Gains from Trade Lecture

Introduction

• Markets: where buyers and sellers converge.
• Prices and quantities determined by supply and demand.
• Markets maximize efficiency: total economic surplus.
• Economic surplus = Producer surplus + Consumer surplus.

How Markets Increase Economic Surplus

• Markets reallocate resources to better uses.
• Goods can have varying values for different people.
  • e.g., Medicine, luxury items like fancy wine, monogram shirts.
• Trading reallocates these goods to those who value them more.

Example with Jay and Emil

• Scenario: Jay receives a Starburst, Emil receives a Reese's cup.
  • Jay values the Starburst at $1, Reese's at $5.
  • Emil values Starburst at $3, Reese's at $0 (allergic).
• Initial economic surplus: $1.
• After trading: Jay has Reese’s ($5 value), Emil has Starburst ($3 value).
  • New total surplus: $8.
• Trading increases total economic surplus without additional effort or innovation.

Market Functions

• Resource Reallocation: Markets reallocate resources to better uses.
  • Example: Selling an unwanted gift on eBay.
  • Labor Markets: Tasks are reallocated, e.g., DoorDash.
• Intermediate Inputs: Allocate resources like gold for various uses.
• Purchasing Power: Mortgages allow purchasing over time.
• Risk Reallocation: Insurance companies absorb individual risks.

Application Examples

• Opportunity Costs: Example of coffee makers during COVID-19.
  • Purchasing decisions influenced by reduced opportunity costs (e.g., not dining out).
  • Counter space as a limited resource and associated opportunity cost.

Price Floors and Market Effects

• Price Floors: Minimum price regulation.
  • Results in surplus: Quantity supplied > Quantity demanded.
• Crude Oil Price Increase:
  • Marginal cost increase affects gasoline prices.
  • Supply curve shifts up; equilibrium price increases but less than the cost increase.

Conclusion

• Markets enhance economic surplus by efficient resource allocation.
• Trading benefits both parties, increasing total welfare without extra effort.
• Opportunity costs play a critical role in economic decision-making.