This chapter discusses consumer surplus, producer surplus, and market efficiency. It defines consumer surplus as the difference between what consumers are willing to pay and what they actually pay. Producer surplus is defined as the difference between what producers are paid and their costs. The market equilibrium maximizes the total surplus, which is the sum of consumer surplus and producer surplus. This allocation of resources through supply and demand is efficient because it maximizes the total benefits to both consumers and producers.

1. Chapter 7Chapter 7
Consumers,
Producers, and
the Efficiency of
Markets
©© 2002 by Nelson, a division of Thomson Canada Limited2002 by Nelson, a division of Thomson Canada Limited

2. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi
• Examine the link between buyers’ willingness to
pay for a good and the demand curve.
• Learn how to define and measure consumer
surplus.
• Examine the link between sellers’ cost of
producing a good and the supply curve.
• Learn how to define and measure consumer
surplus.
• See that the equilibrium of supply and demand
maximizes total surplus in a market.
• Examine the link between buyers’ willingness to
pay for a good and the demand curve.
• Learn how to define and measure consumer
surplus.
• Examine the link between sellers’ cost of
producing a good and the supply curve.
• Learn how to define and measure consumer
surplus.
• See that the equilibrium of supply and demand
maximizes total surplus in a market.
In this chapter you will…In this chapter you will…

3. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi
• Do the equilibrium price and quantity
maximize the total welfare of buyers and
sellers?
• Market equilibrium reflects the way
markets allocate scarce resources.
• Whether the market allocation is desirable
can be addressed by welfare economics.
• Do the equilibrium price and quantity
maximize the total welfare of buyers and
sellers?
• Market equilibrium reflects the way
markets allocate scarce resources.
• Whether the market allocation is desirable
can be addressed by welfare economics.
CONSUMERS, PRODUCERS, AND THECONSUMERS, PRODUCERS, AND THE
EFFICIENCY OF MARKETSEFFICIENCY OF MARKETS

4. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi
• Welfare economics is the study of how the
allocation of resources affects economic well-
being.
• Buyers and sellers receive benefits from taking
part in the market.
• The equilibrium in a market maximizes the total
welfare of buyers and sellers.
• Equilibrium in the market results in maximum
benefits, and therefore maximum total welfare for
both the consumers and the producers of the
product.
• Welfare economics is the study of how the
allocation of resources affects economic well-
being.
• Buyers and sellers receive benefits from taking
part in the market.
• The equilibrium in a market maximizes the total
welfare of buyers and sellers.
• Equilibrium in the market results in maximum
benefits, and therefore maximum total welfare for
both the consumers and the producers of the
product.
CONSUMERS, PRODUCERS, AND THECONSUMERS, PRODUCERS, AND THE
EFFICIENCY OF MARKETSEFFICIENCY OF MARKETS

5. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi
• Consumer surplus measures economic
welfare from the buyer’s side
• Consumer surplus measures economic
welfare from the buyer’s side
• Producer surplus measures economic
welfare from the seller’s side.
• Producer surplus measures economic
welfare from the seller’s side.
CONSUMERS, PRODUCERS, AND THECONSUMERS, PRODUCERS, AND THE
EFFICIENCY OF MARKETSEFFICIENCY OF MARKETS

6. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi
• Consumer surplus is the buyer’s
willingness to pay for a good minus the
amount the buyer actually pays for it.
• Consumer surplus is the buyer’s
willingness to pay for a good minus the
amount the buyer actually pays for it.
CONSUMER SURPLUSCONSUMER SURPLUS
• Willingness to pay is the maximum
amount that a buyer will pay for a good.
• It measures how much the buyer values
the good or service.
• Willingness to pay is the maximum
amount that a buyer will pay for a good.
• It measures how much the buyer values
the good or service.

7. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi
Table 7-1: Four Possible Buyers’ WillingnessTable 7-1: Four Possible Buyers’ Willingness
to Payto Pay

8. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi
CONSUMER SURPLUSCONSUMER SURPLUS
• The market demand curve depicts the
various quantities that buyers would be
willing and able to purchase at different
prices.
• The market demand curve depicts the
various quantities that buyers would be
willing and able to purchase at different
prices.

9. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi
Table 7-2: The Demand Schedule for theTable 7-2: The Demand Schedule for the
Buyers in Table 7-1Buyers in Table 7-1
4John, Paul, George, Ringo$50 or less
3John, Paul, George$50 to $70
2John, Paul$70 to $80
1John$80 to $100
0NoneMore than $100
Quantity
Demanded
BuyersPrice

10. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi
Quantity
of Albums
Price of
Album
$100
$80
$70
$50
0 1 2 3 4
John’s willingness to pay
Paul’s willingness to pay
George’s willingness to pay
Ringo’s willingness to pay
Demand
Figure 7-1: The Demand CurveFigure 7-1: The Demand Curve

11. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi
(a) Price = $80 (b) Price = $70
Price of
Album
Quantity
of Albums
$100
$80
$70
$50
0 1 2 3 4
John’s consumer surplus
($20)
Demand
Price of
Album
$100
$80
$70
$50
0 1 2 3 4 Quantity
of Albums
John’s consumer surplus
($30)
Paul’s consumer surplus ($10)
Total consumer
surplus ($40)
Figure 7-2: Measuring Consumer SurplusFigure 7-2: Measuring Consumer Surplus
with the Demand Curvewith the Demand Curve
Demand

12. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi
Using the Demand Curve to MeasureUsing the Demand Curve to Measure
Consumer SurplusConsumer Surplus
• The area below the demand curve and
above the price measures the consumer
surplus in the market.
• The area below the demand curve and
above the price measures the consumer
surplus in the market.

13. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi
(a) Consumer Surplus at a Price of P1
(b) Consumer Surplus at a Price of P2
Price
Quantity
Price
0 Quantity
Consumer surplus for new
consumers
P1
0 Q1
B
A
C
Demand
Additional
consumer
surplus to initial
consumers
Q1
A
C
P1
B
P2
Q2
E
F
D
Figure 7-3: How the Price Affects ConsumerFigure 7-3: How the Price Affects Consumer
SurplusSurplus

14. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi
What Does Consumer Surplus Measure?What Does Consumer Surplus Measure?
• 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.
• 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.

15. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi
PRODUCER SURPLUSPRODUCER SURPLUS
• Producer surplus is the amount a
seller is paid for a good minus the
seller’s cost.
• It measures the benefit to sellers
participating in a market.
• Producer surplus is the amount a
seller is paid for a good minus the
seller’s cost.
• It measures the benefit to sellers
participating in a market.

16. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi
Table 7-3: The Cost of Four Possible SellersTable 7-3: The Cost of Four Possible Sellers

17. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi
Using the Supply Curve to MeasureUsing the Supply Curve to Measure
Producer SurplusProducer Surplus
• Just as consumer surplus is related to the
demand curve, producer surplus is closely
related to the supply curve.
• Just as consumer surplus is related to the
demand curve, producer surplus is closely
related to the supply curve.

18. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi
Table 7-4: The Supply Schedule for theTable 7-4: The Supply Schedule for the
Sellers in Table 7-3Sellers in Table 7-3
0NoneLess than $500
1Grandma$500 to $600
2Georgia, Grandma$600 to $800
3Frida, Georgia, Grandma$800 to $900
4Mary, Frida, Georgia, Grandma$900 or more
Quantity
Supplied
SellersPrice

19. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi
0 1 2 3 4
Mary’s
cost
Frida’s cost
Georgia’s cost
Grandma’ cost
Price of
House
Painting
Supply
$900
$800
$500
$600
Figure 7-4: The Supply CurveFigure 7-4: The Supply Curve

20. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi
Using the Supply Curve to MeasureUsing the Supply Curve to Measure
Producer SurplusProducer Surplus
• The area below the price and above the
supply curve measures the producer
surplus in a market.
• The area below the price and above the
supply curve measures the producer
surplus in a market.

21. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi
(a) Price = $600 (b) Price = $800
Price of
House
Painting
Quantity of
Houses Painted
$900
$800
$500
0 1 2 3 4
Grandpa’s producer
surplus ($100)
Supply
$600
Price of
House
Painting
0 1 2 3 4
Quantity of
Houses Painted
$900
$800
$500
$600
Grandpa’s producer
surplus ($300)
Georgia’s producer surplus ($200)
Supply
Total producer
surplus ($500)
Figure 7-5: Measuring Producer Surplus withFigure 7-5: Measuring Producer Surplus with
the Supply Curvethe Supply Curve

22. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi
Producer
surplus
(a) Producer Surplus at a Price of P1
(b) Producer Surplus at a Price of P2
Price
Quantity
Price
0 Quantity
Producer surplus
for new producers
Additional
producer surplus
to initial
producers
P1
0 Q1
B
A
C
Supply
Supply
Initial
producer
surplus
P1
Q1
B
A
C
P2
Q2
E
F
D
Figure 7-6: How the Price Affects ProducerFigure 7-6: How the Price Affects Producer
SurplusSurplus

23. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi
MARKET EFFICIENCYMARKET EFFICIENCY
• Consumer surplus and producer surplus
may be used to address the following
question:
– Is the allocation of resources
determined by free markets in any way
desirable?
• Consumer surplus and producer surplus
may be used to address the following
question:
– Is the allocation of resources
determined by free markets in any way
desirable?

24. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi
Consumer Surplus
= Value to buyers – Amount paid by buyers
and
Producer Surplus
= Amount received by sellers – Cost to
sellers
Consumer Surplus
= Value to buyers – Amount paid by buyers
and
Producer Surplus
= Amount received by sellers – Cost to
sellers
MARKET EFFICIENCYMARKET EFFICIENCY

25. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi
Total surplus
= Consumer surplus + Producer surplus
or
Total surplus
= Value to buyers – Cost to sellers
Total surplus
= Consumer surplus + Producer surplus
or
Total surplus
= Value to buyers – Cost to sellers
MARKET EFFICIENCYMARKET EFFICIENCY

26. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi
• Efficiency is the property of a resource
allocation of maximizing the total surplus
received by all members of society.
• 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.
• Efficiency is the property of a resource
allocation of maximizing the total surplus
received by all members of society.
• 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.
MARKET EFFICIENCYMARKET EFFICIENCY

27. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi
Demand
Supply
B
Quantity
Price
0
Consumer surplus
A
C
D
Equilibrium
price
Equilibrium
quantity
E
Producer surplus
Figure 7-7: Consumer and Producer SurplusFigure 7-7: Consumer and Producer Surplus
in the Market Equilibriumin the Market Equilibrium

28. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi
• Three Insights Concerning Market
Outcomes
– Free markets allocate the supply of goods to
the buyers who value them most highly, as
measured by their willingness to pay.
– Free markets allocate the demand for goods to
the sellers who can produce them at least
cost.
– Free markets produce the quantity of goods
that maximizes the sum of consumer and
producer surplus.
• Three Insights Concerning Market
Outcomes
– Free markets allocate the supply of goods to
the buyers who value them most highly, as
measured by their willingness to pay.
– Free markets allocate the demand for goods to
the sellers who can produce them at least
cost.
– Free markets produce the quantity of goods
that maximizes the sum of consumer and
producer surplus.
MARKET EFFICIENCYMARKET EFFICIENCY

29. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi
Demand
Supply
Quantity
Price
0 Equilibrium
quantity
Value to buyers is greater
than cost to sellers
Value to buyers is less
than cost to sellers
Cost to
sellers
Value to
buyers
Value to
buyers
Cost to
sellers
Figure 7-8: The Efficiency of the EquilibriumFigure 7-8: The Efficiency of the Equilibrium
QuantityQuantity

30. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi
Evaluating the Market EquilibriumEvaluating the Market Equilibrium
• Because the equilibrium outcome is an
efficient allocation of resources, the social
planner can leave the market outcome as
he/she finds it.
• This policy of leaving well enough alone
goes by the French expression laissez
faire.
• Because the equilibrium outcome is an
efficient allocation of resources, the social
planner can leave the market outcome as
he/she finds it.
• This policy of leaving well enough alone
goes by the French expression laissez
faire.

31. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi
Evaluating the Market EquilibriumEvaluating the Market Equilibrium
• Market Power
– If a market system is not perfectly
competitive, market power may result.
• Market power is the ability to influence
prices.
• Market power can cause markets to be
inefficient because it keeps price and
quantity from the equilibrium of supply and
demand.
• Market Power
– If a market system is not perfectly
competitive, market power may result.
• Market power is the ability to influence
prices.
• Market power can cause markets to be
inefficient because it keeps price and
quantity from the equilibrium of supply and
demand.

32. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi
Evaluating the Market EquilibriumEvaluating the Market Equilibrium
• Externalities
– created when a market outcome affects
individuals other than buyers and sellers in
that market.
– cause welfare in a market to depend on more
than just the value to the buyers and cost to
the sellers.
• 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.
• Externalities
– created when a market outcome affects
individuals other than buyers and sellers in
that market.
– cause welfare in a market to depend on more
than just the value to the buyers and cost to
the sellers.
• 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.

33. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi
SummarySummary
• Consumer surplus equals buyers’
willingness to pay for a good minus the
amount they actually pay for it.
• Consumer surplus measures the benefit
buyers get from participating in a market.
• Consumer surplus can be computed by
finding the area below the demand curve
and above the price.
• Consumer surplus equals buyers’
willingness to pay for a good minus the
amount they actually pay for it.
• Consumer surplus measures the benefit
buyers get from participating in a market.
• Consumer surplus can be computed by
finding the area below the demand curve
and above the price.

34. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi
SummarySummary
• Producer surplus equals the amount
sellers receive for their goods minus their
costs of production.
• Producer surplus measures the benefit
sellers get from participating in a market.
• Producer surplus can be computed by
finding the area below the price and above
the supply curve.
• Producer surplus equals the amount
sellers receive for their goods minus their
costs of production.
• Producer surplus measures the benefit
sellers get from participating in a market.
• Producer surplus can be computed by
finding the area below the price and above
the supply curve.

35. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi
SummarySummary
• An allocation of resources that maximizes
the sum of consumer and producer
surplus is said to be efficient.
• Policymakers are often concerned with the
efficiency, as well as the equity, of
economic outcomes.
• An allocation of resources that maximizes
the sum of consumer and producer
surplus is said to be efficient.
• Policymakers are often concerned with the
efficiency, as well as the equity, of
economic outcomes.

36. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi
SummarySummary
• The equilibrium of demand and supply
maximizes the sum of consumer and
producer surplus.
• This is as if the invisible hand of the
marketplace leads buyers and sellers to
allocate resources efficiently.
• Markets do not allocate resources
efficiently in the presence of market
failures.
• The equilibrium of demand and supply
maximizes the sum of consumer and
producer surplus.
• This is as if the invisible hand of the
marketplace leads buyers and sellers to
allocate resources efficiently.
• Markets do not allocate resources
efficiently in the presence of market
failures.

37. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi
The EndThe End