Price Elasticity of Demand & Elasticity of Supply

Consumer Surplus

The extra benefit a buyer receives when they pay less than the maximum price they are willing to pay.

Willingness to Pay

The maximum price a buyer is willing and able to pay for a product.

Marginal Benefit

The additional benefit received from consuming one more unit of a product.

Consumer Surplus Formula

Consumer Surplus = Willingness to Pay − Price Paid.

Consumer Surplus on a Graph

The area below the demand curve and above the market price.

Total Consumer Surplus

The sum of consumer surplus for all buyers in a market.

Demand Curve and Willingness to Pay

The demand curve shows the maximum prices buyers are willing to pay for different quantities.

Demand Curve and Marginal Benefit

The demand curve represents the marginal benefit buyers receive from each additional unit.

Effect of a Higher Price on Consumer Surplus

A higher price decreases consumer surplus.

Effect of a Lower Price on Consumer Surplus

A lower price increases consumer surplus.

Consumer Surplus and Market Participation

Consumer surplus measures the net benefit buyers receive from purchasing a product.

Producer Surplus

The extra benefit a seller receives when they sell a product for more than the minimum price they are willing to accept.

Minimum Acceptable Price

The lowest price a seller is willing to accept for a product.

Marginal Cost

The additional cost of producing one more unit of a product.

Producer Surplus Formula

Producer Surplus = Price Received − Minimum Acceptable Price.

Producer Surplus on a Graph

The area above the supply curve and below the market price.

Total Producer Surplus

The sum of producer surplus for all sellers in a market.

Supply Curve and Minimum Acceptable Price

The supply curve represents the minimum prices sellers are willing to accept for different quantities.

Supply Curve and Marginal Cost

The supply curve represents the marginal cost of producing additional units.

Effect of a Higher Price on Producer Surplus

A higher price increases producer surplus.

Effect of a Lower Price on Producer Surplus

A lower price decreases producer surplus.

Producer Surplus and Market Participation

Producer surplus measures the net benefit sellers receive from selling a product.

Economic Surplus

The total benefit created in a market.

Economic Surplus Formula

Economic Surplus = Consumer Surplus + Producer Surplus.

Economic Efficiency

A situation where total economic surplus is maximized.

Efficient Market Outcome

The market outcome where the maximum possible total economic surplus is achieved.

Mutually Beneficial Trade

A trade where the buyer's marginal benefit is greater than the seller's marginal cost.

Efficient Quantity

The quantity at which marginal benefit equals marginal cost.

Efficient Quantity Rule

Produce and trade units as long as marginal benefit is greater than or equal to marginal cost.

MB > MC

If marginal benefit is greater than marginal cost, the trade creates additional economic surplus and should occur.

MB < MC

If marginal benefit is less than marginal cost, the trade reduces economic surplus and should not occur.

MB = MC

At the efficient quantity, marginal benefit equals marginal cost.

Why MB = MC Is Efficient

The efficient quantity occurs where the benefit from the last unit equals the cost of producing it.

Competitive Equilibrium and Efficiency

Competitive equilibrium produces the efficient quantity because quantity demanded equals quantity supplied.

Equilibrium Price and Marginal Benefit

At competitive equilibrium, the price represents the marginal benefit of the last unit purchased.

Equilibrium Price and Marginal Cost

At competitive equilibrium, the price represents the marginal cost of the last unit produced.

Competitive Equilibrium and Economic Surplus

Competitive equilibrium maximizes total economic surplus when the market is competitive.

Efficient Trades

Efficient trades occur when buyers value a unit more than it costs sellers to produce it.

Inefficient Trades

Inefficient trades occur when the cost of producing a unit is greater than the benefit buyers receive.

Government Intervention

Government intervention occurs when the government changes or restricts the outcome of a market.

Price Control

A government rule that legally limits the price that can be charged or received.

Price Floor

A legal minimum price that can be charged for a product.

Price Ceiling

A legal maximum price that can be charged for a product.

Binding Price Floor

A price floor set above the equilibrium price that prevents the market from reaching equilibrium.

Binding Price Ceiling

A price ceiling set below the equilibrium price that prevents the market from reaching equilibrium.

Non-Binding Price Floor

A price floor set below the equilibrium price that does not affect the market outcome.

Non-Binding Price Ceiling

A price ceiling set above the equilibrium price that does not affect the market outcome.

Binding Price Floor Graph

The price floor is drawn above the equilibrium price.

Binding Price Ceiling Graph

The price ceiling is drawn below the equilibrium price.

Price Floor and Quantity Demanded

A binding price floor raises the price, causing quantity demanded to decrease.

Price Floor and Quantity Supplied

A binding price floor raises the price, causing quantity supplied to increase.

Price Ceiling and Quantity Demanded

A binding price ceiling lowers the price, causing quantity demanded to increase.

Price Ceiling and Quantity Supplied

A binding price ceiling lowers the price, causing quantity supplied to decrease.

Excess Supply

A situation where quantity supplied is greater than quantity demanded.

Excess Supply Formula

Excess Supply = Quantity Supplied − Quantity Demanded.

Price Floor and Excess Supply

A binding price floor creates excess supply.

Why a Price Floor Creates Excess Supply

The higher legal price encourages sellers to supply more while causing buyers to demand less.

Excess Supply on a Graph

The distance between quantity supplied and quantity demanded at the controlled price.

Excess Demand

A situation where quantity demanded is greater than quantity supplied.

Excess Demand Formula

Excess Demand = Quantity Demanded − Quantity Supplied.

Price Ceiling and Excess Demand

A binding price ceiling creates excess demand.

Why a Price Ceiling Creates Excess Demand

The lower legal price encourages buyers to demand more while causing sellers to supply less.

Excess Demand on a Graph

The distance between quantity demanded and quantity supplied at the controlled price.

Deadweight Loss

The economic surplus lost because mutually beneficial trades no longer occur.

Deadweight Loss and Economic Efficiency

Deadweight loss means the market is producing less economic surplus than the efficient outcome.

Cause of Deadweight Loss

Deadweight loss occurs when a market intervention prevents mutually beneficial trades.

Price Controls and Deadweight Loss

Binding price controls can create deadweight loss by preventing some efficient trades.

Deadweight Loss on a Graph

The area representing the surplus from trades that would have occurred at equilibrium but no longer occur.

Price Floor and Deadweight Loss

A binding price floor can prevent some mutually beneficial trades and create deadweight loss.

Price Ceiling and Deadweight Loss

A binding price ceiling can prevent some mutually beneficial trades and create deadweight loss.

Deadweight Loss vs. Surplus Transfer

Deadweight loss is surplus that disappears; a surplus transfer moves surplus from one group to another.

Surplus Transfer

A change in economic surplus where benefits are transferred between buyers and sellers.

Price Floor and Surplus Transfer

A binding price floor can transfer surplus from buyers to sellers.

Price Ceiling and Surplus Transfer

A binding price ceiling can transfer surplus from sellers to buyers.

Surplus Transfer vs. Economic Loss

A transfer changes who receives the surplus, while deadweight loss reduces total surplus.

Government Purchases of Excess Supply

The government may purchase surplus products created by a binding price floor.

Government Purchases and Price Floors

Government purchases can prevent excess supply from remaining unsold while maintaining the price floor.

Cost of Government Purchases

Government purchases are ultimately paid for through government funds, including tax revenue.

Price Floor and Unsold Surplus

A binding price floor can create products that sellers want to sell but buyers do not want to purchase.

Rent Control

A price ceiling placed on rental housing.

Rent Ceiling

A legal maximum rent that can be charged for a rental unit.

Binding Rent Ceiling

A rent ceiling set below the equilibrium rent.

Rent Ceiling and Quantity Demanded

A binding rent ceiling increases the quantity of rental housing demanded.

Rent Ceiling and Quantity Supplied

A binding rent ceiling decreases the quantity of rental housing supplied.

Rent Ceiling and Shortage

A binding rent ceiling creates a shortage of rental housing.

Shortage

A situation where quantity demanded is greater than quantity supplied.

Rent Ceiling and Excess Demand

The shortage created by a rent ceiling is an example of excess demand.

Rent Ceiling and Non-Price Allocation

When a rent ceiling creates a shortage, methods other than price may be needed to decide who receives the available housing.

Non-Price Allocation

Using a method other than price to determine who receives a scarce product.

Rent Ceiling and Economic Efficiency

A binding rent ceiling can reduce economic efficiency.

Rent Ceiling and Deadweight Loss

A binding rent ceiling can create deadweight loss by preventing mutually beneficial rental transactions.

Rent Ceiling and Surplus Transfer

A rent ceiling can transfer some surplus from sellers to buyers.

Price Control and Market Equilibrium

A binding price control prevents the market price from reaching its equilibrium level.

Price Control and Quantity

A binding price control causes quantity demanded and quantity supplied to differ.

Binding Price Floor Summary

Price floor above equilibrium → higher price → quantity supplied increases → quantity demanded decreases → excess supply.

Binding Price Ceiling Summary

Price ceiling below equilibrium → lower price → quantity demanded increases → quantity supplied decreases → excess demand.

Market Efficiency Summary

Competitive equilibrium maximizes economic surplus when there are no market distortions.

Graphing Consumer Surplus

Shade the area below the demand curve and above the equilibrium price.

Graphing Producer Surplus

Shade the area above the supply curve and below the equilibrium price.

Graphing Economic Surplus

Combine the consumer surplus and producer surplus areas.