MICROECONOMICS

CHAPTER 4:
MARKET AND WELFARE
Willingness to Pay (WTP) and the Demand Curve
• A buyer’s willingness to pay for a good is the maximum amount the buyer
will pay for that good.
WTP measures how much the buyer values the good.

• At any Q, the height of the D curve is the WTP of the marginal buyer, the
buyer who would leave the market if P were any higher.
 Consumer Surplus (CS)
• Consumer surplus is the amount a buyer is willing to pay minus the
amount the buyer actually pays.
CS = WTP – P
• Consumer surplus measures the benefit buyers receive from participating in
a market.
• Consumer surplus equals the area below the demand curve and above the
price.
• Consumer surplus can be calculated using the formula for the area of a
triangle.
CS with Lots of Buyers & a Smooth D Curve
CS is the area b/w P The demand for shoes
and the D curve, from P
0 to Q. $ 60
Recall: area of 50
a triangle equals h
½ x base x height 40
Height = 30
$60 – 30 = $30.
So, 20
CS = ½ x 15 x $30 10
= $225. D
0 Q
0 5 10 15 20 25 30
How a Higher Price Reduces CS
If P rises to $40,
CS = ½ x 10 x $20 P
1. Fall in CS
= $100. 60
due to buyers
Two reasons for the 50 leaving market
fall in CS.
40
30

2. Fall in CS due to 20
remaining buyers 10
D
paying higher P 0 Q
0 5 10 15 20 25 30
How a Lower Price Increases CS
 Cost and the Supply Curve
• Cost is the value of everything a seller must give up to produce a good
(i.e., opportunity cost).

• A seller will produce and sell the good/service only if the price exceeds his
or her cost.
Hence, cost is a measure of willingness to sell.
• At each Q, the height of the S curve is the cost of the marginal seller, the
seller who would leave the market if the price were any lower.
 Producer Surplus (PS)
• Producer surplus is the amount a seller is paid for a good minus
the seller’s cost.
PS = P – cost

• Producer surplus equals in the area below the price and above the
supply curve.

• Producer surplus can be calculated using the formula for the area of
a triangle.
PS with Lots of Sellers & a Smooth S Curve
PS is the area b/w The supply of shoes
P
P and the S curve,
from 0 to Q. 60

The height of this 50 S

triangle is 40
$40 – 15 = $25.
So, 30
h
PS = ½ x b x h 20
= ½ x 25 x $25
= $312.50 10
0 Q
0 5 10 15 20 25 30
How a Lower Price Reduces PS
If P falls to $30, P 1. Fall in PS
PS = ½ x 15 x $15 60 due to sellers
= $112.50 leaving market
50 S
Two reasons for the
fall in PS. 40
30

2. Fall in PS due to 20
remaining sellers 10
getting lower P
0 Q
0 5 10 15 20 25 30
How a Higher Price Increases PS
 CS, PS, and Total Surplus
CS = (value to buyers) – (amount paid by buyers)
= buyers’ gains from participating in the market
PS = (amount received by sellers) – (cost to sellers)
= sellers’ gains from participating in the market
Total surplus = CS + PS
= total gains from trade in a market
= (value to buyers) – (cost to sellers)
 13

12

11

The market eq’m 10

consumer surplus $.........
quantity maximizes 9
Consumer
8
total surplus: At 7
Surplus producer surplus $.........
any other quantity, 6 Producer
Surplus
can increase total 5 total economic $..........
Price 4 surplus
surplus by moving 3

toward the market 2

1
eq’m quantity.
1 2 3 4 5 6 7 8 9 10 11

Quantity of Gadgets (hundreds)

 Taxes
• The government levies taxes on many goods & services to raise revenue to
pay for national defense, public schools, etc.
• The govt can make buyers or sellers pay the tax.
• The tax can be a % of the good’s price, or a specific amount for each unit
sold.
• For simplicity, we analyze per-unit taxes only.
 EXAMPLE: The Market for Pizza

QD­ = -8P + 960

QS­ = 12P - 340 P
S

Eq’m w/o tax:

Q
 A Tax on Buyers
The price buyers pay is now $10 higher Effects of a $10 per unit tax on
than the market price P. buyers (The government makes buyers pay a
P $10 tax on each pizza they purchase)
P would have to fall by $10 to make
S
buyers willing to buy same Q as before.

Tax

D
Dt
Q

Hence, a tax on buyers shifts the D

curve down by the amount of the tax.
 A Tax on Buyers
New eq’m: Effects of a $10 per
unit tax on buyers

P
S
Tax

D
Dt
Q
 The Incidence of a Tax:
how the burden of a tax is shared among
market participants (“Market participants” simply means buyers and sellers)
P
In our example, S
tax buyers pay = Tax

tax sellers pay =

D
Dt
Q
 A Tax on Sellers
Effects of a $10 per unit tax on
The tax effectively raises sellers’ costs sellers (The government makes sellers pay a
by $10 per pizza. $10 on each pizza they sell)
P St
Sellers will supply same Q as before
Tax S
only if P rises by $10, to compensate for

this cost increase.

Hence, a tax on sellers shifts the

S curve up by the amount of the tax.
 A Tax on Sellers
New eq’m: Effects of a $10 per
unit tax on sellers
P St
S
Tax

Q
The Outcome Is the Same in Both Cases!
The effects on P and Q, and the tax incidence are the
same whether the tax is imposed on buyers or sellers!
What matters P
is this: S
PB =
A tax drives Tax
a wedge
between the PS =
price buyers
pay and the
D
price sellers
receive.
Q
The Effects of a Tax Eq’m with no tax:
P Price = PE
Without a tax,
Quantity = QE
CS = A + B + C
PS = D + E + F A
Tax revenue = 0 S
B C
Total surplus PE
D E
= CS + PS
=A+B+C D
F
+D+E+F

Q
QT QE
 Eq’m with tax = $T per unit:
The Effects of a Tax Buyers pay PB
P
With the tax, Sellers receive PS
CS = A Size of tax = $T
Quantity = QT
PS = F
A
Tax revenue = $T x QT PB S
=B+D B C
Total surplus D E
=A+B PS D
+D+F F
The tax reduces
total surplus by Q
C+E QT QE
The Effects of a Tax P
C + E is called the
deadweight loss
(DWL) of the tax - A
PB S
the fall in total
B C
surplus that
results from a market D E
distortion, such as a PS D
tax. F

Q
QT QE
About the Deadweight Loss
P
When the government
imposes a tax on a
good, the quantity sold
falls from QE to QT. At
PB S
every quantity
between QE and QT,
the potential gains
from trade among PS D
buyers and sellers are
not realized. These
lost gains from trade
create the deadweight Q
loss. QT QE
Active Learning 1
Market research has revealed the following information about the market for chocolate bars:
QD = -2P + 2000
QS = 8P

a. What are the equilibrium price and quantity in the market? Draw a graph
b. Calculate the price elasticity of demand Ed at equilibrium price and quantity.
Would a price increase cause sellers’ total revenue to increase or decrease?
c. If the market price P1 is 150, what would happen? Calculate CS, PS at P1 if the government provides
assistance.
d. If the market price P2 is 300, what would happen? Calculate CS, PS at P2 if the government provides
assistance.
e. Suppose the government requires buyers to pay a $10 tax on each bar of chocolate purchased.
Calculate:
- CS and PS without the tax.
- With the tax: CS, PS, tax revenue and deadweight loss.

f. Suppose the government requires sellers to pay a $10 tax on each bar of chocolate sold. Calculate:
- CS and PS without the tax.
- With the tax: CS, PS, tax revenue and deadweight loss.
Active Learning 2
Market research has revealed the following information about the market for beer:
QD = 120 - P
QS = P - 40

a. If the market price P1 is 70, what would happen? Calculate CS, PS at P1 if the government provides
assistance.
b. If the market price P2 is 90, what would happen? Calculate CS, PS at P2 if the government provides
assistance.
c. Suppose the government requires buyers to pay a $10 tax on each case of beer purchased. Calculate:
- CS and PS without the tax.
- With the tax: CS, PS, tax revenue and deadweight loss.

d. Suppose the government requires sellers to pay a $10 tax on each case of beer sold. Calculate:
- CS and PS without the tax.
- With the tax: CS, PS, tax revenue and deadweight loss.
 SUMMARY
- Thị trường? CS và PS? (Market? Consumer surplus and producer surplus?)
- Thuế của chính phủ: ảnh hưởng đến CS và PS; doanh thu thuế của chính phủ
và phần tổn thất vô ích của xã hội; người tiêu dùng chịu thuế; nhà sản xuất
chịu thuế. (Tax on buyers/sellers: CS, PS, tax revenue of government,
deadweight loss; tax that buyers pay, tax that sellers pay)