YR1SM1 MICROECONOMICS: Chapter 7 - Consumers, Producers, Efficiency of Markets

Allocation of resources considers what 3 factors?

how much of each good is produced, which producers produce it, and which consumers consume it

Welfare economics studies…

how the allocation of resources affects economic well-being

Welfare goal of a supply-demand equilibrium

reaching equilibrium will maximize the total benefits received by the buyers and sellers

WTP =

Willingness to Pay, or how much the consumer values a good and thus how much they are willing to pay for it

Consumer surplus (CS) =

WTP (value to buyers) - actual price (P)

Marginal buyer

the buyer now entering the market because the price has fallen to their WTP, meaning that if the price climbs any higher, they will drop out again

Existing buyer

Consumers already within the market because a previous price ≤ their WTP and who will remain in the market because the price has now decreased further

How is WTP represented on the supply demand graph?

The height of the demand curve at any point represents the willingness to pay of the marginal buyer(s)

How is individual CS represented on the supply and demand graph?

Individual CS is the vertical difference between their WTP and the demand curve at a specific point

With every decrease in price, the consumer surplus of existing consumers increases by …

the area of the rectangle formed by

difference between old and new price * the quantity demanded at the old price (because the new quantity demanded is attributed to new buyers entering the market)

With a decrease in price, what is the consumer surplus of new buyers equal to?

the area of the triangle with base and height of

the difference between the quantity demanded at the previous price and the new total quantity demanded * the difference between the previous price and the new price

If a decrease in price brings in marginal buyers, how is there a consumer surplus for new buyers, considering that marginal buyers should not have a CS?

The price of a good does not decrease at each, infinite step, but rather jumps multiple steps, meaning that out of the new buyers, there will be some marginal buyers but there will also be buyers whose WTP falls between the previous, higher price and the new, lower price

Cost; EX of a specific cost?

The value of everything a seller must give up in order to produce a good/service

EX: opportunity cost

Willingness to sell (WTS) definition; WTS = …?

the lowest price at which the seller is willing to sell one unit of their good/service

WTS = cost, which represents no profit

What does individual PS equal?

the vertical difference between the selling price and their WTS / production cost

Who is the marginal seller?

The seller that, at any height of the S curve, is now producing the good because the price just became high enough for them, meaning that they won’t have any PS/profit

Each seller’s PS is equal to …

the vertical difference between the selling price and their WTS

The total producer surplus of new sellers equals the area of

the triangle with base and height of

BASE = the added quantity of goods now in the market thanks to them

HEIGHT = difference between the previous price and the new price

Benevolent social planners (BSP)

an omniscient, well-meaning hypothetical committee that wants to maximize the economic well-being of everyone as a whole, so they prioritize total surplus and efficiency

Total surplus =

Consumer surplus + producer surplus

Benevolent social planners thoughts on the different surpluses?

As long as total surplus is higher, whether producer surplus is hurt or consumer surplus is hurt, they see this as a positive

How is allocation of resources measured?

Through the number of interactions between buyers and sellers in a competitive market and through the total surplus

CS + PS = (what each surplus is made of and what cancels out)

(WTP / value to buyers) - (amount paid by buyers / price)

plus

(Amount received by sellers / price) - (cost to sellers / WTS)

=

(WTP / value to buyers) - (cost to sellers / WTS)

How do competitive markets assist in efficiency (3)?

Allocate supply of goods to buyers with the highest WTP

Allocate demand of goods to sellers who can produce at the lowest cost (WTS)

At equilibrium, allow for the production and distribution of a quantity of goods that maximizes total surplus

What happens to the total surplus from equilibrium to any other point?

total surplus decreases

How can the demand curve also be seen as the marginal benefit curve?

Marginal benefit measures the added satisfaction/utility gained from consuming one more of a good, an amount which decreases with every additional unit consumed

Marginal benefit = the area of …, while total benefits = the area of …

Marginal benefit = the area under the demand curve, between one quantity and that quantity + 1 unit

Total benefits = the area under the demand curve, from the starting quantity to the current quantity

How can the supply curve be seen as the marginal cost curve?

Marginal cost measures the added cost of producing one more unit of a good, an amount which rises with every additional unit

Marginal cost = the area of …, while total costs = the area of …

Marginal cost = the area under the supply curve, between one quantity and that quantity + 1 more unit

Total costs = the area under the supply curve, from the starting quantity to the current quantity

At any quantity, total surplus = what?

total benefits - total costs, with the net amount also being equal to the consumer surplus + producer surplus

What occurs at a quantity that exceeds the equilibrium quantity?

Onwards from equilibrium, total costs exceed total benefits because higher quantities mean that production costs grow while satisfaction/utility declines, thus causing deadweight loss

From the Supply-Demand graph, how do you calculate the total surplus at quantities below or at equilibrium quantity? (3)

1) Draw a horizontal line from the current price on the y axis to the point above the current quantity

2) Top part = CS while the bottom part = PS

3) Calculate the CS and PS areas and add together

Adam Smith’s Invisible Hand idea

an invisible, omniscient force acts in public interest by considering all information about buyers and sellers and guiding everyone towards decisions that will maximize economic well-being

What is market failure?

the inability of a free market to efficiently allocate resources

What two situations lead to market failure?

Market power and externalities

Market power

a single producer of consumer entity (can be just one buyer/seller or a small group like a household/company) holds significant influence over the market price

Externalities

the decisions of buyers and sellers impact people who do not participate in the market

Allocative Efficiency is achieved by …

achieved by dividing and utilizing resources in a way that maximizes total surplus