Outline

Session 7

Econ 200

1. Chapter 4- The process of voluntary exchange between a seller and a

buyer: Trade takes place until the mutual gains are exhaustedan example
2. How do we derive the supply behavior in pure exchange?
a. The graphical representation of the supply schedule
3. Does a seller have a sellers surplus (sellers rent)?
4. How do we derive the market supply curve?
------------------------------------------------------------- Readings to be done before Tuesday, Jan. 27: Chapter 4 up to Section
4.4
Readings to be done before Thursday, Jan. 29: Chapter 4 to the end
Problems to do with your peer group (or on your own) from
Chapter 4: Review Questions: numbers 1-8 and in the
Problems section: numbers 1, 2, 3a, 4-10. Also relevant is
Reading 5 under Files and then Readings.
Information about your Quiz # 3 on Friday, Jan. 30 is posted on the
course website.
Information about the material for your First Exam (held on
Thursday, Feb. 5) is posted on the course website under
Announcements.
-------------------------------------------------------------------------------These notes highlight important concepts that are covered in the lectures.
They may not coincide exactly with the materials discussed in this particular
session. These summary notes are provided as a scaffold to focus your
learning.
Session 7-Econ 200
Chapter 4
Source of Mutual gains from exchangeChapter 4
1

An Example:
Trevor is shirtless (!) would like to buy a shirt. He values a shirt at $20 (MV
of the first shirt-- what he is willing to give up of other goods to acquire this
shirt).
Sunil has received and accumulated many shirts on his various birthdays.
He values a shirt at 0 (MV = $0).
Trevor would be happy to buy a shirt from Sunil for anything less than $20
and Sunil would be happy to get anything from Trevor.
If P = $10, Trevor gains $ ------ and Sunil gains $ ----If P = $12, Trevor gains $ ----- and Sunil gains $ ----If P = $5, Trevor gains $15 and Sunil gains $5.
What common attribute do all these calculation have in common?
What is the sum of their gains from trade?
The source of mutual benefit from exchange is the difference
between the marginal evaluations of a good by different people.
Mutual Gains from Trade:
Trade takes place until all the mutual gains from trade are exhausted.
Lets look at the table of MVs for A and B for shirts.
We assume that A has no shirts at all. B has 11 shirts.
Quantity
1
2
3
4
5
6
7
8
9
10
11

MV ($) for A
12
10
8
6
4
2
0
0
0
0
0

MV ($) for B
20
18
16
14
12
10
8
6
4
2
0

For B, the 11th item has a MV of 0. For the 1 st item that B gives up, A would
be willing to pay $12. So the difference in MVs is $12 and maximum amount
of mutual gains from this trade is -------.
The next item is valued by B at $2 (B is willing to give up $2 of other goods
to have this unit). If B is offered $3 for the shirt, will she give it up and sell it
to A?
A values the 2nd shirt at $10. The maximum mutual gains from this trade is
$ -----.
The next (3rd) item is valued by B at $4 and by A at $8, so the (maximum)
mutual gains from this trade is $ ----.
The 4th item is valued by B at $6 and by A at $6, so the gains from trade
from this exchange are $ -------.
The 5th shirt is valued by B at $8 and by A at $4. Will this trade take place?
Therefore ----- shirts are to be purchased by A from B.
The total gains from trade are $12+$8+$4 = $24.
We conclude that trade takes place until all the gains from trade are
exhausted!!
The price they agree upon may change the distribution of the gains
between the buyer and the seller, but the total gains will be $24 for any set
of mutually agreed prices.
An important insight about trade:
Trade is mutually beneficial.
More trade is not necessarily preferred by all (to less trade) as some
groups may lose. For example, some groups lose from expansion of
domestic trade to international trade.
The gains to millions of consumers outweigh the losses to some
groups
3

Deriving the supply behavior in pure exchange:

Lets consider Meena with an endowment of 8 comic books. We can
think of a scenario, where Meena will voluntarily offer a quantity of her
books for sale, given a market price for comic books. In other words, she
will supply some of her books for sale. We derive the supply behavior
for Meena from her marginal value (demand) behavior for comic
books.
Meenas MV schedule for comic books is in Table 2 below:
Table 2Meenas MV Schedule
Marginal Value ($)
14
12
10
8
6
4
2
0

Quantity of Comic Books

1
2
3
4
5
6
7
8

This table shows that at the market price of $14 per book, Meena will
demand a quantity such that her MV = market price. Therefore at the
market price of $14, Meena will demand 1 book. Since she has 8, how
many will she offer for sale?
At a market price of $14 per book, why does she not keep two books and
sell the rest? The answer lies in the MV table: she only values the second
book at $12 of other goods and services given up, not $14. For a market
price of $14 per book, if she keeps the second book, she would have to give
up $14 worth of other goods and services to have that 2 nd book. Since she
only values the second book at $12, the second book is too expensive for
her to keep and so she offers it for sale!
Why would she not keep the third book? She values the 3 rd book at $10. If
she keeps it when she can get $14 for it in sale, she would have given up
4

$14 worth of other goods, while she is only willing to give up $10. Clearly,
the 3rd book is too expensive for her to keep so she offers it for sale. And so
on for the rest of the books with lower MVs.
Therefore, at a market price of $14, she keeps (i.e., demands) 1 book and
offers 7 for sale.
[One important point of this exercise is to appreciate that given a market
price for a good, a person who owns some quantities of this good can be on
either side of the market: buyer and/or seller!!]
Now consider another scenario. Suppose now the market price of comic
books drops to $12 per book. At a price of $12, how many books does
Meena demand (in this case, keep)? She demands 2 books. She will offer
the restthat is, 6 books-- for sale! Why does she not keep the 3 rd book?
She only values the 3rd book at $10, while if she sells it, she can get $12 for
it. How about the 4th book? She values that at $8 while she can get $12 for
it. By the same reasoning she puts up a total of 6 books up for sale.
Now suppose the market price changes again. Now the market price is $10
per book. How many books does she demand (i.e., keep)? How many books
does she offer for sale?
From our analysis above, we can build the supply schedule for books Meena
offers for sale (columns 1 and 3 -Table 3 below):

Table 3- Deriving Meenas Supply Schedule

Market Price per
Book ($)
14
12
10
8
6
4
2
0

Meenas Quantity
Demanded
1
2
3
4
5
6
7
8

Meenas quantity of
books supplied
7
6
5
4
3
2
1
0
5

The first and the third column of the table above show the supply schedule
for Meena. Therefore, if the market price for a comic book is $14, she offers
7 books for sale. At a market price of $12, she offers 6 books for sale and so
on.

The supply curve (in continuous form) on a graph:

P

As P rises, Meena is willing to sell more books! [Since she will consume less
of her own endowed good as its price rises]
Sellers rents (also called the producer surplus): Just as the consumer has a
surplus, the seller does have a surplus too. The area under the supply up
the quantity is the minimum total amount the seller must be paid to
voluntarily offer the good at that quantity for sale.

Table 4-Meenas Supply behavior

6

Market Price per unit ($)

0
2
4
6
8
10
12
14

Quantity of books supplied

0
1
2
3
4
5
6
7

Consider Meenas supply behavior. Suppose the market price is $8 per book.
How many books does Meena sell?
What is her total revenue?
What is the sellers cost? The books are just sitting on her bookshelf so is
there any cost to the seller? We do not have a production cost here since
she is not producing any book. It would look like there is no cost here since
the books are just there in her house. But if you look at the supply schedule
below closely, you will see that she requires $2 to offer her first book for
sale! As a seller, she will NOT sell this first book at $0, $.10, $.50, or $.70 or
$1.0but she will only offer it for sale if she is offered at least $2. [Please
note the asymmetry of behavior as a buyer versus a seller: as a consumer
she values her 8th book at $0, but as a seller, she will not sell it for $0.]
To sell the 1st unit (book), she requires a minimum payment of -----------.
[In other words, she values the first book-- that she is offering for sale
at $2. As a seller, when she gives up something she values she incurs a
cost. And she values the first unit of the book --that she is offering to sell-at $2. We denote the cost of giving up a unit of a good that a seller
values as the sellers Marginal Cost (MC). The minimum payment the
seller requires to be paid in order to give up her first book is her MC of
selling the first book.]
To sell the 2nd unit, she requires a minimum payment of -----------To sell the 3rd unit, she requires a minimum payment of -----------7

To sell the 4th unit, she requires a minimum payment of -----------[Please note: There is some asymmetry of behavior heredue to the use of
discreet numbers. As a buyer, she values the 8th book at $0, however, to
give that book up for sale, she requires a payment of $2. She will not sell
her first book for $0.]
The total minimum she requires for selling 4 units is simply the sum of the
abovethis is also the Total Cost of the seller which is the addition of all
her MC:
Since the market price of each book is $8, her Total Revenue is:
Now lets look at her producer Surplus!
At the market price of $8, her Producer Surplus also called sellers rent
--is:
Derivation of the Market Supply Curve:
Consider two individual suppliers of a good:

Which one of the following graphs best depicts the Market Supply?
Derivation of the Market Supply Curve:
P