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JONATHAN GRUBER: So let's
continue our discussion
of welfare economics.
Just to review where
we are, the first set
of lectures in the course were
about positive economics--
about understanding where supply
and demand curves come from
and what they mean.
Now, last lecture,
we turned from
positive to normative
economics and actually making
judgments about whether
things are good or bad.
And we introduced the concept
of welfare, economic welfare
or well-being.
And we talked about
consumer surplus, which
is a measure of how well-off
consumers are made by a given
exchange of goods and services,
and producer surplus--
how well-off produces are made.
We're going to start our lecture
by proving what's modestly
called the first fundamental
theorem of welfare
economics, which is that
competition maximizes welfare.
So this is basically taking
our positive economics
and meeting our
normative economics.
That is, we are going
to talk about how
the model we've
derived so far, which
is the equilibrium under
perfect competition,
happens to also be
the outcome that
delivers the maximum
well-being to society.
So let's step back.
Well-being we called welfare.
How do we define the
well-being of society?
Well, we're going to start
with a simple definition, which
is we're going to at least
say that social welfare--
social welfare, the total
welfare of society--
is simply consumer surplus
plus producer surplus.
That is, we're not going to
put any different weights.
We're not going to say we like
somebody better than another.
We're just going to
say, look, surplus
is produced by a transaction.
And we just care about the
total surplus that's produced.
And later, we can come to
help you about consumers
versus producers, and we will.
But right now, let's just say
we care about the total surplus
that's produced for society.
How much benefit is produced
by this transaction?
Well, the benefits produced
by this transaction
is going to be the surplus
generated for consumers
by that transaction and the
surplus generated for producers
by that transaction.
So our total measure
of social well-being
is going to be the sum of
consumer and producer surplus.
And we are going to prove--
as I said, you don't
need to know this.
But in [INAUDIBLE] it's called
the first fundamental theorem
of welfare economics, which
is that under the assumptions
we've made-- which are many--
under the assumptions
we've made,
the competitive equilibrium
where supply equals demand
is the point that
maximizes social welfare.
That is, the key insight is the
point that the market naturally
delivers.
The equilibrium that's gained
by the market naturally
happens to be the point
that also makes society
as well off as possible--
a very profound result. That
is, the positive conclusion,
which is that supply
and demand will
meet at a certain
equilibrium, delivers
a normative conclusion,
which is that equilibrium
is the point which
maximizes social welfare.
Now, the best way to see
this is just graphically.
So let's go to Figure 10-1.
Figure 10-1 has supply
and demand curve.
Once again, whether these
are curved or linear,
it's still the basic idea
of supply and demand curve.
So curve, supply
and demand curve,
are things which are more
constant elasticity type
curves.
But that doesn't really
affect the intuition.
We have here the triangles of
consumer surplus and producer
surplus.
So consumer surplus--
give me the letter.
Somebody raise their
hand and tell me
which letters on this diagram
correspond to consumer surplus,
and why.
Which areas denoted by
which letters correspond
to consumer surplus, and why?
Yeah?
AUDIENCE: R and v.
JONATHAN GRUBER: R and
v. And why is that?
AUDIENCE: Because the price is--
it really [INAUDIBLE]
here in between the supply
and demand [INAUDIBLE].
JONATHAN GRUBER: Exactly.
Everything below
the demand curve
and above the price
consumer surplus.
So, r plus v. So therefore,
what's producer surplus?
Same person.
AUDIENCE: S, t, and u.
JONATHAN GRUBER: S plus t
plus u is producer surplus.
So, consumer surplus-- r
plus v. Producer surplus
is s plus t plus u.
You can see, those of you
who are graphically oriented,
can immediately see the
sum of those two triangles
will be maximized at the
intersection of the curves
and nowhere else.
So for example, let's think
about the case where I say,
well, look, it's a shame
the price is that high.
We ought to make
the price lower.
Let's set a new price.
So let's have the government
mandate a new price at P2.
Suppose the government
intervenes and says,
we're going to set
a price ceiling.
We're going to say no one
can charge more than P2
for their product.
And won't that be a good
thing because the consumers
will be better off?
They'll pay lower prices.
Well, what does that do?
What does that do
to consumer surplus?
Well, consumer surplus used to
be r plus v. It instead becomes
r plus s, which is bigger.
Consumer surplus rises.
You lose the triangle v, and
you gain the rectangle s.
But the key point is
at the price P2, yeah,
that becomes the new
consumer surplus.
The new producer
surplus is what?
At that price P2, what's
the new producer surplus?
Someone raise their
hand and tell me.
Yeah?
It's t.
It drops to t.
Producers just get below the
price above the supply curve.
So what has happened to
total social welfare?
It has fallen by
the amount v plus u.
Total social welfare
has fallen by v plus u.
So in some sense, two
things have happened here.
We've set this price.
The first is a transfer.
We have transferred
the rectangle
s from producers to consumers.
s used to be part
of producer surplus.
We're now giving
it to consumers.
So first thing we
have is a transfer.
That was probably the
idea of this policy--
make consumers better off.
So we transferred
what used to be
producer surplus to consumers.
That's the rectangle s.
That's the first
thing that's happened.
So thing one that's
happened is a transfer of s.
But the second thing
that's happened
is we have created what we call
a deadweight loss of u plus v--
a deadweight loss
of u plus v. DWL--
Deadweight Loss.
What is a deadweight loss?
That is the net
reduction in welfare
from trades that are not made.
The deadweight loss-- this is a
key concept we'll come back to,
and I'll expect you
know it in your sleep.
It's that deadweight loss is the
net reduction in social welfare
from trades that are not made.
The intuition here is
that every trade that
makes at least one
party better off
without making the
other party worse off
is a good trade to do.
Under the assumption
we've made so far,
if you ever trade that increased
consumer surplus or producer
surplus or both, that's
a good thing to have.
Right?
If my daughter has any song she
wants to buy by Kendrick Lamar
that she values at
more than $1.00--
she gets them for $1.00--
anything which stops her from
buying those songs is bad.
She's losing surplus.
So basically, the key point
is that deadweight loss
is an inefficiency.
We talked about how
competition leads
to maximally efficient
production through cost
minimization.
Competition also leads to
the maximum welfare outcome
because that point is the point
which makes society best off,
defined as the sum of consumer
surplus plus producer surplus.
But once again, I cannot
highlight enough the depth
of this insight.
That this point which before
today, you knew as the outcome.
I showed you in
the first lecture
this is what happens when
you have supply and demand.
You get to this equilibrium
that happens to be
the very best place to be.
And that's why we call it the
first fundamental theorem.
It's very important.
Yeah?
AUDIENCE: But the idea
then of since we're
caring about social worth, even
though the consumers are better
off, there is not as many
trades because the consumers
don't get as much out of it?
JONATHAN GRUBER: I
want to come to that.
Let's talk about that.
Let's go to another
example to talk about that.
Let's talk about interventions.
Let's do it.
Let's do an example.
That was just to teach
you the basic idea,
but let's go on to a
more explicit example
of a government intervention.
Actually, I'll do it here.
Let me do an explicit example
of a government intervention.
And that will
address the question
which was just asked because I
skipped over a key point, here.
I'm always not sure the right
order to teach these things.
So let's take
example of a market.
Let's consider the
market for gas.
So go to Figure 10-2.
This is a market we talked about
before, the market for gas.
Imagine the market
for gas is initially
in equilibrium with supply
curve S1 and a demand curve D.
And it's initially in
equilibrium at point little e1,
with Q1 gallons of gas
being sold at a price P1.
That's initial equilibrium.
Now, imagine that
there is an oil crisis
because, for example,
the oil company decided
it would be good
idea to drill eight
miles underground horizontally.
And it busts, and
there are spills
everywhere--
something like that,
some random example like that.
And there's a supply crisis.
What happens now is
suddenly, it gets
more expensive to produce gas.
So the supply curve
shifts upwards--
we talked about this last time--
leading us to a new
equilibrium at point E2.
And you remember,
we talked about how
the equilibrium works.
Initially, if we think
about it in steps,
initially you've
created an excess demand
because gas companies
no longer want
to supply Q1 gallons at a price
P1 from their new supply curve.
So you shift along
the demand curve
to the new point E2, which
is a new equilibrium.
And all is well and good.
Prices go up.
That's what happened after Deep
Water and things like that.
Now, imagine the government
doesn't like that.
Imagine the government says,
well, we don't like that.
We don't like the fact consumers
have to pay more for gas.
Consumers vote us
out of office when
they have to pay more for gas.
So we are going to solve this
by imposing a price ceiling.
We are going to announce
the price of gas
must remain at its old level P1.
So let's go to Figure 10-3.
Figure 10-3 shows what happens
when the government imposes
that price ceiling.
Well, the first question
is if the government
imposes a price ceiling
of P1, how much actually
gets sold in the market?
This comes to the question
that was just asked.
Well, this is sort of a
new thing we've looked at,
which is we have the situation
where there's excess demand.
At the price P1, consumers
still want Q little d.
But suppliers are only willing
to supply Qs, Q little s.
See?
Consumers still are working
off the same demand curve.
If the government says we
still want the price to be P1,
they're like, great.
We still want as much
gas as we had before.
Supplies are like, no way.
We're not going to supply it.
If you're going to keep
the price at that level,
we're going to produce
less gas because we
have a rising marginal cost.
So if you're going to
force out that same price,
we're going to work our way
back down the supply curve
and produce less gas.
So suddenly, you have a
situation of excess demand
that doesn't get resolved.
Remember, last time, we said
excess demand got resolved
by moving up the demand curve.
Well, you can't, here.
You can't resolve
that because the price
is forced to be at P1.
Now, what determines what
actually gets sold when
there's a price restriction?
Here's the way I
like to think of it.
I like to think of the
actual quantity gets
set by the constrained party.
So in this case, a
price ceiling means
that suppliers want
or are asked to supply
more than they're willing
to, so they just say no.
So you actually get the ultimate
quantity in the market is Qs.
It doesn't matter that
demanders want Qd.
They can't buy stuff
that's not produced.
Likewise, we'll
do examples later
with a price floor,
where consumers want less
than suppliers want to provide.
Then, it's consumers that
decide what gets sold.
So basically, whoever
wants less gets
to decide because
you can't force
the producers to produce more.
We have a private oil
industry, gas industry.
So you end up with Qs units
of gas sold at a price P1.
So what the price ceiling does
is move you from E1 to E3.
You would have moved to
E2 without the government
intervention.
Instead, it moves you to E3.
And as a result, you
end up with consumers--
consumer surplus-- being A plus
C, producer surplus being E,
and relative to an
unconstrained world,
not relative to the world
before, but relative to
without government
intervention, you
have a deadweight loss
of B plus D. Yeah?
AUDIENCE: Why can't [INAUDIBLE]
by producing stuff yourself?
JONATHAN GRUBER: Well,
that's a very deep question.
As I said, that we don't have
a nationalized gas industry.
We just have a
private gas industry.
There's a separate issue of--
a larger issue about whether
private or public sector
should be producing things.
And that's beyond the scope
of what we're discussing here.
But for now, assume
the government just
has a regulatory role,
not a gas production role.
The government, by
the way, does have
a little of a gas
production role
because the government
actually has something called
the Strategic Oil Reserve where
they have millions of barrels
they can actually
release and release
onto the market
at certain times.
The government does have a
way to try to deal with this.
But for now, let's
assume that they're not
going to use the Strategic
Reserve, just regulate price.
So they regulate price.
And what they've done is they've
created a deadweight loss.
So basically, if
we think about it,
what are the costs and benefits
of government intervention?
The costs of government
intervention are twofold.
What are the costs of
this price ceiling?
There's two costs.
Cost one is you've
created an inefficiency.
You've just created
this deadweight loss
because basically, if you
didn't restrict things,
there are people who
would have bought gas
to the right of Q sub S
and to the left of E2.
Those units between
Q sub S and E2,
where E2 intersects
the x-axis, those
are units where the consumer
surplus plus the producer
surplus is positive.
Right?
You look at the unit right
to the right of Q sub
S. That's a unit that consumers
would have happily bought
at the new higher price and
producers would have happily
sold at the new higher
price, but the government
isn't letting it happen.
So that's a deadweight loss.
So that's an inefficiency.
So that's the first cost--
the cost to society of
trades that don't get made.
And we call this
an efficiency loss
because there are
efficient trades.
Things are efficient
if they make
the whole-- the joint surplus
is positive, if on net, people
are better off.
They're efficient trades which
both sides were happy to make,
and they can't make.
So we call this an
efficiency loss.
But that's not the only
cost to this policy.
What's the other cost?
This is a hard question.
Yeah?
AUDIENCE: Do we have to
force the price to not be
[INAUDIBLE] what
it'd normally be?
JONATHAN GRUBER: Yeah,
so there's enforcement.
You have to go around and
send regulators around
to gas stations,
make sure they're
not charging the wrong price.
That's true.
I sort of say that's small.
Let's think more of a
theoretical-- not theoretical,
but what's the other
big source of--
yeah?
AUDIENCE: Isn't it
the loss to producers?
There's no new producers
wanting to innovate
and stuff like that?
JONATHAN GRUBER: There's
sort of a dynamic.
But once again,
the producers think
this may be a short-run thing.
And once the Deepwater
Horizon gets fixed,
prices will be back
down or whatever.
But what's the other miracle of
the market that we lose here?
We talked about this
the very first lecture.
Yeah?
AUDIENCE: It felt like,
related to [INAUDIBLE]
entering and exiting?
JONATHAN GRUBER: No,
there's entry and exit.
But once again, let's rule out
[INAUDIBLE] because it's just
a short-run deal.
Yeah?
AUDIENCE: Is it like how do
you ensure that the people who
value it the most--
JONATHAN GRUBER: Yes.
There is allocative
inefficiency.
Remember, one of the
things we talked about
in the very first lecture--
I think we did.
Maybe not.
Anyway, one of the
most important benefits
of the competitive equilibrium--
it doesn't just deliver
the right quantity,
it delivers it to the
people who want it the most.
So let's go back to figure 10-2.
It's easy to see there.
If you think about who gets gas
at the initial equilibrium E1.
And actually, no.
But let's go 10-3.
That's fine.
So let's say we
hadn't interfered,
and we'd allowed the
price to go to E2.
Well, fewer people would
have bought gas, right?
The quantity would
have fallen from Qd--
would have fallen all
the way from E1 to E2.
But the people who dropped
out would have been who?
The people who
valued gas the least,
the people who got the
lowest surplus from it.
However, now, suddenly, you
only have Qs units of gas,
and you have Qd
people who want them.
Well now, who decides
who gets them?
Before, the market
did the magic.
The market made sure the people
who wanted the units got them.
Now, all of a sudden,
something else has to decide.
So how do you resolve this?
Well, we actually
an answer to this.
We had a gas crisis
in the 1970s.
And the government
imposed a price ceiling.
And how did it get resolved?
How did we decide
then who got the gas?
Does anyone know?
Raise your hand and
tell me if you know.
Yeah?
AUDIENCE: [INAUDIBLE]
JONATHAN GRUBER:
People waited in line.
People basically sat in their
cars and waited in line.
Now, so essentially,
if you think about it,
goods are going to
get allocated somehow.
If the market doesn't
allocate them,
there'll be another less
efficient allocation mechanism.
And basically, why
is it inefficient
that people waited
in line for gas?
There's actually two reasons.
One is sort of cute.
But what's the main reason
it's inefficient for people
to be waiting in line for gas?
Yeah?
AUDIENCE: They're
wasting [INAUDIBLE]..
JONATHAN GRUBER: Yes,
the opportunity cost.
Point little 1, you have
the opportunity cost.
You have the fact that that
time I spent waiting in line,
I could have been
working or having fun,
but certainly something I
would've enjoyed more than
waiting in line for gas.
I think we'd all
agree that there's
something we'd rather
be doing with our time
than waiting in line for gas.
Unless you really like
the music in your car
stereo, and you can't
listen anywhere else.
I don't know what
the story would be.
But I can't imagine
that many of us
would prefer to wait in line
for gas than do something else.
So there's the opportunity cost.
That's an inefficiency.
Society is losing out because
you are not using your time
in the most productive way--
in the way that
maximizes your welfare.
What else?
What's the other
small, other cost?
Yeah?
AUDIENCE: Isn't waiting
in line [INAUDIBLE]??
JONATHAN GRUBER: Yeah, people
used gas waiting in line.
So there's literally the
technical inefficiency.
And remember, this is back
when cars got like 8 miles
to the gallon.
So you'd get to the
front line, get gas,
and have to go back to
the back of the line
again because you
used so much gas,
plus not to mention
the pollution and all
that other stuff.
So basically, this
is the inefficiency
from a non-market
allocation mechanism, which
is that people could be
doing more productive things
and not wasting gas
waiting in line.
Yeah?
AUDIENCE: Is the excess
of demand Qs minus Qd,
or Qs minus E2?
JONATHAN GRUBER: No, Qd--
because we fixed the price
of P1, so it's Qd minus--
since we fixed the price
of P1, people want--
what's the demand at that price?
Qd, but it's supplied
at that price Qs.
So that's the excess demand.
So now, yeah?
AUDIENCE: You mentioned
how the market makes sure
that people who want the
gas the most can get it.
But isn't the one thing it
involves like however much
they're willing to spend on it?
So does this market
assume that all people
make the same amount of income?
JONATHAN GRUBER: No, it doesn't.
But it does assume that
basically, the market--
and this comes to the tradeoff.
What's the benefit
of this policy?
Which you've raised with your
question, which is equity.
I've defined consumer
surplus as simply
being what the market delivers.
So basically, rich guys
have more consumer surplus
than poor guys.
That might not seem
fair to people.
As a result, the benefit is
equity, which is that if you--
that everyone gets
gas at a lower price.
Rather than the price rising,
the people who drop out
may actually not be the people
who don't need to drive.
They're people who can't afford
to drive, so they drop out.
Remember, where does the
main curve come from?
It comes from
utility maximization.
That's a constrained
maximization.
So the people who drop
out may be people we want.
Maybe they're people who have
to lose their jobs because they
can't drive to
their jobs anymore.
That's unfortunate.
So basically, the benefit
of this is equity.
And that raises something
we're going to come back
to over and over again in this
class, which is what we call
the equity-efficiency tradeoff.
The equity-efficiency
tradeoff, which is there
are many government policies
which make society more equal,
but along the way
deliver deadweight loss.
And I'll actually tell
you later in the class
how to optimize
across that problem--
how to optimize across the
tradeoff between equity
and efficiency.
But for right now, I just
need you to understand
that there's a tradeoff.
Yeah?
AUDIENCE: [INAUDIBLE] equity.
Like [INAUDIBLE] let the
people who [INAUDIBLE]
because if there's
no price ceiling,
then the people who are
able to pay the most money
will get it, right?
JONATHAN GRUBER: Yeah, exactly.
So the point is--
right, the people who--
was there more to your--
AUDIENCE: Yes.
But if there's a
price ceiling, then
wouldn't it just [INAUDIBLE]?
JONATHAN GRUBER: Exactly.
At issue is a different
kind of inequity.
So if you're worried about--
so in some sense, the
rich guy would say, well,
that's not fair to
me, Just because I've
got a productive job
I could be doing.
And someone else has extra time.
Why should they get
the gas instead of me?
So you're right.
There's always an inequity.
That's a great point.
When I say "equity," I
implicitly mean what we call--
ethics is a very
important point.
Whenever I say equity
in this course,
I implicitly mean what
we call vertical equity.
Vertical equity is
rich versus poor.
There are other kinds of
equity you might care about
like who has extra time versus
who doesn't have extra time.
And that's a good point.
But for now, when
I say equity, I'm
only thinking about
rich versus poor.
When we're thinking
about government policy
and the equity-efficiency
tradeoff,
we're really thinking
about vertical equity.
Other questions about that?
So let's do a
couple more examples
to drill this intuition home.
Let's do a couple more
examples because this
is a very important point.
Example A-- let's talk
about ticket scalping.
I love going to music concerts.
I went to my 51st concert
of the year last year--
last night, sorry.
Went to my 51st
concert of the year.
I love going to music
concerts, so I know
a lot about the music business.
And ticket scalping at
concerts is a big deal.
For those of you who
don't know the term,
this is the idea of
buying tickets essentially
on a secondary market.
So let's use the
example of Adele.
So Adele, about two
years ago, went on tour
for the first time in
four years to back up
an incredibly successful album.
And folks really
wanted to see her life
because she had a big fan base.
She was quiet for a while.
She made an album.
People really wanted
to see her live.
She wanted to make sure her
fans could afford to see her.
So what she did is
she said, I'm going
to price many tickets for
$40 and the highest tickets
at $150, which is
really, really cheap.
So my daughter's going
to see J. Cole tonight.
And she's paying like $150 for a
mediocre ticket, so $40 to $150
is really cheap.
But she's saying, I want
to deliver consumer surplus
to my fans.
I want to make sure
my fans can really
enjoy this and get surplus.
But what happened?
Well, what happened is that the
tickets sold out instantly--
like, literally instantaneously.
And the major
purchasers were what
we call scalpers, who are
essentially professionals
who buy tickets and
then resell them on what
we call the secondary market.
You might have heard of
StubHub or other sites
like that, where you
essentially go on
and buy tickets to
sold-out events.
And the prices on
StubHub were much higher.
It was about $1,500
for good ticket--
about 10 times what
she'd set the price at.
So basically, who's
getting the surplus?
Not the fans, the scalpers--
the people who were quick enough
to get online who had bots
set up, so that the
second it went online,
they went online
and got the tickets.
They had thousands of
bots set up, essentially.
Somehow, they got around the
"click this if you're human"
box.
I don't know how they do that.
But essentially, I'm sure
it's smart programmers.
You guys can probably
do that in an hour
as an extra-credit project.
They got around it,
and they bought.
And so essentially,
Adele actually
didn't create
surplus for her fans.
She created surplus
for scalpers.
Now, it didn't used
to be this way.
When I was a kid, we didn't
have a secondary market.
We waited on line.
So when I saw my first
concert in 1981--
can you guys believe that?
In 1981, I saw The Cars.
How many of you guys
have heard of The Cars?
Oh, god.
Anyway, I saw The Cars, and I
had to wait on line for hours
to get tickets because that
was the allocation mechanism.
So let's think about whether
life is better or worse.
Because on the one hand,
scalpers get money.
On the other hand, people don't
waste time waiting on line.
So it really comes down to
the same equity tradeoff
we talked about before.
Now.
As a 16-year-old in
1981, I could not
have afforded to pay, probably,
the secondary market price.
But as I was 16, I had
nothing do with my time,
so I was happy to spend
hours waiting on line.
But on the other hand, you could
say someone is very productive,
who is a big fan who
is very productive
and could be out
inventing new products
if they weren't
standing on line.
They might say that's
really inefficient.
I'm happy to pay $1,500
and spend my time inventing
new things, rather than have
to sit around waiting on line.
So it's not clear which is the
better or the worse system.
It's hard to say.
Yeah.
AUDIENCE: [INAUDIBLE].
So like the demand for
[INAUDIBLE] will be only
changing prices and all--
JONATHAN GRUBER: Well,
no, but here's the point--
that's a great point, which
is that, in some sense,
what the scalpers do
is undo Adele's action
and create a truly
efficient market.
So think of the scalpers as
essentially undoing Adele's
action, which
distorted the market.
So you have a market
for Adele tickets
which is at
equilibrium at $1,500.
Adele tried to set
a price ceiling
at $150, seemingly
selfishly, saying,
I'm going to give up
my surplus for my fans.
But unfortunately, it
didn't work out that way.
What happened was the market
re-equilibrated at $1,500,
but that extra surplus
didn't go to Adele.
The consumer surplus still
remained above $1,500.
The difference was that extra
gap between 150 and 1500
didn't go to Adele.
It went to the scalpers.
So it's probably more
efficient than waiting online,
because waiting online
has inefficiency,
whereas instantaneous
bidding is more efficient.
But in some sense,
the efficiency gain
is being delivered not to
consumers, as Adele wanted.
It's being delivered
to scalpers.
So basically, now, there's
another alternative.
What could Adele
have done instead?
What's another way Adele
could've approached this?
She could have auctioned
her tickets online.
She could've said,
look, I know that I
can't manage to deliver
$40 tickets to my fans.
I just can't defeat
the scalper system.
But why should the
scalpers have the money?
I'm going to auction my tickets.
And essentially, she could
have set up an efficient market
online, where people bid.
And then you would have
gotten the efficient outcome.
And you wouldn't wait on line.
You would have bid.
Now, it would've been
inequitable outcome,
but basically, the
same fans would
have gotten the tickets as in
the end got them from scalpers.
But instead of paying
$1,500 to the scalpers,
they'd pay $1,500 to Adele.
And probably that's
a better outcome.
I mean, Adele doesn't
need the money,
but at the end of
the day, if Adele's
generating that amount of
goodwill from her fans,
it seems like she should get the
money, not a bunch of scalpers.
So I guess probably I'd
rather have her have it
than the scalpers.
Now, Ticketmasters tried
to set up auction systems,
recognizing this problem, and
they're not really taking off.
And it sort of
speaks to the fact
that people don't really like
to think about economics.
That basically, people were
like, yeah, but if you auction,
that's ripping off the fans.
That's no fair.
And Ticketmasters
would say, well,
you're getting ripped off
anyway, just by scalpers.
And they said, no, I can
still get online first
and get my ticket.
And people just didn't like
it, thought it was unfair,
even though it's almost
certainly a better outcome
for society that Adele
should have the money rather
than the scalpers.
Which speaks to the fact that
morals matter in markets.
We like the way these markets
abstract amoral concepts,
but morals do matter.
And that basically,
it sort of matters
you sometimes can't do the
right thing because it might not
be the thing that
makes consumers
willing to participate.
So that's one example, scalping.
Another example-- food banks.
Food banks are
organizations which
provide-- oh, yeah, go ahead.
AUDIENCE: What if you
force everyone, I mean,
when you buy a ticket you have
to put your name on the ticket,
so that only you--
JONATHAN GRUBER: I've
thought about that.
So if I could do anything
I wanted in life,
I'd be a rock star.
And I thought if I was a
rock star, it would be cool.
I'd have a concert
for my mega fans,
where they'd have to
prove who they were,
and I'd have a
bracelet and stuff.
It just seems like
it's too hard.
It seems the technology
is just too hard.
So actually, there's
a really cool example.
So I was on the
phone this morning
with rock and roll promoter
who's doing a super cool thing.
So as the election approaches,
I will nag you guys to vote.
Voter turnout among the young
is an enormous problem the US.
So she is running a
series of concerts
around the country where if
you show a picture of yourself
outside a polling place,
you get into the concert
for free, to try to promote
voting among young people.
It's super cool.
It's called "I voted."
You can look it up on the web.
It's kind of a cool thing.
There's a couple of
concerts here in Boston.
They're all over the country.
So you could think
about things like that.
The question is ultimately, do
people Photoshop their picture
in front of the polling place?
It's all just a
question of enforcement.
Let's talk about food banks.
So basically,
these organizations
provide free food to the poor.
And the biggest one is
called "Feeding America."
Feeding America has food
banks all over the nation,
and they provide free
food to the poor.
Now, their goal,
then, is they have
to figure out where to
send the food to get it
to people who need it the most.
Now, a market does
this naturally.
Basically, if people
want more turkey
in location A, then all of a
sudden, the price for turkey
goes up.
All of a sudden, the
store runs out of turkey.
It says, wow, I can
charge more for turkey.
It raises the price, and
it equilibrates the market.
So a market solves for
sending the right food
to where people want it.
But the problem
with Feeding America
is that they didn't
have that market.
So they had to decide
where to send stuff.
And they'd screw up.
They'd send potatoes to
Idaho, where they're drowning
in potatoes, stuff like that.
So it was very hard
for them to figure out
where to send the food
exactly where people wanted
it the most, because they didn't
have the market mechanism.
They wanted to give
it away for free.
That defeats the purpose
if they charge for it.
But they didn't
really know, they
didn't have the
market to tell them
where folks wanted which foods.
In the real market,
if you want real food,
you bit the price up.
In their market, you couldn't.
So Feeding America came up
with a really clever solution.
They made a virtual market.
They said to each
food bank, we are
going to give you a fake
budget of x $100,000,
and you bid for which foods
you want based on what
the people in your area want.
And we'll then allocate it
according to those bids.
So they got the market mechanism
working without the food banks
having to actually
give any money.
So in that way, they
massively reallocated food.
They suddenly said,
hey, the one from Idaho
is bidding really high
for turkey and not at all
for potatoes.
Maybe we should send them
more turkey and the potatoes
elsewhere.
So they essentially
got market signals
from a non-financial
transaction.
It was a super cool idea.
And it was a huge benefit.
They were able to
effectively allocate
about 50 million pounds of
food through this mechanism,
making sure that food got
to the folks that needed it.
So there's an example
how you can use a market
mechanism without actually--
while not violating equity.
The food was always
free, but by setting up
these virtual
prices, they managed
to get the food
delivered to where
people wanted it the most.
They let the market send
its allocative signals.
They let the market be
allocatively efficient,
send signals of
where people wanted
the food, without
actually violating equity.
Questions about that?
Now, let's go to the hardest,
but my favorite example, which
is taxi medallions.
This is a hard example,
but it's a really cool one,
and it ends with a great story.
Taxicabs-- now, cast
your mind back pre Uber.
Go back 10 years, or even--
yeah, about 10 years.
Taxicabs were the only way
you could get around town
if you didn't have--
if you wanted to get from
point A to point B in a car,
you didn't own one,
you took a taxi.
And this was a great example
of an economist's perfectly
competitive market, in theory.
It's identical product--
you want to go from point A
to point B.
There could be lots of them
riding around the streets.
You can price
compare, because cabs
are coming by all the time.
It should have been a very
effective, perfectly efficient,
perfectly competitive market.
But it wasn't,
because every city
limited the amount
of taxicabs that
were allowed in their city.
Every city had a system
where to be a taxicab,
you had to have what was
called a "medallion."
It wasn't really a medallion.
It was originally a medallion.
It's just a piece
of paper, actually.
And they regulated the number
of taxicabs allowed in the city.
They said, we're only
going allow x many taxicab
drivers in the city.
And every city did this.
Now, we're going to do both a
positive and normative analysis
of this policy.
Let's start with a
positive analysis.
What did this policy do?
Now I'm going to
go to figure 10-4.
Figure 10-4 will be one of
the most complicated figures
we do in this class.
I'm going to go through
it as slowly as I can,
but please stop me
if it's not clear.
This is one of these figures
we'll go back and forth
between the two sides.
So on the right-hand
side is the market.
On the left-hand
side is the cab firm.
We're going to start by
assuming all cabs are identical.
We assume all cabs
are identical,
so one representative firm
tells us about every cab firm.
Now, we start with the market.
We have an initial
demand, which is d.
The line d, the blue line,
is the demand for taxicabs.
An initial supply
curve s1, we're
going to assume
that essentially,
in a perfectly
competitive market,
you have a flat, long
run supply curve.
You have perfectly
elastic supply.
Anybody can just grab a
cab and start driving.
Once again, in a cab
market without medallions,
anyone could throw a
taxi sign on the car
and start driving around,
picking people up.
So it's effectively
perfectly entry and exit,
so it's a perfectly competitive
long run market, therefore,
flat supply at s1.
So the initial equilibrium
is at point big E1.
We have Q1 rides, big
Q1 rides per month.
And that amounts to--
so you have q.
That's the equilibrium.
Now, how many firms are there?
Well, we know many
firms there are,
because we say at that
price, p1, we go to the left.
We know that firms will produce
where marginal cost equals
the average cost at the minimum
of long run average cost.
We proved that a
couple lectures ago.
Therefore, if the
price is E1, we
know each efficient firm
will produce little q1.
If each firm's going
to produce little q1,
and the total amount of
rides is going to be big Q1,
then that implies
little n1 firms.
So let me go through it again.
Supply equals demand at big Q1.
That gives you a price P1.
Now we shift to the left.
At that price P1, we
know that each firm
will choose to produce
little q1 rides,
because that's where price
equals marginal cost equals
average cost.
Now we go back to the right.
We know if each firm is
providing little q1 rides,
and you need big Q1, then
there must be N1 firms.
Questions about that?
That's the initial equilibrium.
And at that point, there
are long run zero profits.
Consumer surplus
is a plus b plus c.
c, by the way, is the
gray area on either side
of the dashed line.
a plus b plus c, we mark it
twice because it's confusing,
the dashed line there.
So the blue area, the green
area, and the gray area
are the consumer surplus.
And what's the producer surplus?
What's the producer surplus?
Raise your hand and tell me.
Yeah.
AUDIENCE: [INAUDIBLE]
JONATHAN GRUBER: Zero because?
AUDIENCE: [INAUDIBLE]
JONATHAN GRUBER: Yeah, there's
no-- in long run equilibrium,
there's no profits.
In long run equilibrium, price--
remember, profits are
price minus average cost,
but price equals average cost.
So there's no profit, so
it's all consumer surplus--
all well and good.
Now let's say the government
comes in and says,
we're going to have
a medallion system.
So let's say we're going to
have a system where only little
n2 cabs are allowed
in the market.
Little n2 are the only number
of cabs allowed in the market.
So what is the new
market supply curve?
Start on the right.
What's the new
market supply curve?
Well, up to little n2 times
q1, nothing's changed.
Each cab company used to provide
little q1 rides at a price P1.
So up to the point
little n2 little q1,
we're on the same supply
curve we used to be on.
But then things change.
Why do they change?
Because now, let's say riders
want more than little n2 q1.
Well, you can't deal
with that by entry.
You have to deal with
that by the existing cab
drivers working more.
But if they work
more, supply curve
is upward sloping, because now
marginal costs can be rising.
Before, the reason
the supply curve
was flat when you went to the
right of little n2 little q1,
as you moved to the right,
you just got more entry.
And everyone still produces
their efficient level
of little q1.
Now, when you can't
allow more entry,
firms have to produce more.
And suddenly, they're not at
the cost minimizing point.
They're riding up their
marginal cost curve.
So the supply curve
becomes flat to that point,
and then becomes upward sloping.
And that's s2.
s2 is the red line that
is flat to the left
of little n2 little q1, and
then becomes upward sloping.
And the new equilibrium
is at point E2.
With n2 firms-- by law, you
can only have n2 firms--
producing little q2 rides each.
And your new
equilibrium is big Q2.
And that new
equilibrium price is P2.
The new equilibrium price is P2.
Now P2, if you go to the old--
P2 is the point, if you
look at the price as P2,
but forget the a c2 curve.
Focus on the a c1 curve.
The average cost
function hasn't changed.
It's still a c1.
So if the price is P2 and the
average cost curve is a c1,
they're going to produce
where price equals
marginal cost at little e2.
So let me back up.
Let's go back to the
curve on the right.
The equilibrium is now big E2.
That's at a price little p2.
Now shift to the left.
At a price of little
p2, firms produce where
price equals marginal cost.
Price equals marginal cost
at a quantity little q2.
So firms produce little
q2, because that's
the point at which price
equals marginal cost.
They produce at little q2, if
they're making little q2 units
at a price p2, their earning
profits of pi, the shaded area,
because they are producing units
at price above marginal cost.
And they're producing
little q2 units,
so every unit they produce,
they're earning profits on.
So the taxi medallion
workers or the taxi companies
are now making money.
They're making profits.
Questions about that?
Yeah.
AUDIENCE: [INAUDIBLE] the
idea that if you allowed
for people, more people to
go then, profits would be
[INAUDIBLE]?
JONATHAN GRUBER: Yeah, but
they're not allowing them in.
They're making profits.
So imagine where we started
at E2 and allowed free entry.
Then you'd see, basically,
more firms willing to drive
the price down to P1.
But we don't allow
that, so it's profits.
It's a barrier to
entry, which creates
profits, which breaks us from
our long run flat supply curve.
We talked about
one of the reasons
why that loop won't be flat.
So now, let's move
to the normative.
Is this a good idea or not?
Well, let's look at the
welfare implications.
What's happened?
What's happened
is consumers used
to have a surplus
of a plus b plus c.
Now, their surplus is what?
What's the new consumer surplus?
Raise their hand and tell me.
Yeah.
AUDIENCE: A.
JONATHAN GRUBER: Just a, because
the line below the demand
above price is just a.
Producers used to
have zero surplus.
What's their new surplus?
Behind you, yeah.
AUDIENCE: B.
JONATHAN GRUBER: B, because
it's the area above the supply
curve, below the price line.
And c is what?
The deadweight loss.
Those are transactions
no longer happening--
the deadweight loss.
So basically, normatively,
you can pose the problem
as the following--
is it worth society
losing the area c
in order to transfer the
area b from consumers
to taxicab drivers?
That's the way to think
about this problem.
Let me say it again.
It's very important.
Essentially what the government
policy is doing is saying,
I'm going to transfer
b from consumers
to producers, even though
it's going to cost me
c in deadweight loss.
That's what the
government's saying.
That's the
government's position.
Now, why is the
government wrong?
Why, in fact, is that
not the proper statement
of what happens?
It's very complicated.
What does the government
miss when it says,
I've made the
drivers better off?
Sure, I've created
deadweight loss,
and I make consumers
[INAUDIBLE],,
but at least I made
these drivers better off.
They live terrible lives.
There's articles in the paper
all the time about suicides
of taxicab drivers.
It's terrible.
What did they miss?
Yeah.
AUDIENCE: The cost
of taxis goes up.
JONATHAN GRUBER: They've missed
the fact that the taxicab
drivers have to
buy the medallions,
that the limited
number of medallions
aren't just given to taxicab
drivers, they're bought.
And the taxicab drivers--
what is a taxicab driver
willing to pay for a medallion?
They are willing to pay, in
the limit, the total surplus
they get from driving the cab
minus $1 or minus some amount
that they need to eat.
So if suddenly, in a world
with no restrictions,
with no taxicab
medallions, if you said
we need a piece of
paper to drive a taxi,
but anyone can have it for
free, what would it be worth?
Zero.
But in a world where you say
if you have this piece of paper
you can drive, and
drivers earn profits pi,
what will the taxicab
medallions sell for?
Pi minus some small amount.
So actually, who wins?
The taxicab medallion owners.
And who are they?
They are random
folks who happened
to get these things in
1920 when they were issued,
and their descendants, and
people who bought them.
So this leads to my great story,
the taxicab medallion king
of Long Island was
a guy who happened
to have a bunch of these
taxicab medallions.
And as they went through the
roof, they got worth a lot.
In New York, New York
had 12,000 permits,
and that number did not
change since they originally
sold for $10 each in 1937.
1937, you could have
bought [INAUDIBLE] for $10,
and they issued 12,000 of them.
They've never increased it.
Right now, a taxicab medallion
in New York is worth $400,000.
The taxicab King of
New York is a guy
who lives in Long Island who
made so much money that he
actually, for his
kid's bar mitzvah
not only had rented out a hotel,
whole basketball-themed bar
mitzvah, but hired Nicki Minaj.
This was paid for by area b.
This was paid for--
so in fact, it's
not the taxicab drivers that
make out of this policy.
It's the taxicab medallion
King of New York.
Now, here's what happens--
what happens, then,
when Uber comes in?
Who's the big loser?
Not the taxicab drivers, the
taxicab medallion owners.
So everyone tells you
Uber is a bad thing
because these poor taxicab
drivers are starving.
Taxicab drivers were
always starving.
It was always a terrible life.
The difference is pricing
medallions is down like 50%.
And I cry no tears for the Nicki
Minaj-hiring class of America.
So basically, when you think
about people saying Uber is
bad, it steals jobs from
taxicab drivers, no, it doesn't.
It steals money from
taxicab medallion owners,
and that is something
we might be OK with.
So feel fine taking your Uber.
It's a great thing.
So let me stop there.
I'm going to come back.
We'll come back next lecture.
And we will start talking about
monopoly, the market structure,
not the game.
