Ch 07 micro 1

Lecture PowerPoint® Slides
to accompany

Prepared by
Marc Prud‘Homme, University of Ottawa 1

Chapter 7

Consumers, Producers, and the
Efficiency of Markets

Copyright © 2011 Nelson Education Limited 2

WTP and the Demand Curve
Q: If price of iPod is $200, who will buy an iPod, and
what is quantity demanded?

A: Anthony & Flea will buy an iPod,
Chad & John will not.
name WTP
Hence, Qd = 2
Anthony $250
when P = $200.
Chad 175
Flea 300
John 125


Derive the
P (price
demand who buys Qd
of iPod)
schedule:
$301 & up nobody 0

name WTP 251 – 300 Flea 1

Anthony $250 176 – 250 Anthony, Flea 2
Chad 175 Chad, Anthony,
126 – 175 3
Flea 300 Flea
John, Chad,
John 125 0 – 125 4
Anthony, Flea

P
$350
P Qd
$300
$250 $301 & up 0

$200 251 – 300 1
$150 176 – 250 2
$100
126 – 175 3
$50
0 – 125 4
$0 Q
0 1 2 3 4

About the Staircase Shape…
P This D curve looks like a staircase
$350 with 4 steps – one per buyer.
$300 If there were a huge # of buyers,
as in a competitive market,
$250
there would be a huge #
$200
of very tiny steps,
$150 and it would look
$100 more like a smooth
curve.
$50
$0 Q
0 1 2 3 4 6
Copyright © 2011 Nelson Education Limited

Consumer Surplus (CS)
Consumer surplus is the amount a buyer is willing
to pay minus the amount the buyer actually pays:
CS = WTP – P

name WTP Suppose P = $260.

Anthony $250 Flea’s CS = $300 – 260 = $40.

Chad 175 The others get no CS because
they do not buy an iPod at this
Flea 300 price.
John 125 Total CS = $40.


CS and the Demand Curve
P
Flea’s WTP P = $260
$350
Flea’s CS =
$300 $300 – 260 = $40
$250 Total CS = $40
$200
$150
$100
$50
$0 Q
0 1 2 3 4 8

P
Flea’s WTP Instead, suppose
$350 P = $220
$300 Anthony’s WTP
Flea’s CS =
$250 $300 – 220 = $80
$200 Anthony’s CS =
$250 – 220 = $30
$150
Total CS = $110
$100
$50
$0 Q
0 1 2 3 4 9

P
$350 The lesson:
Total CS equals
$300
the area under
$250 the demand curve
$200 above the price,
from 0 to Q.
$150
$100
$50
$0 Q
0 1 2 3 4 10

CS with Lots of Buyers & a Smooth D Curve
Price P The demand for shoes
per pair
$ 60
At Q = 5(thousand), 50
the marginal buyer 40
is willing to pay $50
for pair of shoes. 30
1000s of pairs
Suppose P = $30. 20 of shoes
Then his consumer 10
D
surplus = $20. 0 Q
0 5 10 15 20 25 30

CS with Lots of Buyers & a Smooth D Curve
CS is the area b/w The demand for shoes
P and the D curve, P
from 0 to Q. $ 60

Recall: area of 50
h
a triangle equals 40
½ x base x height
30
Height =
20
$60 – 30 = $30.
10
So, D
CS = ½ x 15 x $30 0 Q
= $225. 0 5 10 15 20 25 30

How a Higher Price Reduces CS
If P rises to $40,
P
CS = ½ x 10 x $20 1. Fall in CS
60
= $100. due to buyers
50 leaving market
Two reasons for the
fall in CS. 40
30

2. Fall in CS due to 20
remaining buyers 10
paying higher P D
0 Q
0 5 10 15 20 25 30

ACTIVE LEARNING 1
Consumer surplusP
50
demand curve
A. Find marginal $ 45
buyer’s WTP at
40
Q = 10.
35
B. Find CS for
P = $30. 30
Suppose P falls to $20.
25
How much will CS 20
increase due to… 15
C. buyers entering 10
the market 5
D. existing buyers paying 0
lower price
0 5 10 15 20 Q
25

ACTIVE LEARNING 1
Answers demand curve
P
50
A. At Q = 10, marginal $ 45
buyer’s WTP is $30.
40
B. CS = ½ x 10 x $10 35
= $50 30
P falls to $20. 25
C. CS for the 20
additional buyers 15
= ½ x 10 x $10 = $50 10
D. Increase in CS 5
on initial 10 units 0
= 10 x $10 = $100 0 5 10 15 20 Q
25

Cost and the Supply Curve

P Qs
Derive the supply schedule
from the cost data: $0 – 9 0

10 – 19 1
name cost
20 – 34 2
Jack $10
35 & up 3
Janet 20
Chrissy 35


Producer Surplus and the S Curve
P PS = P – cost
$40 Suppose P = $25.
Chrissy’s
cost Jack’s PS = $15
$30
Janet’s Janet’s PS = $5
$20 cost Chrissy’s PS = $0

$10 Jack’s cost Total PS = $20
Total PS equals the
area above the supply
$0 Q
curve under the price,
0 1 2 3 from 0 to Q.

ACTIVE LEARNING 2
Producer surplus P
50 supply curve
A. Find marginal 45
seller’s cost
40
at Q = 10.
35
B. Find total PS for
P = $20. 30
25
Suppose P rises to $30.
Find the increase 20
in PS due to… 15
C. selling 5 10
additional units 5
D. getting a higher price 0
on the initial 10 units 0 5 10 15 20 25
18
Q

ACTIVE LEARNING 2
Answers P
50
supply curve
A. At Q = 10, 45
marginal cost = $20
40
B. PS = ½ x 10 x $20
35
= $100
30
P rises to $30. 25
C. PS on 20
additional units 15
= ½ x 5 x $10 = $25
10
D. Increase in PS
5
on initial 10 units
= 10 x $10 = $100 0
0 5 10 15 20 19
Q
25

Evaluating the Market Equilibrium
Market eq’m:
P
P = $30
60
Q = 15,000
50 S
Total surplus
= CS + PS 40 CS
Is the market eq’m 30
efficient? PS
20
10
D
0 Q
0 5 10 15 20 25 30

Which Buyers Consume the Good?
Every buyer
P
whose WTP is
60
≥ $30 will buy.
50 S
Every buyer
whose WTP is 40
< $30 will not. 30
So, the buyers 20
who value the
10
good most highly D
are the ones who 0 Q
consume it. 0 5 10 15 20 25 30

Which Sellers Produce the Good?
Every seller whose
P
cost is ≤ $30 will
60
produce the good.
50 S
Every seller whose
cost is > $30 will 40
not.
30
So, the sellers with
20
the lowest cost
produce the good. 10
D
0 Q
0 5 10 15 20 25 30

Does Eq’m Q Maximize Total Surplus?
At Q = 20,
P
cost of producing
the marginal unit 60
is $35 50 S
value to consumers 40
of the marginal unit
is only $20 30
Hence, can increase 20
total surplus
10
by reducing Q. D
This is true at any Q 0 Q
greater than 15. 0 5 10 15 20 25 30

At Q = 10,
P
cost of producing
the marginal unit 60
is $25 50 S
value to consumers 40
of the marginal unit
is $40 30
Hence, can increase 20
total surplus
10
by increasing Q. D
This is true at any Q 0 Q
less than 15. 0 5 10 15 20 25 30

The market P
eq’m quantity 60
maximizes S
50
total surplus:
At any other 40
quantity, 30
can increase
20
total surplus by
moving toward 10
D
the market eq’m 0 Q
quantity.
0 5 10 15 20 25 30

Adam Smith and the Invisible Hand
Passages from The Wealth of Nations, 1776
“Man has almost constant occasion
for the help of his brethren, and it is
vain for him to expect it from their
benevolence only. He will be more
likely to prevail if he can interest their
self-love in his favor, and show them
that it is for their own advantage to do
for him what he requires of them…
It is not from the benevolence of the
butcher, the brewer, or the baker that
Adam Smith,
we expect our dinner, but from their
1723-1790
regard to their own interest….

Adam Smith and the Invisible Hand
Passages from The Wealth of Nations, 1776
“Every individual…neither intends to
promote the public interest, nor knows
how much he is promoting it….
He intends only his own gain, and he is
in this, as in many other cases, led by
an invisible hand to promote an end
which was no part of his intention.
Nor is it always the worse for the society
that it was no part of it. By pursuing his
own interest he frequently promotes
Adam Smith, that of the society more effectually than
1723-1790
when he really intends to promote it.”

The Free Market vs. Govt Intervention
 The market equilibrium is efficient. No other
outcome achieves higher total surplus.
 Govt cannot raise total surplus by changing the
market’s allocation of resources.
 Laissez faire (French for “allow them to do”):
the notion that govt should not interfere with the
market.


Ch 07 micro 1

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