Principles of Microeconomics Chapter 7 Consumers, Producers, & the Efficiency of Markets

Ch. 7 - Consumers, Producers, and the Efficiency of Markets

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

• Equilibrium of S and D maximizes the total benefits received by all buyers and sellers combined

7-1 Consumer Surplus

• Willingness to Pay

  • Willingness to pay: a buyer’s maximum; measures how much that buyer values the good

  • Price > WTP: won’t buy | Price < WTP: will buy | Price = WTP: fine with buying or keeping the $

  • Consumer surplus: amt a buyer is willing to pay for a good MINUS the amt the buyer actually pays for it; measures the benefit buyers receive from participating in market

  • Total consumer surplus = adding consumer surpluses of all participants

• Using the Demand Curve to Measure Consumer Surplus

  • At any qty, the price given by the demand curve shows the WTP of the marginal buyer (buyer who would leave market 1st if price were any higher)

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

• How a Lower Price Raises Consumer Surplus

  • When price falls, increase in consumer surplus of EXISTING buyers is the rectangle that is still at Q1 and between P1 and P2

  • When price falls, the consumer surplus of NEW buyers is the new triangle formed from Q1 to Q2 between P1 and P2

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• What Does Consumer Surplus Measure? 

  • Consumer surplus is a good measure of economic well-being if policymakers want to satisfy BUYERS

  • Policymakers can disregard CS if they do not respect preferences that drive buyer behavior (ex. drugs)

7-2 Producer Surplus

• Cost and the Willingness to Sell

  • Cost in this case: opportunity cost = willingness to sell

  • Price > WTS: will sell | Price < WTS: won’t sell | Price = WTS: fine with getting the job or spending time/energy elsewhere

  • Producer surplus: amt a seller is paid MINUS the cost of production; measures the benefit sellers receive from participating in a market

  • Total producer surplus = adding producer surpluses of all participants

• Using the Supply Curve to Measure Producer Surplus

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

  • Area below price and above supply curve measures producer surplus in a market

  • Total area: sum of producer surplus of ALL sellers

• How a Higher Price Raises Producer Surplus

  • When price rises, increase in PS of EXISTING sellers is the rectangle formed from P1 to P2 at the same Qty 

  • When price rises, PS of NEW sellers is triangle formed from P1 to P2 and Q1 to Q2

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7-3 Market Efficiency

• The Benevolent Social Planner

  • Benevolent social planner wants to maximize economic well-being of everyone in society

  • One possible measure of economic well-being: total surplus (CS+PS)

  • Total surplus = value to buyers - cost to sellers

  • If an allocation of resources maximizes total surplus, it exhibits EFFICIENCY

  • Social planner also considers EQUALITY (whether buyers and sellers have similar levels of economic well-being)

• Evaluating the Market Equilibrium

  • Total surplus = area between S and D curves up to eq. Qty

  • Free markets allocate:

    • Supply of goods to buyers who value them most (highest WTP) 

    • Demand of goods to sellers who produce them at lowest cost

  • Free markets produce the qty of goods that maximizes total surplus (social planner CANNOT change qty of good) 

  • Qty BELOW eq: value to marginal buyer > cost to marginal seller; increasing qty raises total surplus

  • Qty ABOVE eq: value to marginal buyer < cost to marginal seller; decreasing qty raises TS

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  • Invisible hand guides everyone in market to best outcome of economic efficiency

  • Economists support the idea of a human kidney market (shortage of kidneys would disappear)