3   SUPPLY AND DEMAND II: MARKETS AND WELFARE
7 Consumers, Producers, and the Efficiency of Markets
REVISITING THE MARKET EQUILIBRIUM <ul><li>Do the equilibrium price and quantity maximize the total welfare of buyers and s...
Welfare Economics <ul><li>Welfare economics  is the study of how the allocation of   resources affects economic well-being...
Welfare Economics <ul><li>Equilibrium in the market results in maximum benefits, and therefore maximum total welfare for b...
Welfare Economics <ul><li>Consumer surplus measures economic welfare from the buyer’s side. </li></ul><ul><li>Producer sur...
CONSUMER SURPLUS <ul><li>Willingness to pay  is the maximum amount that a buyer  will pay for a good. </li></ul><ul><li>It...
CONSUMER SURPLUS <ul><li>Consumer surplus  is the buyer’s willingness to pay for a good minus the amount the buyer actuall...
Table 1 Four Possible Buyers’ Willingness to Pay Copyright©2004  South-Western
CONSUMER SURPLUS <ul><li>The market demand curve depicts the various quantities that buyers would be willing and able to p...
The Demand Schedule and the Demand Curve
Figure 1 The Demand Schedule and the Demand Curve Copyright©2003  Southwestern/Thomson Learning Price of Album 0 Quantity ...
Figure 2 Measuring Consumer Surplus with the Demand Curve Copyright©2003  Southwestern/Thomson Learning (a) Price = $80 Pr...
Figure 2 Measuring Consumer Surplus with the Demand Curve Copyright©2003  Southwestern/Thomson Learning (b) Price = $70 Pr...
Using the Demand Curve to Measure Consumer Surplus <ul><li>The area below the demand curve and above the price measures th...
Figure 3 How the Price Affects Consumer Surplus Copyright©2003  Southwestern/Thomson Learning Quantity (a) Consumer Surplu...
Figure 3 How the Price Affects Consumer Surplus Copyright©2003  Southwestern/Thomson Learning Quantity (b) Consumer Surplu...
What Does Consumer Surplus Measure? <ul><li>Consumer surplus , the amount that buyers are willing to pay for a good minus ...
PRODUCER SURPLUS <ul><li>Producer surplus  is the amount a seller is paid for a good minus the seller’s  cost .  </li></ul...
Table 2 The Costs of Four Possible Sellers Copyright©2004  South-Western
Using the Supply Curve to Measure Producer Surplus <ul><li>Just as consumer surplus is related to the demand curve, produc...
The Supply Schedule and the Supply Curve
Figure 4 The Supply Schedule and the Supply Curve
Using the Supply Curve to Measure Producer Surplus <ul><li>The area below the price and above the supply curve measures th...
Figure 5 Measuring Producer Surplus with the Supply Curve Copyright©2003  Southwestern/Thomson Learning Quantity of Houses...
Figure 5 Measuring Producer Surplus with the Supply Curve Copyright©2003  Southwestern/Thomson Learning Quantity of Houses...
Figure 6 How the Price Affects Producer Surplus Copyright©2003  Southwestern/Thomson Learning Quantity (a)  Producer Surpl...
Figure 6 How the Price Affects Producer Surplus Copyright©2003  Southwestern/Thomson Learning Quantity (b) Producer Surplu...
MARKET EFFICIENCY <ul><li>Consumer surplus and producer surplus may be used to address the following question: </li></ul><...
MARKET EFFICIENCY <ul><li>Consumer Surplus  </li></ul><ul><li>= Value to buyers – Amount paid by buyers </li></ul><ul><li>...
MARKET EFFICIENCY <ul><li>Total surplus  </li></ul><ul><li>= Consumer surplus + Producer surplus </li></ul><ul><li>or </li...
MARKET EFFICIENCY <ul><li>Efficiency  is the property of a resource allocation of maximizing the total surplus received by...
MARKET EFFICIENCY <ul><li>In addition to market efficiency, a social planner might also care about  equity  – the fairness...
Figure 7 Consumer and Producer Surplus in the Market Equilibrium Copyright©2003  Southwestern/Thomson Learning Price 0 Qua...
MARKET EFFICIENCY  <ul><li>Three Insights Concerning Market Outcomes </li></ul><ul><ul><li>Free markets allocate the suppl...
Figure 8 The Efficiency of the Equilibrium Quantity Copyright©2003  Southwestern/Thomson Learning Quantity Price 0 Supply ...
Evaluating the Market Equilibrium <ul><li>Because the equilibrium outcome is an efficient allocation of resources, the soc...
Evaluating the Market Equilibrium  <ul><li>Market Power </li></ul><ul><ul><li>If a market system is not perfectly competit...
Evaluating the Market Equilibrium  <ul><li>Externalities </li></ul><ul><ul><li>created when a market outcome affects indiv...
Summary <ul><li>Consumer surplus equals buyers’ willingness to pay for a good minus the amount they actually pay for it. <...
Summary <ul><li>Producer surplus equals the amount sellers receive for their goods minus their costs of production. </li><...
Summary <ul><li>An allocation of resources that maximizes the sum of consumer and producer surplus is said to be efficient...
Summary <ul><li>The equilibrium of demand and supply maximizes the sum of consumer and producer surplus. </li></ul><ul><li...
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  1. 1. 3 SUPPLY AND DEMAND II: MARKETS AND WELFARE
  2. 2. 7 Consumers, Producers, and the Efficiency of Markets
  3. 3. REVISITING THE MARKET EQUILIBRIUM <ul><li>Do the equilibrium price and quantity maximize the total welfare of buyers and sellers? </li></ul><ul><li>Market equilibrium reflects the way markets allocate scarce resources. </li></ul><ul><li>Whether the market allocation is desirable can be addressed by welfare economics. </li></ul>
  4. 4. Welfare Economics <ul><li>Welfare economics is the study of how the allocation of resources affects economic well-being. </li></ul><ul><li>Buyers and sellers receive benefits from taking part in the market. </li></ul><ul><li>The equilibrium in a market maximizes the total welfare of buyers and sellers. </li></ul>
  5. 5. Welfare Economics <ul><li>Equilibrium in the market results in maximum benefits, and therefore maximum total welfare for both the consumers and the producers of the product. </li></ul>
  6. 6. Welfare Economics <ul><li>Consumer surplus measures economic welfare from the buyer’s side. </li></ul><ul><li>Producer surplus measures economic welfare from the seller’s side. </li></ul>
  7. 7. CONSUMER SURPLUS <ul><li>Willingness to pay is the maximum amount that a buyer will pay for a good. </li></ul><ul><li>It measures how much the buyer values the good or service. </li></ul>
  8. 8. CONSUMER SURPLUS <ul><li>Consumer surplus is the buyer’s willingness to pay for a good minus the amount the buyer actually pays for it. </li></ul>
  9. 9. Table 1 Four Possible Buyers’ Willingness to Pay Copyright©2004 South-Western
  10. 10. CONSUMER SURPLUS <ul><li>The market demand curve depicts the various quantities that buyers would be willing and able to purchase at different prices. </li></ul>
  11. 11. The Demand Schedule and the Demand Curve
  12. 12. Figure 1 The Demand Schedule and the Demand Curve Copyright©2003 Southwestern/Thomson Learning Price of Album 0 Quantity of Albums 1 2 3 4 Demand $100 John ’ s willingness to pay 80 Paul ’ s willingness to pay 70 George ’ s willingness to pay 50 Ringo ’ s willingness to pay
  13. 13. Figure 2 Measuring Consumer Surplus with the Demand Curve Copyright©2003 Southwestern/Thomson Learning (a) Price = $80 Price of Album 50 70 80 0 $100 1 2 3 4 Quantity of Albums Demand John ’ s consumer surplus ($20)
  14. 14. Figure 2 Measuring Consumer Surplus with the Demand Curve Copyright©2003 Southwestern/Thomson Learning (b) Price = $70 Price of Album 50 70 80 0 $100 1 2 3 4 Quantity of Albums Demand Total consumer surplus ($40) John ’ s consumer surplus ($30) Paul ’ s consumer surplus ($10)
  15. 15. Using the Demand Curve to Measure Consumer Surplus <ul><li>The area below the demand curve and above the price measures the consumer surplus in the market. </li></ul>
  16. 16. Figure 3 How the Price Affects Consumer Surplus Copyright©2003 Southwestern/Thomson Learning Quantity (a) Consumer Surplus at Price P Price 0 Consumer surplus Demand P 1 Q 1 B A C
  17. 17. Figure 3 How the Price Affects Consumer Surplus Copyright©2003 Southwestern/Thomson Learning Quantity (b) Consumer Surplus at Price P Price 0 Initial consumer surplus Demand A B C D E F P 1 Q 1 P 2 Q 2 Consumer surplus to new consumers Additional consumer surplus to initial consumers
  18. 18. What Does Consumer Surplus Measure? <ul><li>Consumer surplus , the amount that buyers are willing to pay for a good minus the amount they actually pay for it, measures the benefit that buyers receive from a good as the buyers themselves perceive it . </li></ul>
  19. 19. PRODUCER SURPLUS <ul><li>Producer surplus is the amount a seller is paid for a good minus the seller’s cost . </li></ul><ul><li>It measures the benefit to sellers participating in a market. </li></ul>
  20. 20. Table 2 The Costs of Four Possible Sellers Copyright©2004 South-Western
  21. 21. Using the Supply Curve to Measure Producer Surplus <ul><li>Just as consumer surplus is related to the demand curve, producer surplus is closely related to the supply curve. </li></ul>
  22. 22. The Supply Schedule and the Supply Curve
  23. 23. Figure 4 The Supply Schedule and the Supply Curve
  24. 24. Using the Supply Curve to Measure Producer Surplus <ul><li>The area below the price and above the supply curve measures the producer surplus in a market. </li></ul>
  25. 25. Figure 5 Measuring Producer Surplus with the Supply Curve Copyright©2003 Southwestern/Thomson Learning Quantity of Houses Painted Price of House Painting 500 800 $900 0 600 1 2 3 4 (a) Price = $600 Supply Grandma ’ s producer surplus ($100)
  26. 26. Figure 5 Measuring Producer Surplus with the Supply Curve Copyright©2003 Southwestern/Thomson Learning Quantity of Houses Painted Price of House Painting 500 800 $900 0 600 1 2 3 4 (b) Price = $800 Georgia ’ s producer surplus ($200) Total producer surplus ($500) Grandma ’ s producer surplus ($300) Supply
  27. 27. Figure 6 How the Price Affects Producer Surplus Copyright©2003 Southwestern/Thomson Learning Quantity (a) Producer Surplus at Price P Price 0 Producer surplus Supply B A C Q 1 P 1
  28. 28. Figure 6 How the Price Affects Producer Surplus Copyright©2003 Southwestern/Thomson Learning Quantity (b) Producer Surplus at Price P Price 0 P 1 B C Supply A Initial producer surplus Q 1 P 2 Q 2 Producer surplus to new producers Additional producer surplus to initial producers D E F
  29. 29. MARKET EFFICIENCY <ul><li>Consumer surplus and producer surplus may be used to address the following question: </li></ul><ul><ul><li>Is the allocation of resources determined by free markets in any way desirable? </li></ul></ul>
  30. 30. MARKET EFFICIENCY <ul><li>Consumer Surplus </li></ul><ul><li>= Value to buyers – Amount paid by buyers </li></ul><ul><li>and </li></ul><ul><li>Producer Surplus </li></ul><ul><li>= Amount received by sellers – Cost to sellers </li></ul>
  31. 31. MARKET EFFICIENCY <ul><li>Total surplus </li></ul><ul><li>= Consumer surplus + Producer surplus </li></ul><ul><li>or </li></ul><ul><li>Total surplus </li></ul><ul><li>= Value to buyers – Cost to sellers </li></ul>
  32. 32. MARKET EFFICIENCY <ul><li>Efficiency is the property of a resource allocation of maximizing the total surplus received by all members of society. </li></ul>
  33. 33. MARKET EFFICIENCY <ul><li>In addition to market efficiency, a social planner might also care about equity – the fairness of the distribution of well-being among the various buyers and sellers. </li></ul>
  34. 34. Figure 7 Consumer and Producer Surplus in the Market Equilibrium Copyright©2003 Southwestern/Thomson Learning Price 0 Quantity Producer surplus Consumer surplus Equilibrium price Equilibrium quantity Supply Demand A C B D E
  35. 35. MARKET EFFICIENCY <ul><li>Three Insights Concerning Market Outcomes </li></ul><ul><ul><li>Free markets allocate the supply of goods to the buyers who value them most highly, as measured by their willingness to pay. </li></ul></ul><ul><ul><li>Free markets allocate the demand for goods to the sellers who can produce them at least cost. </li></ul></ul><ul><ul><li>Free markets produce the quantity of goods that maximizes the sum of consumer and producer surplus. </li></ul></ul>
  36. 36. Figure 8 The Efficiency of the Equilibrium Quantity Copyright©2003 Southwestern/Thomson Learning Quantity Price 0 Supply Demand Cost to sellers Cost to sellers Value to buyers Value to buyers Value to buyers is greater than cost to sellers. Value to buyers is less than cost to sellers. Equilibrium quantity
  37. 37. Evaluating the Market Equilibrium <ul><li>Because the equilibrium outcome is an efficient allocation of resources, the social planner can leave the market outcome as he/she finds it. </li></ul><ul><li>This policy of leaving well enough alone goes by the French expression laissez faire. </li></ul>
  38. 38. Evaluating the Market Equilibrium <ul><li>Market Power </li></ul><ul><ul><li>If a market system is not perfectly competitive, market power may result. </li></ul></ul><ul><ul><ul><li>Market power is the ability to influence prices. </li></ul></ul></ul><ul><ul><ul><li>Market power can cause markets to be inefficient because it keeps price and quantity from the equilibrium of supply and demand. </li></ul></ul></ul>
  39. 39. Evaluating the Market Equilibrium <ul><li>Externalities </li></ul><ul><ul><li>created when a market outcome affects individuals other than buyers and sellers in that market. </li></ul></ul><ul><ul><li>cause welfare in a market to depend on more than just the value to the buyers and cost to the sellers. </li></ul></ul><ul><li>When buyers and sellers do not take externalities into account when deciding how much to consume and produce, the equilibrium in the market can be inefficient. </li></ul>
  40. 40. Summary <ul><li>Consumer surplus equals buyers’ willingness to pay for a good minus the amount they actually pay for it. </li></ul><ul><li>Consumer surplus measures the benefit buyers get from participating in a market. </li></ul><ul><li>Consumer surplus can be computed by finding the area below the demand curve and above the price. </li></ul>
  41. 41. Summary <ul><li>Producer surplus equals the amount sellers receive for their goods minus their costs of production. </li></ul><ul><li>Producer surplus measures the benefit sellers get from participating in a market. </li></ul><ul><li>Producer surplus can be computed by finding the area below the price and above the supply curve. </li></ul>
  42. 42. Summary <ul><li>An allocation of resources that maximizes the sum of consumer and producer surplus is said to be efficient. </li></ul><ul><li>Policymakers are often concerned with the efficiency, as well as the equity, of economic outcomes. </li></ul>
  43. 43. Summary <ul><li>The equilibrium of demand and supply maximizes the sum of consumer and producer surplus. </li></ul><ul><li>This is as if the invisible hand of the marketplace leads buyers and sellers to allocate resources efficiently. </li></ul><ul><li>Markets do not allocate resources efficiently in the presence of market failures. </li></ul>

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