Consumer, Producer and Market Efficiency

CONSUMER
,
PRODUCER
AND
MARKET
EFFICIENC
Y
 Allocation of resources refers to:
WELFAR  How much of each good is

produced
E
 Which producers produce it
 Which consumers consume it
ECONOM  Welfare economics

 Studies how the allocation of
resources affects economic well-
ICS being
2
Willingness to Pay (WTP)
 A buyer’s willingness to pay for a good

 Maximum amount the buyer will pay for that good
 How much the buyer values the good
name WTP Example:

4 buyers’ WTP
Anthony $250 for an iPod
Chad 175
Flea 300
John 125
3
WTP AND THE DEMAND CURVE
Q: If price of iPod is $200, who will buy an iPod, and what
is quantity demanded?
name WTP A: Anthony & Flea will buy an

iPod, Chad & John will not.
Anthony $250
Hence, Qd = 2
Chad 175 when P = $200.
Flea 300
John 125
4
 Derive the demand P (price
who buys Qd
schedule: of iPod)
$301 & up nobody 0
251 – 300 Flea 1

name WTP
176 – 250 Anthony, Flea 2
Anthony $250
Chad, Anthony,
Chad 175 126 – 175 3
Flea
Flea 300 John, Chad,
0 – 125 4
John 125 Anthony, Flea
5
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
6
P Flea’s WTP At any Q, the height
$350 of the D curve is the
$300 Anthony’s WTP
WTP of the marginal
$250 Chad’s WTP buyer, the buyer who
$200 John’s would leave the
$150 WTP market if P were any
higher.
$100
$50
$0
Q
0 1 2 3 4
7
Consumer Surplus (CS)
 Consumer surplus CS = WTP – P

 Amount a buyer is willing to pay minus the amount the
buyer actually pays:
name WTP Suppose P = $260.

Anthony $250 Flea’s CS = $300 – 260 = $40.
The others get no CS because
Chad 175 they do not buy an iPod at
Flea 300 this price.
John 125 Total CS = $40.
8
CS AND THE DEMAND CURVE
P P = $260
Flea’s WTP
$350 Flea’s CS =
$300 $300 – 260 = $40
$250 Total CS = $40
$200
$150
$100
$50
$0
Q
0 1 2 3 4
9
Producer Surplus
 Cost
 Value of everything a seller must give up to produce a
good
 Measure of willingness to sell: produce and sell the
good/service only if the price > cost
name cost Example: Costs of 3

sellers in the lawn-cutting
Jack $10 business.
Janet 20
Chrissy 35
10
COST AND THE SUPPLY CURVE
P
$40 P Qs
$0 – 9 0
$30
10 – 19 1
$20
20 – 34 2
$10 35 & up 3
$0
Q
0 1 2 3
11
COST AND THE SUPPLY CURVE
At each Q, the
P
height of the S
$40
Chrissy’s curve is the cost of
the marginal
$30 cost seller, the seller
who would leave
Janet’s
$20 the market if the
cost
price were any
lower.
$10 Jack’s cost
$0 Q
0 1 2 3
12
PRODUC  Producer surplus, PS = P - cost
ER  Amount a seller is paid for a

good minus the seller’s cost
of providing it
SURPLU  Price received minus
willingness to sell
S
13
MARKET EFFICIENCY
Market Efficiency
Total surplus = CS + PS Total surplus = Value to buyers – Cost

to sellers
Consumer surplus = Value to buyers – Amount
paid by buyers
• Buyers’ gains from participating in the
market
Producer surplus = Amount received by sellers
– Cost to sellers
• Sellers’ gains from participating in the
market
14
MARKET’  Allocation of resources – desirable?
S  Decentralized (in a market

economy)
ALLOCATI  Determined by interactions of

many self-interested buyers and
sellers
ON OF  Total surplus – measure of society’s
well-being
RESOURC  To consider whether the market’s
allocation is efficient
ES
15
MARKET’S  Efficient allocation of resources
maximizes total surplus
 The goods are consumed by
ALLOCATI the buyers who value them
most highly
ON OF  The goods are produced by
the producers with the lowest
RESOURC costs
 Raising or lowering the
ES quantity of a good would not

increase total surplus
16
MARKE  Adam Smith’s invisible hand
 Takes all the information
T
about buyers and sellers into
account
 Guides everyone in the
EFFICIE market to the best outcome

 Economic efficiency
NCY  Free markets

 Best way to organize
economic activity
17
 Forces of supply and demand
MARKET
– Allocate resources efficiently
 Assumptions about how markets work
EFFICIEN 1. Markets are perfectly

competitive
CY & 2. Outcome in a market matters

only to the buyers and sellers
in that market
MARKET  When these assumptions do not
FAILURE 
hold
“Market equilibrium is
efficient” may no longer be
true
18
 Market failures
 Market power: a single buyer
MARKET or seller (small group)
control market prices
EFFICIEN  Markets are inefficient
CY &  Externalities: decisions of

buyers and sellers affect
MARKET people who are not
participants in the market at
FAILURE all
 Inefficient equilibrium -
from the standpoint of
society as a whole
19
 Consumer surplus: buyers’
willingness to pay for a good minus
the amount they actually pay
 Measures the benefit buyers get
from participating in a market
SUMMA  Area below the D curve and above

P
RY  Producer surplus: amount sellers

receive for their goods minus their
costs of production
 Measures the benefit sellers get
from participating in a market
 Area below P and above the S
curve
20
 An allocation of resources that
maximizes total surplus is said to be
efficient
 Policymakers are concerned with
the efficiency, as well as the
SUMMA equality, of economic outcomes.

 Equilibrium of S and D maximizes
total surplus
RY  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 (market power or
externalities)
21

Consumer, Producer and Market Efficiency

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Consumer, Producer and Market Efficiency

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CONSUMER

WELFAR  How much of each good is

ECONOM  Welfare economics

 A buyer’s willingness to pay for a good

name WTP Example:

name WTP A: Anthony & Flea will buy an

251 – 300 Flea 1

$200 251 – 300 1

 Consumer surplus CS = WTP – P

name WTP Suppose P = $260.

name cost Example: Costs of 3

ER  Amount a seller is paid for a

Total surplus = CS + PS Total surplus = Value to buyers – Cost

S  Decentralized (in a market

ALLOCATI  Determined by interactions of

ES quantity of a good would not

EFFICIE market to the best outcome

NCY  Free markets

 Assumptions about how markets work

EFFICIEN 1. Markets are perfectly

CY & 2. Outcome in a market matters

CY &  Externalities: decisions of

SUMMA  Area below the D curve and above

RY  Producer surplus: amount sellers

SUMMA equality, of economic outcomes.

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