LECTURE 4 – CHAPTER 7 – PRINCIPLES OF ECONOMICS

CONSUMERS, PRODUCERS, AND THE

EFFICIENCY OF MARKETS
 Consumers, Producers, and the Efficiency of Markets

OBJECTIVES

 Consumer surplus
 Producer surplus
 Market efficiency & equilibrium
 Consumers, Producers, and the Efficiency of Markets

Welfare economics

 Welfare economics: the study of how the allocation of

resources affects economic well-being
 Consumers, Producers, and the Efficiency of Markets

Consumer Surplus

 Willingness to pay:
the maximum amount
that a buyer will pay for
a good  WTP
measures how much the
buyer values the good
 Consumers, Producers, and the Efficiency of Markets

Consumer Surplus

 Willingness to pay: the maximum amount that a buyer will

pay for a good  WTP measures how much the buyer values
the good
Table 1. Willingness to pay
 Consumer Surplus:
CS = WTP – P
 Case study: Elvis Presley album
 Consumers, Producers, and the Efficiency of Markets

Consumer Surplus (cont.)

 Demand Schedule:
Derived from the willingness Demand Schedule
to pay of the possible buyers
Table 1. WTP
 Consumers, Producers, and the Efficiency of Markets

Consumer Surplus (cont.)

 Demand Curve: Price of
Album
At any quantity, the price given by the €100 John’s willingness to pay
demand curve shows the willingness to Paul’s willingness
pay of the marginal buyer 80 to pay
70 George’s willingness
to pay
50 Ringo’s willingness
to pay

Demand

0 1 2 3 4 Quantity of Albums
 Consumers, Producers, and the Efficiency of Markets

Consumer Surplus (cont.)

 Demand Curve: Price of
Album
John’s willingness to pay
The height of the demand €100

curve reflects 80 Paul’s willingness to pay

George’s willingness to pay
buyers’ willingness to pay 70

Table 1. Willingness to pay 50 Ringo’s willingness to pay

Demand

0 1 2 3 4 Quantity of
Albums
Copyright©2003 Southwestern/Thom
 Consumers, Producers, and the Efficiency of Markets

Consumer Surplus (cont.)

(a) Price = €80
 Measuring Consumer Price of
Album
Surplus with the €100
Demand Curve: Area John’s consumer surplus (€20)

below the demand curve 80

and above the price

70

50

Demand

0 1 2 3 4 Quantity of
Albums
 Consumers, Producers, and the Efficiency of Markets

Consumer Surplus (cont.)

 Measuring Consumer Surplus with the Demand Curve
(a) Price = €80 (b) Price = €70
Price of Price of
Album Album
€100
John’s consumer surplus
€100
John’s consumer surplus (€20) (€20 + €10 )

80 80
Paul’s consumer
70 surplus (€10)
70
P Total
50
CS 50 consumer
surplus (€40)

Demand

0 1 2 3 4 Quantity of 0 1 2 3 4 Quantity of
Albums Albums
Consumer Surplus (cont.)
Price

 Measuring Consumer
A

Surplus with the

Demand Curve: Initial
consumer
 A lower price raises surplus
C Consumer surplus
P1
consumer surplus B to new consumers

F
P2
D E
Additional consumer Demand
surplus to initial
consumers
0 Q1 Q2 Quantity
Copyright©2003 Southwestern/Thomson Learning
 Consumers, Producers, and the Efficiency of Markets

OBJECTIVES

 Consumer surplus
 Producer surplus
 Market efficiency & equilibrium
 Consumers, Producers, and the Efficiency of Markets

Producer Surplus

 Cost: the value of everything a seller must give up to produce a

good
Table 1.The costs of four possible sellers
 Producer Surplus:
PS = P – Cost to seller
 Case study: house painting
 Consumers, Producers, and the Efficiency of Markets

Producer Surplus (cont.)

 Supply Schedule: Supply Schedule

Table 1.The costs of four possible sellers

 Consumers, Producers, and the Efficiency of Markets

Producer Surplus (cont.)

 Supply curve:
the height of the supply
curve reflects sellers’
costs.
Table 1.The costs of four possible sellers
 Consumers, Producers, and the Efficiency of Markets

Producer Surplus (cont.)

Price of (a) Price = €600
House
 Supply curve:
Supply
Painting

PS = area below the price €900

and above the supply 800

curve
600
500
Nana’s producer
’
surplus (€100)

0 1 2 3 4
Quantity of
Houses Painted
 Consumers, Producers, and the Efficiency of Markets

Producer Surplus (cont.)

 Measuring Consumer Surplus with the Demand Curve: PS
= area below the price and above the supply curve
(a) Price = €600 (b) Price = €800
Price of Price of
House House
Painting Supply Painting Supply
Total
producer
€900 €900 surplus (€500)
800 P 800

600
PS 600 Georgia’s producer
500 500 surplus (€200)
Nana’s producer
’
surplus (€100)
’
Nana’s producer
surplus (€100 + €200)

Quantity of 0 1 2 3 4 Quantity of
0 1 2 3 4 Houses Painted Houses Painted
 Consumers, Producers, and the Efficiency of Markets

Producer Surplus (cont.)

 Measuring Price
Supply
Producer Surplus Additional producer
surplus to initial
with the Supply producers

Curve: P2
D E
F

 A higher price raises B

P1
producer surplus Initial C
Producer surplus
producer to new producers
surplus

0 Q1 Q2 Quantity
 Consumers, Producers, and the Efficiency of Markets

OBJECTIVES

 Consumer surplus
 Producer surplus
 Market efficiency & equilibrium
 Consumers, Producers, and the Efficiency of Markets

Market efficiency & equilibrium

Price
A
 Total Surplus D
Supply
• CS = WTP – P
Consumer
• PS = P – Cost to seller surplus
PE E

Producer
surplus
TS = CS + PS
TS = WTP – Cost to seller B
Demand

0 QE Quantity
 Consumers, Producers, and the Efficiency of Markets

Market efficiency & equilibrium (cont.)

 Efficiency: the property of a resource allocation of

maximizing the total surplus received by all members of
society
=> Get the most output from the least input
 Equality: the property of distributing economic prosperity
uniformly among the members of society
 Consumers, Producers, and the Efficiency of Markets

Market efficiency & equilibrium (cont.)

Equality vs Equity?
Equal distribution of
benefits (equality) does
not always result in equal
gains (equity)

Source: Health Knowledge

 Consumers, Producers, and the Efficiency of Markets

Market efficiency & equilibrium(cont.)

Supply

 Evaluating the market

Price

equilibrium: maximizes
the sum of consumer and Value
to
Cost
to

producer surplus buyers sellers

Cost Value
to to
sellers buyers Demand

0 Equilibrium Quantity
quantity

Value to buyers is greater Value to buyers is less

than cost to sellers. than cost to sellers.
 Consumers, Producers, and the Efficiency of Markets

Market efficiency & equilibrium(cont.)

Price
Supply

 Free markets allocate:

• the supply of goods to the
Value Cost
buyers who value them most to to
buyers sellers
highly, as measured by their
willingness to pay.
• the demand for goods to the Cost
to
Value
to
Demand
sellers who can produce them sellers buyers

at the lowest cost. 0 Equilibrium

quantity
Quantity

Value to buyers is greater Value to buyers is less

than cost to sellers. than cost to sellers.
 Consumers, Producers, and the Efficiency of Markets

SUMMARY

 Consumer surplus
 Producer surplus
 Market efficiency & equilibrium