7.1 Consumer Surplus

Willingness to Pay:

• Welfare economics- the study of how the allocation of resources affects the economic well-being

• Willingness to pay- the maximum amount that a buyer will pay for a good

• Consumer surplus- the amount a buyer is willing to pay for a good minus the amount the buyer actually pays for it

Using the Demand Curve to Measure Consumer Surplus:

• The area below the demand curve and above the price measures the consumer surplus in a market

  • The difference between buyer’s willingness to pay and the market price is each buyer’s consumer surplus

How a Lower Price Raises Consumer Surplus:

• Buyers always want to pay less for the goods they buy, a lower price makes buyers of a good better off

  • The increase in consumer surplus of existing buyers is the reduction in the amount they pay

  • As a result, the quantity demanded in the market increases from its original quantity

What Does Consumer Surplus Measure?:

• The concept of consumer surplus is to make judgments about the desirability of market outcomes

7.2 Producer Surplus

Cost and Willingness to Sell:

• cost - the value of everything a seller must give up to produce a good

• Producer surplus- the amount a seller paid for a good minus the seller’s cost of providing it

Using the Supply Curve to Measure Producer Surplus:

• At any quantity, the price given by the supply curve shows the cost of the marginal seller, the seller who would leave the market first if the price were any lower

• The area below the price and above the supply curve measures the producer surplus in a market

  • The height of the supply curve measures sellers’ cost, and the difference between the price and cost of production is each seller’s producer surplus

How a Higher Price Raises Producer Surplus:

• Sellers always want to receive a higher price for the goods they sell

• Producer surplus is used to measure the well-being of sellers in much the same way consumer surplus is used to measure the well-being of buyers

• New sellers who enter the market willing the produce the good at a higher price, it increases the original quantity of supplies

7.3 Market Efficiency

The Benevolent Social Planner:

• They are the “all-knowing, all-powerful, well-intentioned dictator”

• The sum of consumer and producer surplus is called total surplus

• Efficiency- the property of a resource allocation of maximizing the total surplus received by all members of society

• Equality- the property of distributing economic prosperity uniformly among the members of society

Evaluating the Market Equilibrium:

1. Free markets allocate the supply of goods to the buyers who value them most highly, as measured by their willingness to pay.

2. Free markets allocate the demand for goods to the sellers who can produce them at the lowest cost.

3. Free markets produce the number of goods that maximize the sum of consumer and producer surplus.

• These three insights allow us to know that the market outcome makes the total surplus as large as it can be