Ch 07 Consumers, Producers, and the Efficiency of Markets

Chapter Overview

• The chapter discusses consumers, producers, and market efficiency.

• Focuses on key economic principles related to consumer and producer surplus.

• Key concepts derived from Mankiw's "Principles of Economics."

Welfare Economics

• Definition: Studies how the allocation of resources affects economic well-being.

• Allocation of Resources: Involves determining:

  • Amount of each good produced.

  • Producers who manufacture the goods.

  • Consumers who purchase the goods.

• Conclusion: Equilibrium of supply and demand maximizes total benefits for all buyers and sellers.

Consumer Surplus

• Willingness to Pay (WTP): The maximum a buyer will pay for a good.

• Formula: Consumer Surplus (CS) = WTP - Price (P).

• Represents the benefits buyers receive from market participation.

Examples of Consumer Surplus

Example 1A: Willingness to Pay

• Scenario: Sale on refurbished iPad Mini 3.

• Buyers' WTP:

  • Alexis: $250

  • Cameron: $175

  • Fatima: $300

  • Jamir: $125

• At Price (P) = $200:

  • Buyers: Alexis & Fatima.

  • Quantity demanded (Qd) = 2.

Example 1B: Demand Curve Derivation

• Demand schedule derived from WTP:

  • WTP ranges converted into quantities based on various price points ranging from $0 to $300.

Example 1C: Staircase Demand Curve

• Demand curve resembles a staircase with steps representing each buyer's WTP.

• In a competitive market, the curve would smooth out into a curve rather than steps.

Example 1D: Calculating Consumer Surplus

• At Price (P) = $260:

  • Fatima’s CS = $300 - $260 = $40.

  • Others have no CS as they didn’t buy.

  • Total CS = $40.

Example 1E: Impact of Lower Price on CS

• At Price (P) = $220:

  • Fatima’s CS = $300 - $220 = $80.

  • Alexis’ CS = $250 - $220 = $30.

  • Total CS increases to $110.

Total Consumer Surplus

• Calculated as the area below the demand curve and above price level.

• Represents the cumulative benefit received by all buyers in market.

Producer Surplus

• Definition: Producer surplus (PS) measures the benefit sellers receive from participating in a market.

• Formula: PS = Price (P) - Cost; where Cost is the minimum price at which a seller is willing to sell.

Examples of Producer Surplus

Example 3A: Willingness to Sell

• Sellers' costs:

  • Jin: $10

  • Jada: $20

  • Chris: $35

• Determine supply schedule based on these costs.

Example 3B: Supply Curve

• The supply curve shows the minimum cost incurred by sellers at each quantity.

Example 3C: Calculating Producer Surplus

• At Price (P) = $25:

  • Jin’s PS = $25 - $10 = $15.

  • Jada’s PS = $25 - $20 = $5.

  • Total PS = $20.

Efficient Allocation of Resources

• Market outcomes depend on both consumer and producer surplus to determine overall efficiency.

• Total Surplus: Total Surplus = CS + PS, indicating total economic well-being.

• Market equilibrium occurs when supply meets demand, leading to maximized total surplus.

Market Evaluations

Market's Allocation of Resources

• Free market outcomes:

  1. Allocates goods to buyers valuing them most (WTP).

  2. Connects demand to lowest cost sellers.

  3. Produces quantity maximized for total surplus.

Evaluating Market Equilibrium (Example 5)

• Market equilibrium at P = $30 and Q = 15.

• Buyer behavior: Buyers with WTP ≥ $30 will purchase.

• Seller behavior: Sellers with costs ≤ $30 will sell.

Efficiency and Market Failures

• Identifies the conditions under which market assumptions hold.

• Market failures may arise due to factors such as market power and externalities, affecting overall efficiency across society.

Conclusion: Key Takeaways

• Consumer surplus and producer surplus are essential metrics for evaluating economic participants' benefits.

• Efficient allocations maximize total surplus, but market failures indicate circumstances where efficiency is compromised.