Consumers, Producers, and The Efficiency of Markets
Consumers, Producers, and The Efficiency of Markets
Consumers, Producers, and The Efficiency of Markets
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Consumers, Producers, and the Efficiency of Markets
Consumer Surplus
Welfare economics
How the allocation of resources affects economic well-being
Willingness to pay
Maximum amount that a buyer will pay for a good
Consumer surplus
Amount a buyer is willing to pay for a good Minus amount the buyer actually pays for it
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Table
Consumer Surplus
Using the demand curve to measure consumer surplus
Consumer surplus
Closely related to the demand curve
Demand schedule
Derived from the willingness to pay of the possible buyers
At any quantity
Price given by the demand curve
Willingness to pay of the marginal buyer
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Price More than $100 $80 to $100 $70 to $80 $50 to $70 $50 or less
Buyers None John John, Paul John, Paul, George John, Paul, George, Ringo
Quantity Demanded 0 1 2 3 4
The table shows the demand schedule for the buyers in Table 1.
$100
80 70 50
The graph shows the corresponding demand curve. Note that the height of the demand curve reflects buyers willingness to pay
Consumer Surplus
Using the demand curve to measure consumer surplus Demand curve
Reflects buyers willingness to pay Measure consumer surplus
Demand
2 3 4 Quantity of Albums
In panel (a), the price of the good is $80, and the consumer surplus is $20. In panel (b), the price of the good is $70, and the consumer surplus is $40.
Consumer Surplus
How a lower price raises consumer surplus Buyers - always want to pay less
Initial price, P1
Quantity demanded Q1 Given consumer surplus
Consumer surplus
P1 B
P1 P2 Demand
C F
B D E
Demand
Q1
Quantity
Q1
Q2
Quantity
In panel (a), the price is P1, the quantity demanded is Q1, and consumer surplus equals the area of the triangle ABC. When the price falls from P1 to P2, as in panel (b), the quantity demanded rises from Q1 to Q2, and the consumer surplus rises to the area of the triangle ADF. The increase in consumer surplus (area BCFD) occurs in part because existing consumers now pay less (area 10 BCED) and in part because new consumers enter the market at the lower price (area CEF).
Consumer Surplus
What does consumer surplus measure? Consumer surplus
Benefit that buyers receive from a good
As the buyers themselves perceive it
Societys standpoint
Drug addicts dont get a large benefit from being able to buy heroin at a low price 11
Producer Surplus
Cost and the willingness to sell Cost
Value of everything a seller must give up to produce a good
Producer surplus
Amount a seller is paid for a good Minus the sellers cost of providing it
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Table
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Producer Surplus
Using the supply curve to measure producer surplus
Producer surplus
Closely related to the supply curve
Supply schedule
Derived from the costs of the suppliers
At any quantity
Price given by the supply curve
Cost of the marginal seller
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Price $900 or more $800 to $900 $600 to $800 $500 to $600 Less than $500
Sellers Mary, Frida, Georgia, Grandma Frida, Georgia, Grandma Georgia, Grandma Grandma None
Quantity Supplied 4 3 2 1 0
The table shows the supply schedule for the sellers in Table 2.
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The graph shows the corresponding supply curve. Note that the height of the supply curve reflects sellers costs.
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Producer Surplus
Using the supply curve to measure producer surplus Supply curve
Reflects sellers costs Measure producer surplus
In panel (a), the price of the good is $600, and the producer surplus is $100. In panel (b), the price of the good is $800, and the producer surplus is $500.
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Producer Surplus
How a higher price raises producer surplus Sellers - want to receive a higher price
Initial price, P1
Quantity supplied, Q1 Given producer surplus
P2
P1
D B
Initial consumer surplus
B
Producer surplus
P1
A
0 Q1
Quantity
Q1
Q2 Quantity
In panel (a), the price is P1, the quantity supplied is Q1, and producer surplus equals the area of the triangle ABC. When the price rises from P1 to P2, as in panel (b), the quantity supplied rises from Q1 to Q2, and the producer surplus rises to the area of the triangle ADF. The increase in producer surplus (area BCFD) occurs in part because existing producers now receive more(area BCED) and 20 in part because new producers enter the market at the higher price (area CEF).
Market Efficiency
The benevolent social planner
All-knowing, all-powerful, well-intentioned dictator Wants to maximize the economic well-being of everyone in society
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Market Efficiency
The benevolent social planner
Total surplus = Consumer surplus + Producer surplus
Consumer surplus = Value to buyers Amount paid by buyers Producer surplus = Amount received by sellers Cost to sellers Amount paid by buyers = Amount received by sellers
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Market Efficiency
Efficiency
Property of a resource allocation Maximizing the total surplus
Received by all members of society
Equality
Property of distributing economic prosperity Uniformly among the members of society
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Market Efficiency
Evaluating the market equilibrium Market outcomes
1. Free markets allocate the supply of goods to the buyers who value them most highly
Measured by their willingness to pay
2. Free markets allocate the demand for goods to the sellers who can produce them at the least cost
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Supply
D
Equilibrium price
Consumer surplus
E
Producer surplus B C
Demand
Equilibrium Quantity quantity Total surplusthe sum of consumer and producer surplusis the area between the supply and demand curves up to the equilibrium quantity 25
Market Efficiency
Evaluating the market equilibrium
Social planner
Cannot increase economic well-being by
Changing the allocation of consumption among buyers Changing the allocation of production among sellers
3. Free markets produce the quantity of goods that maximizes the sum of consumer and producer surplus
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Value to buyers
Cost to sellers 0
Value to buyers
Q1
Equilibrium quantity
Q2
Quantity
At quantities less than the equilibrium quantity, such as Q1, the value to buyers exceeds the cost to sellers. At quantities greater than the equilibrium quantity, such as Q2, the cost to sellers exceeds the value to buyers. Therefore, the market equilibrium maximizes the sum of producer and 27 consumer surplus.
Market Efficiency
Evaluating the market equilibrium Equilibrium outcome
Efficient allocation of resources
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Market Efficiency
Evaluating the market equilibrium Adam Smiths invisible hand
Takes all the information about buyers and sellers into account Guides everyone in the market to the best outcome
Economic efficiency
Should there be a market in organs? How a mothers love helped save two lives
Ms. Stevens - her son needed a kidney transplant The mothers kidney was not compatible Donated one of her kidneys to a stranger Her son move to the top of the kidney waiting list
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Public policy
Illegal for people to sell their organs
Should there be a market in organs? Large benefits to allowing a free market in organs
People are born with two kidneys
Usually need only one
Current situation
Typical patient - wait several years for a kidney transplant Every year - thousands of people die because a kidney cannot be found
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Inefficient equilibrium
From the standpoint of society as a whole
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