Market Efficiency

1. Unit 1
Market Efficiency
Does the market achieve an efficient
allocation of resources?
2008/22168

2. • Microeconomics is concerned with
the efficient allocation of scarce
resources.
• Markets (demand & supply) are just
one way to allocate resources
Market Efficiency

3. Resource Allocation Methods
• Resources might be allocated by:
– Market price
– Command
– Majority rule
– Contest
– First-come, first-served
– Lottery
– Personal characteristics
– Force
Economists would
argue that markets
are the ‘best’ or
most efficient way

4. Market Efficiency
“If there is one thing that separates
economists from mere mortals, it is an
appreciation of the power of markets as a
mechanism for allocating scarce resources
. . . it explains the biggest economic event
of the 20th century – the victory of
capitalism over communism” (G. Mankiw)

5. Market Efficiency
• How much benefit do producers and
consumers receive from the existence of
a market?
• How is the welfare of consumers and
producers affected by changes in market
prices?
• Does the market equilibrium
maximise the total welfare of
buyers and sellers?

6. Demand, Marginal Benefit,
and Consumer Surplus
• The demand curve reflects your
willingness to pay - the maximum
price that a person is willing to pay for a
good
• A demand curve is a marginal benefit
curve – the area under the D curve
represents the total benefits from
consumption

7. • Consumer surplus is broadly defined as
the difference between an item's "total
value" or "total value received" to
consumers and the actual price that they
pay for it.
• In other words, if consumers pay less for a
product than what it's worth to them,
consumer surplus represents their
“savings”.

8. • As a simplified example, let's say that a
consumer is in the market for a used car.
• He has given himself $10,000 to spend.
• If he buys a car with everything he wants
for $6,000, we can say that he has a
consumer surplus of $4,000.

10. P Qd
10 1
9 2
8 3
7 4
6 5
5 6
4 7
Demand & Consumer Surplus
P
Q
6
5
D
10
Demand reflects
the maximum
price consumers
are willing to pay

11. • How much value (benefit)
does the consumer receive?
• Notice that total benefits are
more than what you pay
P
Q
6
5
D
10
Demand & Consumer Surplus

12. P Qd $ Paid Con Surplus
10 1 6 4
9 2 6 3
8 3 6 2
7 4 6 1
6 5 6 0
Total 30 + 10
Demand & Consumer Surplus

13. Consumer Surplus
• Consumer surplus is equal to the
difference between the buyer’s willingness
to pay and the actual price paid
• Consumer surplus measures the net
benefits from consumption
• If consumer surplus increases, then
consumers are better off

14. Consumer Surplus
P
Q
6
5
D
Amount paid ($30)
Consumer surplus is the
area below the demand
curve and above the
market price ($10)

15. How a change in Price affects
consumer surplus
Quantity
Price
0
Demand
P1
A
B
Initial
consumer
surplus
C
Q1 Q2
Supply

16. How a change in Price affects
consumer surplus
Quantity
Price
0
Demand
P1
P2
A
B
D
C
E
Q1 Q2
Initial
consumer
surplus
Increase in consumer
surplus
Supply
S

17. Calculating Consumer Surplus

19. • For our example, we know that the point is
going to intersect the price axis at $5.
• The triangular area between this horizontal
line, the vertical line of the price axis, and
where the demand curve intersects both is
the area corresponding to consumer
surplus

20. Use the correct equation. The equation for it is 1/2(base x height) or (base x
height)/2.

21. •Plug in the corresponding numbers. For our example, the base of the triangle is
the quantity demanded at the point of equilibrium, which is 15.
•To get the height of the triangle for our example, we must take the equilibrium price
point ($5) and subtract it from the price point at which the demand curve intersects the
price axis (let’s say $12 for your example. 12 - 5 = 7, so we would use a height of 7.

22. With the numbers plugged into the equation, you’re ready to solve. With
the running example, CS = 1/2(15 x 7) = 1/2 x 105 = $52.50.

23. 15. The following figure illustrates the market demand curve for wine.
Refer to the figure above. What is consumer surplus when the market price of wine is $9?
A. $60,000
B. $90,000
C. $180,000
D. $210,000

24. Calculating
• To get the height of the triangle for our
example, we must take the equilibrium price
point ($9) and subtract it from the price point
at which the demand curve intersects the
price axis ($21 for your example. 21 - 9 = 12,
so we would use a height of 12.
• With the numbers plugged into the equation,
you’re ready to solve. With the running
example, CS = 1/2(10 x 12) = 1/2 x 120 =
$60 ($60,000)

25. P Qd
10 1
9 2
8 3
7 4
6 5
5 6
4 7
Demand & Consumer Surplus
P
Q
6
5
D
10
Demand reflects
the maximum
price consumers
are willing to pay

26. • How much value (benefit)
does the consumer receive?
• Notice that total benefits are
more than what you pay
P
Q
6
5
D
10
Demand & Consumer Surplus

27. P Qd $ Paid Con Surplus
10 1 6 4
9 2 6 3
8 3 6 2
7 4 6 1
6 5 6 0
Total 30 + 10
Demand & Consumer Surplus

28. Consumer Surplus
• Consumer surplus is equal to the
difference between the buyer’s willingness
to pay and the actual price paid
• Consumer surplus measures the net
benefits from consumption
• If consumer surplus increases, then
consumers are better off

29. Consumer Surplus
P
Q
6
5
D
Amount paid ($30)
Consumer surplus is the
area below the demand
curve and above the
market price ($10)

30. How a change in Price affects
consumer surplus
Quantity
Price
0
Demand
P1
A
B
Initial
consumer
surplus
C
Q1 Q2
Supply

31. How a change in Price affects
consumer surplus
Quantity
Price
0
Demand
P1
P2
A
B
D
C
E
Q1 Q2
Initial
consumer
surplus
Increase in consumer
surplus
Supply
S

32. Supply, Marginal Cost, and
Producer Surplus
• Do producers receive a similar
surplus?
• The cost of one more unit of a good or
service is its marginal cost, which
reflects the minimum price that a firm
is willing to accept.
• A supply curve is a marginal cost
curve.

33. Supply & Producer Surplus
P Qs
1 0
2 1
3 2
4 3
5 4
6 5
7 6
P
Q
6
5
S

34. Price Producer
P Qs Received Surplus
1 0 - -
2 1 6 4
3 2 6 3
4 3 6 2
5 4 6 1
6 5 6 0
Total $30 $10
Supply & Producer Surplus

35. Supply & Producer Surplus
• Producer surplus is the price of a
good minus the marginal cost of
producing it
• Producer surplus is measured by the
area below the price and above the
supply curve.
• If producer surplus increases, then
producers are better off

36. Supply & Producer Surplus
P
Q
6
5
Producer surplus
= $10
S
Cost of
production = $20

37. Quantity
Price
0
P1
B
C
Supply
A
Initial
producer
surplus
Q1 Q2
Demand
How a change in price affects
producer surplus

38. Quantity
Price
0
P2
P1
B
C
Supply
A
D
Initial
producer
surplus
E
F
Q1 Q2
Increase in producer
surplus
Demand
D
How a change in price affects
producer surplus

39. Market Efficiency
• Consumer surplus and producer surplus are
the basic tools that economists use to study
the welfare of buyers and sellers in a market.
• The economic well-being of a society is
measured as the sum of consumer surplus
and producer surplus - total surplus.
• Market efficiency is attained when the
allocation of resources maximises total
surplus.

40. Economic well-being and
total surplus
or
Total
Surplus =
Total
Benefits
_ Total
Costs
Total
Surplus =
Consumer
Surplus
Producer
Surplus
+

41. Price
Equilibrium
price
0 Quantity
Equilibrium
quantity
Supply
Demand
Producer Surplus
Consumer Surplus
• TS = MAX
only at EQUIL !
Total Surplus

42. Efficiency and equity
Efficiency – is the economy getting the most
of out its scarce resources (or are they being
wasted)?
1. Technical efficiency – is production
being done at lowest unit cost?
2. Allocative efficiency – are resources
being used to make products that
people want?