33,730
medallions aren't for cabs,
they're for cab companies.

742
00:33:33,730 --> 00:33:37,040
Instead of being n sub 1 cab
companies, we're going to

743
00:33:37,040 --> 00:33:40,960
limit medallions so there can
only be n sub 2 cab companies.

744
00:33:40,960 --> 00:33:42,120
So what happens?

745
00:33:42,120 --> 00:33:43,210
Well, it's a little
complicated so

746
00:33:43,210 --> 00:33:44,530
let's follow along.

747
00:33:44,530 --> 00:33:49,250
If there's only n sub 2 cab
companies, then what that

748
00:33:49,250 --> 00:33:55,480
means is that given the same
market demand, that means

749
00:33:55,480 --> 00:33:59,530
firms are now going to be able
to make some profit.

750
00:33:59,530 --> 00:34:05,140
So up to, if you look at the
right-hand side diagram up to

751
00:34:05,140 --> 00:34:09,600
N2 Q1, the supply curve
is the same.

752
00:34:09,600 --> 00:34:15,670
But at that point, once you pass
N2 Q1, then you have a

753
00:34:15,670 --> 00:34:19,320
point where that's--

754
00:34:19,320 --> 00:34:22,834
at the old, efficient level of
cab rides, the efficient level

755
00:34:22,834 --> 00:34:25,860
is, each cab company provides
Q sub 1 rides.

756
00:34:25,860 --> 00:34:27,080
Well, you then run
out of rides, but

757
00:34:27,080 --> 00:34:28,469
people still want more.

758
00:34:28,469 --> 00:34:29,590
So what happens?

759
00:34:29,590 --> 00:34:33,199
Well, cab companies start to
be able to charge more.

760
00:34:33,199 --> 00:34:36,150
The supply curve becomes
upward sloping.

761
00:34:36,150 --> 00:34:38,540
They start to be able to charge
more for their rides.

762
00:34:38,540 --> 00:34:41,730
Because now you don't have extra
cab companies entering

763
00:34:41,730 --> 00:34:43,989
and competing those
profits away.

764
00:34:43,989 --> 00:34:47,320
They start to be able to charge
more for their rides.

765
00:34:47,320 --> 00:34:51,489
And you see that that upward
sloping supply curve meets the

766
00:34:51,489 --> 00:34:56,639
demand curve at N2 Q2.

767
00:34:56,639 --> 00:34:59,490
So up to N2 Q1 it's the
supply curve which it

768
00:34:59,490 --> 00:35:00,770
was, which is flat.

769
00:35:00,770 --> 00:35:03,000
Once you get beyond that,
now firms can

770
00:35:03,000 --> 00:35:04,230
charge a higher price.

771
00:35:04,230 --> 00:35:06,330
Because they don't have
to worry about entry.

772
00:35:06,330 --> 00:35:09,390
So you get a new supply curve
that's flat until N2 Q1 then

773
00:35:09,390 --> 00:35:10,300
starts to slope up.

774
00:35:10,300 --> 00:35:12,210
That's S super 2.

775
00:35:12,210 --> 00:35:17,960
And S super 2 intersects the
demand curve at point E sub 2.

776
00:35:17,960 --> 00:35:20,600
And that is the new equilibrium,
with the higher

777
00:35:20,600 --> 00:35:26,880
price of P2 and a lower
total quantity of Q2.

778
00:35:26,880 --> 00:35:28,390
Now let's what that
does to the firm.

779
00:35:28,390 --> 00:35:33,980
Well, a given firm at a
price P2, they now--

780
00:35:33,980 --> 00:35:35,270
they always set the price
equal to marginal

781
00:35:35,270 --> 00:35:36,430
cost. That's the rule.

782
00:35:36,430 --> 00:35:38,810
Every profit maximizing
firm does that.

783
00:35:38,810 --> 00:35:43,160
Well, they now are at a
point little e sub 2,

784
00:35:43,160 --> 00:35:44,950
making a huge profit.

785
00:35:44,950 --> 00:35:47,860
Because at that point, their
marginal cost is well above

786
00:35:47,860 --> 00:35:52,100
their average cost. So at that
point, they make the profit of

787
00:35:52,100 --> 00:35:55,750
the shaded area pi in the
left-hand side diagram.

788
00:35:55,750 --> 00:35:58,560
They make the profit pi, because
once again [INAUDIBLE]

789
00:35:58,560 --> 00:36:00,613
go to the right-hand and then
back to the left-hand side.

790
00:36:00,613 --> 00:36:02,940
The right-hand side is, the new
supply curve intersects

791
00:36:02,940 --> 00:36:04,330
the demand curve.

792
00:36:04,330 --> 00:36:05,850
At point E2.

793
00:36:05,850 --> 00:36:07,780
That's the price of P2.

794
00:36:07,780 --> 00:36:10,930
Carry that over the left-hand
diagram, you see at a price of

795
00:36:10,930 --> 00:36:13,960
P2, they make a profit, the
difference between that price

796
00:36:13,960 --> 00:36:18,580
and the average cost curve,
which is that shaded pi box.

797
00:36:18,580 --> 00:36:21,010
So firms now make profits.

798
00:36:21,010 --> 00:36:23,030
And they didn't before.

799
00:36:23,030 --> 00:36:26,700
What's happened to welfare
in the market?

800
00:36:26,700 --> 00:36:29,980
Well, what's happened is
consumer surplus has now

801
00:36:29,980 --> 00:36:35,410
fallen from A plus B to
just A. Because the

802
00:36:35,410 --> 00:36:37,280
price is now P2.

803
00:36:37,280 --> 00:36:39,490
The consumer surplus is the area
under the demand curve

804
00:36:39,490 --> 00:36:40,450
above the price.

805
00:36:40,450 --> 00:36:45,370
That's just the triangle A. Just
the triangle A. At that

806
00:36:45,370 --> 00:36:46,940
new price, that's the
consumer surplus.

807
00:36:46,940 --> 00:36:48,880
What's the producer surplus?

808
00:36:48,880 --> 00:36:51,120
Well, now producers are
making profits.

809
00:36:51,120 --> 00:36:53,320
And what they're making a
surplus is the area below the

810
00:36:53,320 --> 00:36:55,700
price above their
supply curve.

811
00:36:55,700 --> 00:36:58,940
The supply curve is this funky
kinked thing I just described.

812
00:36:58,940 --> 00:37:02,480
So their new producer surplus is
this, I don't know what the

813
00:37:02,480 --> 00:37:04,530
name is for, like a trapezoid
with a curved side.

814
00:37:04,530 --> 00:37:06,050
Does that have a name?

815
00:37:06,050 --> 00:37:06,575
It's still a trapezoid?

816
00:37:06,575 --> 00:37:07,770
I don't know.

817
00:37:07,770 --> 00:37:08,700
Anyway.

818
00:37:08,700 --> 00:37:10,890
Curvazoid.

819
00:37:10,890 --> 00:37:16,810
B. Their new surplus is B. So
producers now make surplus B.

820
00:37:16,810 --> 00:37:20,230
Consumer surplus is reduced to
A. And what's happened to C?

821
00:37:20,230 --> 00:37:21,620
C is gone.

822
00:37:21,620 --> 00:37:23,200
C is dead weight loss.

823
00:37:23,200 --> 00:37:27,080
Consumer surplus is now A.
Producer surplus is now B. The

824
00:37:27,080 --> 00:37:30,640
darkly shaded area C is now
the dead weight loss.

825
00:37:30,640 --> 00:37:33,150
And that's the dead weight loss,
because once again, at

826
00:37:33,150 --> 00:37:35,920
the old marginal cost curve, at
the old supply curve, these

827
00:37:35,920 --> 00:37:39,910
are trades which both the
producer, which is the taxicab

828
00:37:39,910 --> 00:37:42,690
company, and the consumer, which
is a person riding the

829
00:37:42,690 --> 00:37:44,820
taxi, were happy to make.

830
00:37:44,820 --> 00:37:46,460
And they're not being
made now.

831
00:37:46,460 --> 00:37:55,880
So we've now lost an amount
C, dead weight loss.

832
00:37:55,880 --> 00:37:56,610
Sorry about the confusion.

833
00:37:56,610 --> 00:37:59,730
Questions about that?

834
00:37:59,730 --> 00:38:02,260
Now, here's my question
for you.

835
00:38:02,260 --> 00:38:04,170
You can go home and think about
that, and hopefully

836
00:38:04,170 --> 00:38:05,450
it'll be clear in the
examples on Friday.

837
00:38:05,450 --> 00:38:07,920
But let's ask a slightly
deeper question.

838
00:38:07,920 --> 00:38:14,020
Does this mean that if you
become a taxi driver today,

839
00:38:14,020 --> 00:38:16,910
you will derive producer
surplus of B

840
00:38:16,910 --> 00:38:19,270
from driving a taxi?

841
00:38:19,270 --> 00:38:19,860
Why not?

842
00:38:19,860 --> 00:38:23,030
AUDIENCE: Because you have to
pay that lump sum to get--

843
00:38:23,030 --> 00:38:25,830
PROFESSOR: Because the point is,
you have to get into the

844
00:38:25,830 --> 00:38:28,560
market, and to get into the
market you need a medallion.

845
00:38:28,560 --> 00:38:30,010
And the guys with the medallions
isn't going to hand

846
00:38:30,010 --> 00:38:30,710
them over to you for free.

847
00:38:30,710 --> 00:38:33,780
So let's say this guy's retiring
as a cab driver.

848
00:38:33,780 --> 00:38:35,390
He's got his medallion.

849
00:38:35,390 --> 00:38:36,870
You come up him and say, I
want to be a cab driver

850
00:38:36,870 --> 00:38:40,320
because I see this big producer
surplus area B.

851
00:38:40,320 --> 00:38:41,890
[INAUDIBLE] medallion.

852
00:38:41,890 --> 00:38:43,240
What's this guy going to say?

853
00:38:43,240 --> 00:38:44,590
He's going to say, well,
wait a second.

854
00:38:44,590 --> 00:38:46,680
If I give you my medallion,
you're going to make that

855
00:38:46,680 --> 00:38:49,130
profits of pi.

856
00:38:49,130 --> 00:38:50,750
That's the profit you
make by being a taxi

857
00:38:50,750 --> 00:38:52,970
driver in this market.

858
00:38:52,970 --> 00:38:57,420
So what should he do?

859
00:38:57,420 --> 00:38:58,760
What should he do?

860
00:38:58,760 --> 00:38:59,615
AUDIENCE: Sell it to you.

861
00:38:59,615 --> 00:39:00,830
PROFESSOR: He should
sell it to you.

862
00:39:00,830 --> 00:39:03,820
And how much should he
sell it to you for?

863
00:39:03,820 --> 00:39:06,360
Pi minus a penny.

864
00:39:06,360 --> 00:39:07,740
And you might say, well,
that's ridiculous.

865
00:39:07,740 --> 00:39:08,850
I won't pay pi minus a penny.

866
00:39:08,850 --> 00:39:09,670
Then I'll make nothing.

867
00:39:09,670 --> 00:39:10,910
Well, but he will.

868
00:39:10,910 --> 00:39:12,435
He'll pay minus a penny
because at least

869
00:39:12,435 --> 00:39:14,520
he'll make a penny.

870
00:39:14,520 --> 00:39:17,470
Now, you might say a penny, a
dollar, $5, $10 whatever.

871
00:39:17,470 --> 00:39:20,870
But the point is that he'll sell
it for very close to pi.

872
00:39:20,870 --> 00:39:25,780
Because there's someone out
there who's willing to pay

873
00:39:25,780 --> 00:39:27,000
close to pi to get that.

874
00:39:27,000 --> 00:39:28,210
As long as there's a
little bit left.

875
00:39:28,210 --> 00:39:31,600
So it's a little bit
less than pi.

876
00:39:31,600 --> 00:39:32,540
They'll pay it.

877
00:39:32,540 --> 00:39:34,640
But what that means is
having paid it, you

878
00:39:34,640 --> 00:39:36,280
don't make any money.

879
00:39:36,280 --> 00:39:39,970
So let's do the extreme example
where he's willing to

880
00:39:39,970 --> 00:39:42,240
sell it for $1 less than pi.

881
00:39:42,240 --> 00:39:44,420
What that means is you having
bought it for $1 less than pi,

882
00:39:44,420 --> 00:39:47,350
you don't make any money
as a cab driver.

883
00:39:47,350 --> 00:39:47,990
So wait a second.

884
00:39:47,990 --> 00:39:48,690
This is weird.

885
00:39:48,690 --> 00:39:51,200
We've just restricted
the market.

886
00:39:51,200 --> 00:39:53,170
We've said there's all this
profit to be made.

887
00:39:53,170 --> 00:39:55,730
And yet you're a cab driver
and you make no profit.

888
00:39:55,730 --> 00:39:58,050
What happened to the profit?

889
00:39:58,050 --> 00:39:59,194
Who got it?

890
00:39:59,194 --> 00:40:01,010
AUDIENCE: [UNINTELLIGIBLE]

891
00:40:01,010 --> 00:40:03,140
PROFESSOR: The cab drivers who
were originally issued the

892
00:40:03,140 --> 00:40:04,260
medallions.

893
00:40:04,260 --> 00:40:06,310
The first generation cab drivers
who got the medallions

894
00:40:06,310 --> 00:40:08,580
got all the money.

895
00:40:08,580 --> 00:40:14,560
So in fact, taxicab medallions
do nothing [INAUDIBLE]

896
00:40:14,560 --> 00:40:16,800
taxi drivers.

897
00:40:16,800 --> 00:40:19,160
All they do is enrich the set
of people who originally

898
00:40:19,160 --> 00:40:22,090
lobbied for them and got them.

899
00:40:22,090 --> 00:40:22,450
OK.

900
00:40:22,450 --> 00:40:22,870
Yeah.

901
00:40:22,870 --> 00:40:25,270
AUDIENCE: But wouldn't he make
his money back the same day he

902
00:40:25,270 --> 00:40:31,380
sold it, given that he can get
the same price for his--

903
00:40:31,380 --> 00:40:33,520
PROFESSOR: Wouldn't he--

904
00:40:33,520 --> 00:40:36,350
No, but the point is that
basically, what he's done, or

905
00:40:36,350 --> 00:40:37,830
you're saying that when
he goes to sell it.

906
00:40:37,830 --> 00:40:39,900
So, in other words, the taxicab
medallion is worth a

907
00:40:39,900 --> 00:40:41,660
certain amount of money.

908
00:40:41,660 --> 00:40:45,470
But that would be embedded in
the money he would charge you.

909
00:40:45,470 --> 00:40:46,810
So he's not dumb.

910
00:40:46,810 --> 00:40:48,763
He's straightening out the
supply curve, he's a smart

911
00:40:48,763 --> 00:40:49,710
guy, you should have
picked someone else

912
00:40:49,710 --> 00:40:51,550
to negotiate with.

913
00:40:51,550 --> 00:40:54,050
He's going to say, look, I'm
going to charge you enough so

914
00:40:54,050 --> 00:40:59,316
that you'll only make $10
forever on having this.

915
00:40:59,316 --> 00:41:02,150
I'm going to charge you enough
so that basically, you will

916
00:41:02,150 --> 00:41:06,900
not make any money even when
you go to get rid of it.

917
00:41:06,900 --> 00:41:08,410
So basically, what you'll
do is, you'll have

918
00:41:08,410 --> 00:41:09,310
to pay him so much.

919
00:41:09,310 --> 00:41:12,150
So let's say the way it works.

920
00:41:12,150 --> 00:41:12,990
Let me give you an example.

921
00:41:12,990 --> 00:41:14,970
Let me come back to that one in
the context of an example.

922
00:41:14,970 --> 00:41:17,390
So what we know is
that basically--

923
00:41:17,390 --> 00:41:18,500
and this is in Perloff,
give you some

924
00:41:18,500 --> 00:41:19,650
interesting facts on this.

925
00:41:19,650 --> 00:41:20,660
We know that taxicab

926
00:41:20,660 --> 00:41:22,410
medallions are really limiting.

927
00:41:22,410 --> 00:41:24,590
For example, we know that Tokyo
has five times as many

928
00:41:24,590 --> 00:41:26,840
cabs as New York City, despite
the fact that New York City's

929
00:41:26,840 --> 00:41:27,850
bigger than Tokyo.

930
00:41:27,850 --> 00:41:29,670
And Washington DC
has ten times as

931
00:41:29,670 --> 00:41:31,170
many cabs as San Francisco.

932
00:41:31,170 --> 00:41:33,180
Despite the fact that Washington
DC is smaller than

933
00:41:33,180 --> 00:41:33,830
San Francisco.

934
00:41:33,830 --> 00:41:34,630
I'm not from San Francisco.

935
00:41:34,630 --> 00:41:36,210
You can always get a cab in
Washington, I don't know how

936
00:41:36,210 --> 00:41:37,710
hard it is to get in
San Francisco.

937
00:41:37,710 --> 00:41:40,140
But there's 10 times as many
cabs in Washington.

938
00:41:40,140 --> 00:41:42,120
And this is reflected in
the value of a permit.

939
00:41:42,120 --> 00:41:47,660
So in San Francisco, what you
do, and this is sort of an

940
00:41:47,660 --> 00:41:49,870
easier way to think about it.

941
00:41:49,870 --> 00:41:51,550
What he does is, he doesn't
sell you the permit.

942
00:41:51,550 --> 00:41:52,900
In San Francisco they
don't sell it.

943
00:41:52,900 --> 00:41:54,680
He rents it to you.

944
00:41:54,680 --> 00:41:55,930
So you never get to own it.

945
00:41:55,930 --> 00:41:57,360
He rents it to you.

946
00:41:57,360 --> 00:42:02,380
And in San Francisco, the
typical permit costs $42,000 a

947
00:42:02,380 --> 00:42:03,650
year to rent.

948
00:42:03,650 --> 00:42:06,310
So if you want to be a cab
driver, you've got to pay

949
00:42:06,310 --> 00:42:11,650
$42,000 off the top before
you earn a dollar.

950
00:42:11,650 --> 00:42:13,430
And then he rents to you, when
you're done, he takes it back.

951
00:42:13,430 --> 00:42:15,690
So in substance the way-- now,
if he was selling it, I can

952
00:42:15,690 --> 00:42:16,220
describe it to you.

953
00:42:16,220 --> 00:42:18,550
Involves the fact that he would
embed your future asset

954
00:42:18,550 --> 00:42:20,050
in his sale price.

955
00:42:20,050 --> 00:42:22,130
That involves some complicated
finance that we'll get to

956
00:42:22,130 --> 00:42:23,370
later in the course.

957
00:42:23,370 --> 00:42:25,310
So think about renting
it, that's easier.

958
00:42:25,310 --> 00:42:27,840
He'll rent it to you for
the entire surplus

959
00:42:27,840 --> 00:42:30,050
pi, or pi minus $10.

960
00:42:30,050 --> 00:42:33,020
And in San Francisco that
amounts to $42,000 a year.

961
00:42:33,020 --> 00:42:36,590
In New York, New York originally
had 12,000 permits

962
00:42:36,590 --> 00:42:40,380
they issued in 1937.

963
00:42:40,380 --> 00:42:43,380
They issued 12,000 permits
for $10 each.

964
00:42:43,380 --> 00:42:46,740
They have not issued
a new one since.

965
00:42:46,740 --> 00:42:49,250
Literally, there are no more
cabs allowed in New York City

966
00:42:49,250 --> 00:42:52,740
than there were in 1937.

967
00:42:52,740 --> 00:42:57,960
A typical taxicab medallion,
which sold for $10 in 1937,

968
00:42:57,960 --> 00:43:02,570
now sells for $400,000.

969
00:43:02,570 --> 00:43:03,820
Now once again, you typically
don't sell.

970
00:43:03,820 --> 00:43:05,090
You typically rent it out.

971
00:43:05,090 --> 00:43:07,610
But the point is, that taxicab
medallion, which embeds the

972
00:43:07,610 --> 00:43:09,880
entire future stream of having
the right to drive that

973
00:43:09,880 --> 00:43:11,920
taxicab, is worth $400,000.

974
00:43:11,920 --> 00:43:13,870
So what have we done here?

975
00:43:13,870 --> 00:43:17,580
What we've done-- and in Boston,
by the way, a taxicab

976
00:43:17,580 --> 00:43:19,100
medallion's worth
about $250,000.

977
00:43:19,100 --> 00:43:21,010
Think about that the next time
you're standing in the rain

978
00:43:21,010 --> 00:43:23,340
waiting for a cab.

979
00:43:23,340 --> 00:43:25,010
You're standing in the rain
waiting for a cab because some

980
00:43:25,010 --> 00:43:28,480
guy in 1930-something got a
grant from the government

981
00:43:28,480 --> 00:43:30,230
worth $250,000.

982
00:43:30,230 --> 00:43:33,270
But the current cab drivers
don't get crap.

983
00:43:33,270 --> 00:43:36,690
A taxicab driver in your city
makes $10-12 an hour.

984
00:43:36,690 --> 00:43:38,920
It's not a very fun job being
a taxicab driver in New York

985
00:43:38,920 --> 00:43:41,010
City, unless you like taking
your life in your hands every

986
00:43:41,010 --> 00:43:43,950
time you go out on the streets
of New York City.

987
00:43:43,950 --> 00:43:46,400
They make $10 to $12 an hour.

988
00:43:46,400 --> 00:43:48,210
After paying the enormous amount
they have to pay to

989
00:43:48,210 --> 00:43:50,600
rent their taxicab medallion.

990
00:43:50,600 --> 00:43:53,870
Now, this is not the only
example we have in the world

991
00:43:53,870 --> 00:43:56,940
of something we call
occupational restrictions.

992
00:43:56,940 --> 00:43:58,690
There's lots of examples.

993
00:43:58,690 --> 00:44:00,580
Probably the most prominent
example, that may be relevant

994
00:44:00,580 --> 00:44:00,980
to some of you.

995
00:44:00,980 --> 00:44:03,480
I hope the taxi cab driver won't
be relevant to you guys.

996
00:44:03,480 --> 00:44:06,440
But the doctor example
might be.

997
00:44:06,440 --> 00:44:09,370
A great occupational restriction
is the AMA and the

998
00:44:09,370 --> 00:44:12,060
education, the institute that
educates doctors puts a limit

999
00:44:12,060 --> 00:44:15,180
on the number of medical
residency slots, that

1000
00:44:15,180 --> 00:44:17,750
determines how many doctors
there can be in America.

1001
00:44:17,750 --> 00:44:22,280
As a result, we all pay more
to go for our medical care,

1002
00:44:22,280 --> 00:44:25,010
than we would if more doctors
were allowed.

1003
00:44:25,010 --> 00:44:26,200
And you might say, that's
outrageous.

1004
00:44:26,200 --> 00:44:30,200
But why, obviously, how would
the AMA defend this?

1005
00:44:30,200 --> 00:44:34,560
And how would you defend any
occupational license?

1006
00:44:34,560 --> 00:44:35,422
Yeah.

1007
00:44:35,422 --> 00:44:38,380
AUDIENCE: The smaller the amount
of [UNINTELLIGIBLE].

1008
00:44:38,380 --> 00:44:38,586
PROFESSOR: Yeah.

1009
00:44:38,586 --> 00:44:40,980
You don't want everybody
being Dr. Nick.

1010
00:44:40,980 --> 00:44:41,710
You want--

1011
00:44:41,710 --> 00:44:44,040
come on, you guys got
to get Dr. Nick.

1012
00:44:44,040 --> 00:44:44,938
Raise your hand if you
know what I mean

1013
00:44:44,938 --> 00:44:48,090
when I say Dr. Nick.

1014
00:44:48,090 --> 00:44:50,590
Good lord, what is wrong
with you people?

1015
00:44:50,590 --> 00:44:54,496
OK, homework for this course,
you've got to watch one

1016
00:44:54,496 --> 00:44:55,430
episode of The Simpsons.

1017
00:44:55,430 --> 00:44:56,770
Before the end of the term.

1018
00:44:56,770 --> 00:44:58,440
This is crazy.

1019
00:44:58,440 --> 00:45:00,060
Dr. Nick is the terrible
doctor on The Simpsons.

1020
00:45:00,060 --> 00:45:03,680
You don't want this
terrible doctor.

1021
00:45:03,680 --> 00:45:05,270
You don't want these terrible
doctors operating on people,

1022
00:45:05,270 --> 00:45:08,170
so we have these restrictions to
make sure doctors are good.

1023
00:45:08,170 --> 00:45:09,910
And it sounds like
a good idea.

1024
00:45:09,910 --> 00:45:11,400
But next time you hear
it, remember.

1025
00:45:11,400 --> 00:45:13,540
It's not just making sure
there are good doctors.

1026
00:45:13,540 --> 00:45:14,860
There are probably plenty of
people who would be good

1027
00:45:14,860 --> 00:45:16,420
enough doctors who aren't let
in because there are not

1028
00:45:16,420 --> 00:45:17,190
enough slots.

1029
00:45:17,190 --> 00:45:19,330
It's also a way to make sure
doctors earn lots of money.

1030
00:45:19,330 --> 00:45:21,250
And it's not just the government
that does this.

1031
00:45:21,250 --> 00:45:22,880
There's no government
involvement here.

1032
00:45:22,880 --> 00:45:26,050
These are private associations
which license.

1033
00:45:26,050 --> 00:45:31,720
And they restrict, plumbers, and
doctors and optometrists,

1034
00:45:31,720 --> 00:45:34,270
and all these other things
are limited.

1035
00:45:34,270 --> 00:45:38,630
Ostensibly to keep quality up,
but in reality often to make

1036
00:45:38,630 --> 00:45:40,970
sure that there's some surplus
being earned by this initial

1037
00:45:40,970 --> 00:45:42,490
generation who puts puts
them in place.

1038
00:45:42,490 --> 00:45:43,250
Yeah.

1039
00:45:43,250 --> 00:45:46,696
AUDIENCE: So is the relative
effect on the market smaller

1040
00:45:46,696 --> 00:45:48,655
for doctors because they're not

1041
00:45:48,655 --> 00:45:50,950
selling each other permits?

1042
00:45:50,950 --> 00:45:52,210
PROFESSOR: Well, what's
different with the doctors is,

1043
00:45:52,210 --> 00:45:55,620
since it's not a permit but an
ongoing limit, then every

1044
00:45:55,620 --> 00:45:56,710
doctor makes the pi.

1045
00:45:56,710 --> 00:45:57,920
There's no selling.

1046
00:45:57,920 --> 00:46:00,940
So the effect on the market
is no different.

1047
00:46:00,940 --> 00:46:03,500
So imagine here, instead of it
being a medallion, there's a

1048
00:46:03,500 --> 00:46:06,030
limit on how many
cabs could run.

1049
00:46:06,030 --> 00:46:08,920
And that limit was randomly
reallocated.

1050
00:46:08,920 --> 00:46:12,180
Cab ran out, and then
new people went in.

1051
00:46:12,180 --> 00:46:14,280
Then each generation would--
then you wouldn't get the

1052
00:46:14,280 --> 00:46:15,340
thing where the first
generation wins.

1053
00:46:15,340 --> 00:46:16,070
Each generation should win.

1054
00:46:16,070 --> 00:46:18,420
But you still get the same
distortion of the market.

1055
00:46:18,420 --> 00:46:19,400
The same profit being made.

1056
00:46:19,400 --> 00:46:20,850
It's just that instead of the
profit all accruing to the

1057
00:46:20,850 --> 00:46:23,260
first generation, there'd be
an ongoing approval of that

1058
00:46:23,260 --> 00:46:25,300
profit to each generation
of doctors.

1059
00:46:25,300 --> 00:46:25,892
Yeah.

1060
00:46:25,892 --> 00:46:27,614
AUDIENCE: Professors
and tenure, is that

1061
00:46:27,614 --> 00:46:28,850
also related to--

1062
00:46:28,850 --> 00:46:30,340
PROFESSOR: Professors and tenure
would be another very

1063
00:46:30,340 --> 00:46:32,030
good example.

1064
00:46:32,030 --> 00:46:34,400
Basically, an occupational
restriction.

1065
00:46:34,400 --> 00:46:38,410
The difference is there's no
limit to how many tenured

1066
00:46:38,410 --> 00:46:39,740
professors there can be.

1067
00:46:39,740 --> 00:46:42,040
So basically there's no sense
in which, if there's more

1068
00:46:42,040 --> 00:46:43,940
demand for education, a new
university couldn't start up

1069
00:46:43,940 --> 00:46:45,320
and have tenured professors.

1070
00:46:45,320 --> 00:46:46,750
There's no situation in which
a university couldn't just

1071
00:46:46,750 --> 00:46:48,670
say, we're given tenure to any
Tom, Dick, and Harry who walks

1072
00:46:48,670 --> 00:46:49,810
in off the street.

1073
00:46:49,810 --> 00:46:51,490
There's no stopping that,
because tenure is determined

1074
00:46:51,490 --> 00:46:52,750
by the institution.

1075
00:46:52,750 --> 00:46:54,680
So in that sense it's not an
occupational license, because

1076
00:46:54,680 --> 00:46:56,910
there's no board which
determines tenure standards.

1077
00:46:56,910 --> 00:46:58,160
Thank goodness.

1078
00:47:00,140 --> 00:47:01,060
So we'll come back.

1079
00:47:01,060 --> 00:47:02,230
So that's what we were talking
about welfare.

1080
00:47:02,230 --> 00:47:04,000
You'll review this more
in section on Friday.

1081
00:47:04,000 --> 00:47:05,760
On Wednesday we'll come back
to talk about monopoly.