Consumers, Producers, and The Efficiency of Markets
Consumers, Producers, and The Efficiency of Markets
Consumers, Producers, and The Efficiency of Markets
Welfare Economics
Welfare economics is the study of how the
CONSUMER 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.
CONSUMER SURPLUS
Consumer surplus is the buyers willingness to
pay for a good minus the amount the buyer
actually pays for it.
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$100
80
70
50
Demand
Quantity of
T-Shirt
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80
70
50
Demand
Quantity of
Albums
Paul s consumer
surplus ($10)
70
50
Total
consumer
surplus ($40)
Demand
0
4 Quantity of
Albums
Consumer
surplus
P1
Demand
Q1
Quantity
Initial
consumer
surplus
P1
P2
C
B
Consumer surplus
to new consumers
F
D
E
Additional consumer
surplus to initial
consumers
Q1
Demand
Q2
Quantity
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PRODUCER SURPLUS
Producer surplus is the amount a seller is paid
for a good minus the sellers cost.
It measures the benefit to sellers participating in
a market.
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Supply
$900
800
600
500
Grandma s producer
surplus ($100)
4
Quantity of
Houses Painted
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$900
Supply
Total
producer
surplus ($500)
800
600
Georgia s producer
surplus ($200)
500
Grandmas producer
surplus ($300)
4
Quantity of
Houses Painted
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P1
B
Producer
surplus
A
0
Q1
Quantity
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Additional producer
surplus to initial
producers
P2
P1
E
F
B
Initial
producer
surplus
Producer surplus
to new producers
A
0
Q1
Q2
Quantity
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MARKET 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?
MARKET EFFICIENCY
Consumer Surplus
= Value to buyers Amount paid by buyers
and
Producer Surplus
= Amount received by sellers Cost to sellers
MARKET EFFICIENCY
Total surplus
= Consumer surplus + Producer surplus
or
Total surplus
= Value to buyers Cost to sellers
MARKET EFFICIENCY
Efficiency is the property of a resource
allocation of maximizing the total surplus
received by all members of society.
MARKET EFFICIENCY
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.
Supply
Consumer
surplus
Equilibrium
price
E
Producer
surplus
Demand
C
0
Equilibrium
quantity
Quantity
Copyright2003 Southwestern/Thomson Learning
MARKET EFFICIENCY
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.
Supply
Value
to
buyers
Cost
to
sellers
Cost
to
sellers
0
Value
to
buyers
Equilibrium
quantity
Demand
Quantity