Consumer Surplus and Producer Surplus
Consumer Surplus and Producer Surplus
Consumer Surplus and Producer Surplus
UNIT 9
Harcourt
Nothing is more useful than water; but it will scarce purchase anything. A diamond on the other hand, has scarce any value in use; but a very great quantity of other goods may frequently be had in exchange for it. How is it that water, which is essential to life, has little value, while diamonds, which are generally used for conspicuous consumption, command an exalted price? The total utility from water consumption does not determine its price, rather waters price determined by its marginal utility, by the usefulness of the last glass of water.
Welfare Economics
Welfare economics is the study of how the allocation of resources affects economic wellbeing.
Buyers and sellers receive benefits from taking part in
the market. The equilibrium in a market maximises the total welfare of buyers and sellers.
Equilibrium in the market results in maximum benefits, and therefore maximum total welfare for both the buyer and the seller.
Welfare Economics
Consumer surplus measures economic welfare from the buyer side. Producer surplus measures economic welfare from the seller side. Willingness to pay is the maximum price that a buyer is willing and able to pay for a good. It measures how much the buyer values the good or service.
Consumer Surplus
What determines how much a buyer would be willing to pay (the maximum price) for a good or service? Answer: The expected benefits received. The market demand curve depicts the various quantities that buyers would be willing and able to purchase at different prices.
Consumer Surplus
Consumer surplus is the amount a buyer is willing to pay for a good minus the amount the buyer actually pays for it (i.e. market price of that commodity).
Buyer
Quantity Demanded
0 1 2 3 4
Quantity of Albums
Quantity of Albums
Consumer surplus is the area below the demand curve and above the market price.
A lower market price will increase consumer
Demand
Q1
Q2
Quantity
P1
Demand
Q1
Q2
Quantity
P1
P2
Demand
Q1
Q2
Quantity
Producer Surplus
Market Supply
Depicts the various quantities that suppliers
would be willing and able to sell at different prices. May be viewed as a measure of supplier costs, that is, the opportunity cost of supplying various quantities of the good.
Producer Surplus
Market Supply
The marginal opportunity cost of production
increases as market output expands. Because a producers cost is the lowest price he or she will accept, cost is a measure of his or her willingness to sell.
Producer Surplus
Producer surplus is the amount a seller is paid minus the cost of production. It measures the benefit to sellers of participating in a market.
Sellers
Mary, Louise, Georgia, Grandma Louise, Georgia, Grandma Georgia, Grandma Grandma none
Quantity Supplied
4 3 2 1 0
Supply
$900 800
600 500
P1
B
Initial producer surplus C
A 0 Q1 Q2 Quantity
P2 P1
B
Initial producer surplus C Producer surplus to new producers
A 0 Q1 Q2 Quantity
Market Efficiency
Where there is perfect competition and no externalities, the economic well-being of a society is measured as the sum of consumer surplus and producer surplus. Market efficiency is attained when the allocation of resources maximises total surplus.
Consumer Surplus
Supply
Equilibrium price
Producer Surplus
Demand
Equilibrium quantity
Quantity
Free markets allocate the supply of goods to the buyers who value them most highly. 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 maximises the sum of consumer and producer surplus. In a free market system the many buyers and sellers are motivated by self-interest.
A process of coordination and communication
takes place so that buyers and sellers are directed to the most efficient outcome.
If a market system is not the one of perfect competition, market power may result.
Market power is the ability of one buyer or
seller to control market price. Market power can cause markets inefficient, and thus fail.
to
be
Externalities are created when a market outcome affects individuals other than buyers and sellers in that market.
Externalities are the benefits or costs imposed
by a third party who is not the consumer or the producer. Externalities cause markets to be inefficient, and thus fail.
Conclusion
Consumer and producer surplus measures the benefits of buyers and sellers from participating in the market. Consumer surplus equals buyers willingness to pay for a good minus the amount they actually pay for it. Producer surplus equals the amount sellers willing to receive in exchange of their goods minus actual price they receive for their products.
Conclusion
An allocation of resources that maximises the sum of consumer and producer surplus is said to be efficient. Policy-makers are concerned with efficiency. Market power and externalities can cause markets to be inefficient and to fail.
Exercise
Buyers Willingness to pay Alice $800 Bob $600 Carel $500 John $400 Show each comers surplus by a diagram, if market price set at $500. What would be the total consumer surplus?
Harcourt
Exercise
Producers Willingness to sell Ali $90 Baber $70 Lizna $60 Sasi $50 Show each producers surplus by a diagram, if market price set at $50. What would be the total producers surplus?
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