Lecture 4 term 2

Question 1

How to we reprresent consumer willingness to pay? and how can we find market demand using this concept

Answer 1

Each consumer’s WTP 𝜃𝑖 could be a random variable:
 Each consumer independently drawn their own 𝜃𝑖
 Purchase if 𝜃𝑖 ≥ 𝑝

Market demand given by number of consumers with 𝜃𝑖 ≥ 𝑝

Question 2

What influences producer choice of what to supply?

Answer 2

 Because it is more profitable.
 i.e. the product is desirable (high WTP) and efficient to produce (low cost)

Question 3

How does a change in price signal new information

Answer 3

 Producers: A price increase signals that demand may be growing, we should
look for way to expand production.

 Consumers: A price increase signals that others are buying, I should act
quickly if there’s limited supply

Question 4

What is the function of prices

Answer 4

• prices can coordinate economic activity by aggregating information into a single signal of the price that everyoine else can see.
• as price changes at one stage of the supply chain convey new information to other producers down the supply chain
  BUT
• when prices are constrained ie max and min prices, this may limit infor aggregatiion

Question 4

Why are markets not always successful in maximising welfare or organising economic acitivity

Answer 4

• externalities: where economic activity has an impact (+ or -) on a 3rd party without their consent

Question 4

Explain the function of the price mechanism when there is a negative supply shock e.g accident shuts down production for one supplier

Answer 4

• something happens to suppl, shuts down one of the producers so fall in the total amount of goods being solds
• now suppose price is still p after the supply shock, the maximum that suppliers can sell at that price is quite low compared to before (check diagram)
• there is excess demand so upward pressure on prices and the higher price incentivises a correction in the market to the shock but only PARTIALLY
• bc the rise in price causes a rise in Qs but not back to original equilibrium

Question 5

What is EMH and is it always right

Answer 5

• prices must reflect all available information: if they don’t someone would act on them and by acting on them then the process of that brigns the price in line with the true value
• ## so price is always right

Question 5

What is the social choice problem?

Answer 5

• gov have to decide on policy but consider the impacts on this on e,g employee wages, enviro impact and cost for taxpayer
• so how do we weight the diff impacts in our decision making

Question 6

What is a social welfare function

Answer 6

You can think of the SWF as aggregating the welfare of individuals into a society
wide welfare measure (a numerical ‘score’ like a utility).

Question 7

Dictatorial SWF and example

Answer 7

Compare only along one dimension e.g gold medal count only

Question 7

What is utilitarian SWF and an example of it in context of medals

Answer 7

Utilitarian - sum of all utilities e.g total medal count

Question 7

Weighed utilitarian SWF and example

Answer 7

Weighted sum of all utilities: weighted medal tally

Question 8

Rawlsian and example

Answer 8

• Measure social welfare by the impact on the
  individual who is made worst-off
• e.g worst performing medal
  category