Reservation Prices

1
BRING ME SOME WATER
2
Reservation Prices

• Supply Side Lowest price that would induce
  someone to provide a product to the market
• Demand Side Highest price that a consumer would
  pay to acquire a product

3
Consumer Surplus
Consumer As Surplus
Price
A
PA
Market Price
Pm
D
Qm
Quantity
4
Consumer SurplusArea below demand curve but
above market price
Price
Consumer Surplus
Market Price
Market Value PmQm Captured by seller
Pm
D
Qm
Quantity
5
How can seller extract more of the consumer
surplus?

• Charge each consumer person his reservation price
• How is this possible?

6
Producer SurplusArea above supply curve but
below market price
Price
Producer As Surplus
S
Pm
Market Price
A
Qm
Quantity
7
Producer SurplusArea above supply curve but
below market price
Price
Producer Surplus
S
Pm
Market Price
D
Qm
Quantity
8
Total SurplusProducer surplus consumer surplus
Consumer surplus
Price
Producer Surplus
S
Pm
Market Price
D
Qm
Quantity
9
Total SurplusProducer surplus consumer surplus

• Maximized at equilibrium price
• Measure of efficiency

10
Total Surplus when price above equilibriumProduce
r surplus consumer surplus
Consumer surplus
Price
Producer Surplus
S
Pm
Pe
Loss due to inefficient allocation
D
Qe
Qm
Quantity
11
Total Surplus when price is below
equilibriumProducer surplus consumer surplus
Consumer surplus
Price
Producer Surplus
S
Pe
Loss due to inefficient allocation
Pm
D
Qm
Qe
Quantity
12
Total SurplusProducer surplus consumer surplus

• Maximized at equilibrium price

Total Consumer ValueConsumer Surplus Market
Value
13
Total Consumer Value
Consumer surplus
Price
S
Pm
Market Price
D
Market Value
Qm
Quantity
14
Paradox of Value

• If teachers are so important to society,
• Why are they paid so little compared to NBA
  players?
• If water is more important than diamonds for
  life,
• Why are diamonds worth so much more?

15
Offenberg, Jennifer Pate, Markets Gift Cards
Journal of Economic Perspectives 21(2)227-238
16
Willingness to Accept for a 25 Gift Card
lt25 Lost efficiency relative to cash
Price
Supply
25
40 loss
15
Demand
Quantity
q0
17
Welfare Loss Auction Price on Ebay.com relative
to Face Value Does not include shipping and
transaction cost also paid by seller
Offenberg, Jennifer Pate, Markets Gift Cards
Journal of Economic Perspectives 21(2)227-238
18
Welfare Loss Auction Price on Ebay.com relative
to Face Value Does not include shipping and
transaction cost also paid by seller
Offenberg, Jennifer Pate, Markets Gift Cards
Journal of Economic Perspectives 21(2)227-238