Chapter 5: Efficiency

consumer surplus (CS)

Willingness to Pay - Market price = WTP - P*; graphically this is the area BELOW demand and ABOVE price

What do you need to know to calculate CS?

Need to know: demand choke price, P*, Q*

Demand choke price

the max amount that the richest/biggest fan would pay

Producer surplus

Market price - Willingness to sell = P* - WTS; graphically the area BELOW price and ABOVE supply curve

What do you need to know to calculate PS?

Supply choke price, P*, Q*

Supply choke price

the minimum amount that the cheapest producer could supply for

Allocative efficiency

At market equilibrium, those who value the good the most will receive it

productive efficiency

production for the cheapest will supply it

Efficiency vs. equity

outcome that maximizes PS & CS vs. outcome that distributes CS & PS fairly

How does elasticity impact PS and CS?

elastic demand → price sensitive → lower maximum WTP → smaller CS; elastic supply → more flexible → lower WTS → higher PS

Deadweight loss

DWL: consumer or producer surplus that exists at the market equilibrium and is destroyed by moving to a different outcome (usually foregone mutually beneficial transactions)

Missing markets & why they may exist

markets that WOULD create mutually beneficial transactions between buyers and sellers, but do not exist; government, lack of info/communication, lack of technology