Consumer and Producer Surplus-Econ 101

What is willingness to pay (WTP)?

• The maximum price at which a consumer is prepared to pay for a good.

• An individual won’t buy the good if it costs more than this amount but they are eager if it costs less 

• If the price is equal to an individual's willingness to pay they are indifferent between buying and not buying

What is individual consumer surplus and what is it equal to?

• The net gain to an individual buyer from the purchase of a good

• equal to the difference between the buyers willingness to pay and the price paid

What is total consumer surplus and how do you calculate it on a supply and demand graph?

• The sum of an individual consumer surpluses of all the buyers of a good in a market 

• it is equal to the area below the demand curve but above the price

How does a fall in price of a good increase consumer surplus?

 -a gain to consumers who would have bought at the original price

-a gain to consumers who are persuaded to buy by the lower price

What is a sellers cost?

 The lowest price at which a seller is willing to sell a good

What is individual producer surplus and what is it equal to?

The net gain to an individual seller from selling a good; equal to the difference between the price received and the seller’s cost 

What is total producer surplus ?How do you calculate it on a supply and demand curve?

-The sum of the individual producer surpluses of all the sellers of a good in a market

-The total producer surplus from sales of a good at a given price is the area above the supply curve but below that price

How does a fall in price affect surplus?

• increases consumer surplus and it reduces producer surplus 

How does a rise in price affect surplus?

• reduces consumer surplus but it increases producer surplus 

What is total surplus and what is the formula for it?

- The total net gain to consumers and producers from trading in a market; it is the sum of the producer surplus and the consumer surplus 

What does reallocating goods among consumers mean and what does it do to total consumer surplus?

• taking a good or service away from a consumer who values it more and giving it to one who values it less 

  • This reduces total consumer surplus

What does reallocating sales among sellers do?

- increases total cost and reduces total producer surplus 

How does an efficient market maximize total surplus?

1. It allocates consumption of the good to the potential buyers who have the highest willingness to pay 

2. It allocates sales to the potential sellers who have the lowest cost 

What are 3 caveats of efficient markets?

1. Although a market may be efficient, it isn’t necessarily fair, fairness or equity is often in conflict with efficiency 

2. Sometimes markets fail, under some well-defined conditions, markets can fail to deliver efficiency. When this occurs, markets can no longer maximize total surplus 

3. Even when the market equilibrium maximizes total surplus, this doesn't mean that it results in the best outcome for every individual consumer and producer. 

What are property rights?

The rights of owners of resources or goods, to dispose of those items as they choose 

• In the system of property rights, by purchasing a good your receive ownership rights

What are ownership rights?

• the right to use and dispose of a good as you see fit 

What happens when property rights are restricted?

-it would prevent mutually beneficial transactions

What are economic signals?

 Any piece of information that helps people make better economic decisions

What does it mean when a market or economy is inefficient?

-Describes a market or economy in which there are missed opportunities: some people could be made better off without making people worse off 

-When a market or markets are inefficient, the economy in which they are embedded is also inefficient 

What are the two most important reasons why markets are inefficient?

•  lack of property rights and inaccuracy of prices as economic signals 

What are the 3 main ways in which markets can fall short of efficiency?

1. market power,

2. externalities,

3. when the nature of the good makes it unsuitable for efficient allocation by market, For example incomplete property rights and when some people have acess to information that others don’t.

 

Why does market power make a market ineffient?

Because the firm manipulates the market price in order to increase profits and thereby prevents mutually beneficial trades from occurring.

What does willing to accept (WTA) mean?

• is a money measure of how much that person’s values their good

• represent’s that person’s opportunity cost of selling their good

If the price of a good decreases, why does CS typically increase?

• people already in the market pay a lower price for the good

• people already in the market may buy more of the good

• more people may enter the market and buy the good

If the price of a good increases, why does PS typically increase?

• existing producers get a higher price for the units they would have sold at the lower price

• existing producers may sell more of the good

• more producers may enter the market and sell the good

Why are competitive markets economically efficient?

• maximize TS

• ensure that the goods produced are consumed by those who value them most highly

• ensure that the goods are produced by the lowest-cost producers