2: The price system and the

microeconomy
Learning objectives
The price (market) mechanism and market
• Price mechanism: the means of allocating resources in a market economy.
• Market: where buyers and sellers get together to trade.
• In a competitive market, price acts as a signal for shortages and surpluses which help
firms and consumers respond to changing market conditions.
• If a good is in shortage – price will tend to rise. Rising prices discourage demand, and
encourage firms to try and increase supply.
• If a good is in surplus – price will tend to fall. Falling price encourage people to buy,
and cause firms to try and cut back on supply.
• Prices help to redistribute resources from goods with little demand to goods and
services which people value more.
• Adam Smith talked about ‘the invisible hand‘ of the market. This ‘invisible hand’ relies
on the fluctuation of prices to shift resources to where it is needed.
The meaning of a competitive market

• Competition is generally
understood to be a process in
which rivals compete in order to
achieve some objective. For
example, fi rms may compete
over who will sell the most
output, consumers may compete
over who will buy a scarce
product, workers compete over
who will get the best jobs with
the highest salaries, countries
compete over which will capture
the biggest export markets, and
so on.
Key functions of price(market) mechanism
• 1. Allocate – allocating scarce resources among competing uses
• 2. Rationing – prices serve to ration scarce resources when market
demand outstrips supply
• 3. Signalling – prices adjust to demonstrate where resources are
required, and where they are not
• 4. Incentives – e.g. when the price of a product rises, quantity supplied
increases as businesses respond!
• Prices send important signals Prices change incentives for consumers and
suppliers In an economy like the UK, many decisions on how to resolve
the issues of opportunity cost and trade-offs are resolved by prices.
Equilibrium and efficiency
• Equilibrium and efficiency: Prices are set by markets, are always
moving into and out of equilibrium, and can be both efficient and
inefficient in different ways and over different time periods.
• This key concept is central to the content of this chapter and other
microeconomic chapters.
• It recognises that equilibrium in a market depends upon both demand
and supply influences, both of which can change over time.
Effective Demand

• Demand refers to the quantity of a product that purchasers are willing

and able to buy at various prices per period of time, all other things
being equal.
• Effective demand: demand that is supported by the ability to pay.
• Law of demand: More will be demanded at lower prices that at
higher prices.
Demand curve
• Demand curve: represents the relationship between the quantity
demanded and price of a product.
• The demand curve is a graphical representation of the relationship
between the price of a good or service and the quantity demanded
for a given period of time.
• Individual demand: the relationship between the price and the
quantity demanded of a product, ceteris paribus.
• Market demand: the total amount demanded by consumers.
• Demand schedule: the data from which a demand curve is drawn.
Market demand as the sum of individual demands
 Marginal utility theory or
Marginal benefits (G12)
Why the
Since each successive unit of the
demand good you consume produces
curve less and less benefi t, you will
be willing to buy each extra
slopes unit only if it has a lower and
downward? lower
price.
Demand schedule and a demand curve
What does a market demand curve shows?
■ An inverse or negative relationship between price and quantity
demanded. In other words:
❏ when price goes up, there is a decrease in quantity demanded
❏ when price goes down, there is an increase in quantity demanded.

 Changes in price cause a change in quantity demanded and we show

this by movements up and down the demand curve.
■ A linear relationship – this demand curve has been drawn as a
straight line. However, it is perfectly acceptable for price and quantity
demanded to be related in a non-linear manner in the form of a type of
curve.
■ A continuous relationship – we could look at the diagram and find out
at what price consumers would be willing and able to buy 1,259 PCs.
■ A time-based relationship – the time period here is weekly.
■ Other things being equal, ceteris paribus.
• It allows us to estimate how much consumers may spend when
buying PCs or, conversely, how much revenue companies may receive
from selling PCs.
• If the price of each PC is $1,800 and the information provided is
accurate, then consumers will buy 2,000 units and their total
spending will be equal to $3,600,000 – the revenue that companies
receive from selling this quantity of the product.
Assignment 2.1
1. Discuss the key functions of the ‘price mechanism”.
2. Explain how the market mechanism works.
3. What is a competitive market? Explain how competition and
efficiency are connected.
4. Why is demand curve sloping downwards?
Factors influencing demand (The non-price
determinants of demand)
• Income:
• normal goods and inferior goods ,
• Substitutes
• Complementaries (joint demand)
• Normal goods: one whose demand increases as income increases.
• Inferior goods: one whose demand decreases as income increases.
• Substitute: an alternative good.
• Advertisements (both advertisers and competitors)
• Fashion, taste
• Health
• Laws and regulations
Shifts in the demand curve
• A rightward shift of the demand
curve indicates that more is
demanded for a given price; a
leftward shift of the demand
curve indicates that less is
demanded for a given price.
• A rightward shift of the curve is
called an increase in demand; a
leftward shift is called a decrease
in demand.
 • A movement along the demand curve, caused by a change
in price, is called a ‘change in quantity demanded’.
Movements along and shifts
• A shift of a demand curve, caused by a change in a
of the demand curve determinant of demand, is called a ‘change in demand’
• A shift of a demand curve,
caused by a change in a
determinant of demand, is called
a ‘change in demand’
Income
As income rises, the demand curve for a normal good will shift
to the right.
As income rises, the demand curve for the inferior good will
shift to the left.
Supply
• Supply refers to the quantities of a product that suppliers are willing
and able to sell at various prices per period of time, other things
being equal.
• Law of supply: More will be supplied at higher prices than at lower
prices.
• Supply: the quantity of a product that producers are willing and able
to sell at different prices.
The supply curve
• The supply curve is a graphic representation of the correlation
between the cost of a good or service and the quantity supplied for a
given period.
• In a typical illustration, the price will appear on the left vertical axis,
while the quantity supplied will appear on the horizontal axis.
• Supply schedule: the data from which a supply curve is drawn.
Market supply as the sum of individual supplies
Why the supply curve slopes upward?
• Higher prices generally mean that the firm’s profits increase, and so
the firm faces an incentive to produce more output. Lower prices
mean lower profitability, and the incentive facing the firm is to
produce less.
• Therefore, there results a positive relationship between price and
quantity supplied: the higher the price, the greater the quantity
supplied.
• Market supply is the sum of all individual firms’ supplies for a good.
The market supply curve illustrates the law of supply, shown by a
positive relationship between price and quantity supplied.
Movements along and shifts of the supply curve

• (a)A movement along the

supply curve, caused by a
change in price, is called a
‘change in quantity supplied’
• (b) A shift of the supply
curve, caused by a change in
a determinant of supply, is
called a ‘change in supply’
Supply schedule and (market)supply curve
Determinants of supply
(NON-PRICE) Factors influencing supply
• Cost of production
• Size and nature of the industry
• Change in price of other products
• Government policy – subsidy, taxes
• Subsidy: a payment made by government to producers to reduce the
market price.
Reduction/ increase in tax
Effect of a subsidy on supply
Weather and supply: Bad weather reduces
supply and pushes up price.
Elasticity
• Elasticity: a numerical measure of responsiveness of one
variable(demand) following a change in another variable (price),
ceteris paribus.
• Elastic: where the relative change in demand or supply is greater than
the change in price. (10% fall in price 25% increase in
demand)
• Inelastic: where the relative change in demand or supply is less than
the change in price (25% increase in price 10% fall in demand)
Price Elasticity of Demand
PED IED XED
Price elasticity of demand (PED)
• Price elasticity of demand (PED) is a numerical measure of the
responsiveness of the quantity demanded for a product following a
change in the price of that product.
• If demand is elastic, then a small change in price will result in a
relatively larger change in quantity demanded.
• On the other hand, if there is a large change in price and a far lesser
change in quantity demanded, then demand is price inelastic.
Two examples of price changes for two
unrelated products: product A and product B
Factors affecting price elasticity of demand
• The number of close substitutes – the more close substitutes there are in the market, the more elastic is
demand because consumers find it easy to switch.
• The cost of switching between products – there may be costs involved in switching. In this case,
demand tends to be inelastic. For example, mobile phone service providers may insist on a12 month
contract which has the effect of locking-in some consumers once a choice has been made
• The degree of necessity or whether the good is a luxury – necessities tend to have an inelastic demand
whereas luxuries tend to have a more elastic demand.
• The proportion of a consumer's income allocated to spending on the good – products that take up a
high % of income will have a more elastic demand
• The time period allowed following a price change – demand is more price elastic, the longer that
consumers have to respond to a price change. They have more time to search for cheaper substitutes
and switch their spending.
• Whether the good is subject to habitual consumption – consumers become less sensitive to the price of
the good of they buy something out of habit (it has become the default choice).
• Peak and off-peak demand - demand is price inelastic at peak times and more elastic at off-peak times –
this is particularly the case for transport services.
• The breadth of definition of a good or service – if a good is broadly defined, i.e. the demand for petrol
or meat, demand is often inelastic. But specific brands of petrol or beef are likely to be more elastic
following a price change.
Characteristics of PED
PED
Variability of PED along a straight-line
demand curve
PED and tax revenue
PED: Primary commodities with inelastic
demand, Manufactured goods with elastic demand
Test your understanding:
Income elasticity of demand (IED)
• Income elasticity of demand
(YED): a numerical measure of
the responsiveness of the
quantity demanded following a
change in income.
Interpreting income elasticity of demand
• Interpreting income elasticity of demand: • Suppose your income increases from $800
• Income elasticity of demand provides two kinds per month to $1000 per month, and your
of information: purchases of clothes increase from $100 to
• the sign of YED: positive or negative: normal $140 per month. What is your income
goods have a positive value of YED and inferior elasticity of demand for clothes?
goods have a negative value of YED.
• the numerical value of YED: whether it is greater
or smaller than one (assuming it is positive). YED • Your income elasticity demand for
< 1: Necessities If a good has a YED that is clothes is +1.6.
positive but less than one, it has income inelastic
demand. YED > 1: Luxuries If a good has an YED
that is greater than one, it has income elastic
demand: a percentage increase in income
produces a larger percentage increase in quantity
demanded. Luxuries are income elastic goods.
• For normal goods, the value of Y E D is positive,
• Necessity goods are products that have low income elasticity.
• Superior goods are products that have high income elasticity.
• For inferior goods, the value of YED is negative, because the demand
decreases as income increases. People start to switch their
expenditure from the inferior goods that they had been buying to
superior goods,
 • Cross elasticity of demand (XED) is a numerical
measure of the responsiveness of the quantity
Cross elasticity demanded for one product following a change in
the price of another related product, ceteris
of demand paribus.
• Interpreting cross-price elasticity
of demand
• Show that substitute goods have
a positive value of XED and
complementary goods have a
negative value of XED.
• Explain that the (absolute) value
of XED depends on the closeness
of the relationship between two
goods.
Substitutes and degree of substitutability
• The meaning of a positive XED
• Cross-price elasticity of demand for two
goods is positive (XED > 0) when the
demand for one good and the price of the
other good change in the same direction:
when the price of one increases, the
demand for the other also increases. This
occurs when the two goods are substitutes
• For example, Coca-Cola® and Pepsi® are
substitutes: What happens to the demand
for Pepsi, as the price of Coca-Cola
changes
• If the Cross-price elasticity of demand
provides two kinds of information:
• Price of Coca-Cola increases, the quantity of Coca-Cola
demanded falls, and the demand for Pepsi increases as
consumers switch from Coca-Cola to Pepsi, and there
results a rightward shift in the demand curve for Pepsi.
• If the price of Coca-Cola falls, the quantity of Coca-Cola
demanded increases, and the demand for Pepsi falls as
consumers now switch from Pepsi to Coca-Cola; there
results a leftward shift in Pepsi’s demand curve. (Note that
in the case of Coca-Cola, whose own price is changing, we
refer to increases or decreases in the ‘quantity demanded’,
whereas with Pepsi we refer to increases or decreases in
‘demand’ because of demand curve shifts.)
• In fact, the cross-price elasticity of demand for Coca- Cola®
and Pepsi® has been estimated to be about + 0.7.6
• This means that a 1% increase in the price of one leads to a
0.7% increase in demand for the other; or a 10% increase in
the price of one leads to a 7% increase in the demand for
the other. This is considered to be an example of fairly high
substitutability.
Calculating XED in the case of substitutes

• Suppose the price of coffee • XED is +0.5; the positive sign

increases from $10 per kilogram tells us that coffee andtea are
(kg) to $12 per kg and the substitutes.
amount of tea purchased
increases from 1500 kg to 1650
kg. What is the XED?
Complements and degree of complementarity:
The meaning of a negative XED
• The meaning of a negative XED
• Cross-price elasticity of demand for two
goods is negative (XED < 0) when the demand
for one good and the price of the other good
change in opposite directions: when the price
of one good increases, the demand for the
other falls. This occurs when the two goods
are complements
• Calculating XED in the case of
complements
• Suppose the price of pencils
increases from $1.00 per pencil to
$1.30 and the quantity of erasers
purchased falls from 1000 erasers
to 800. What is the XED?
• XED is –0.67; the negative sign
tells us that pencils and erasers
are substitutes.
XED: Positive, Negative and Zero
• If the value of XED is positive, then the two goods in question may be said
to be substitutes for each other. Products that are very close substitutes
will have a higher positive value than products that are not so close.
• If the value of XED is negative, then the two goods in question may be
said to be complements for each other. Products that are very close
complements will have a lower negative value than products that are not
so close.
• If cross-price elasticity of demand is zero (XED = 0) or close to zero, this
means that two products are unrelated or independent of each other. For
example, potatoes and telephones are unrelated to each other: a change
in the price of one is unlikely to affect demand for the other.
Case Study on Page: 50
Revision Activities: MCQ Questions - Answers Explained

• https://www.tutor2u.net/economics/collections/mcq-revision-questio
ns-answers-explained
• https://www.tutor2u.net/economics/collections/mcq-revision-blasts-f
or-alevel-economics
SELF-ASSESSMENT TASK 2.12
1. What will happen to sales of a product whose YED = +0.6?
2. How could you use YED values to advise a company on how to
produce a mix of goods and services that would reduce the risk often
associated with only producing a very narrow range of products?
3. Why might government planners be interested in the YED values of
different products?
Price elasticity of supply
• Price elasticity of supply (PES) is a
numerical measure of the
responsiveness of the quantity
supplied to a change in the price of
the product, ceteris paribus.

• Since the relationship between the

price and quantity supplied is
normally a direct one, the PES will
tend to take on a positive value.
• Suppose the price of • Price elasticity of supply for
strawberries increases from €3 strawberries is +0.59. We will
per kg to €3.50 per kg, and the now see how PES is interpreted.
quantity of strawberries supplied
increases from 1000 to 1100
tonnes per season. Calculate PES
for strawberries.
• If supply is elastic (i.e. PES > 1), then producers can increase output
without a rise in cost or a time delay
• If supply is inelastic (i.e. PES <1), then firms find it hard to change
production in a given time period.
• When Pes > 1, then supply is price elastic
• When Pes < 1, then supply is price inelastic
• When Pes = 0, supply is perfectly inelastic
• When Pes = infinity, supply is perfectly elastic following a change in
demand
THREE EXTREME cases of PES
Factors
influencing
PES
Business relevance of price elasticity of
•supply
Housing supply – inelastic supply of new housing in response to rising demand – pushes up property
prices with consequences for housing wealth, affordability etc
o Oil industry – can OPEC and non-OPEC countries step up crude oil output as global demand expands?
• Trade: I.e. the ability of a nation’s export industries to respond to depreciation in the ex change rate if
export demand grows – important for countries using the exchange rate as an instrument of macro
policy
• Commodity prices: Inelastic supply of many hard and soft commodities – making prices more volatile –
especially in markets where there is strong speculative activity - link to global food price inflation
• Labour market: Elasticity of supply of labour is a factor explaining wage differentials – i.e. migrant
workers can help to relieve shortages of labour and improve the elasticity of supply
• Macroeconomics and the output gap: The changing elasticity of SRAS at different points of the
economic cycle
• Elasticity of supply of renewable sources of energy as demand increases e.g. bio-fuels, solar power
• Quasi public goods – i.e. public goods such as the airwaves, motorways, beaches etc which become
crowded and congested – causing the marginal cost of supplying to an extra user to rise
• Government intervention in a market – if you are answering questions on maximum and minimum
prices or indirect taxes and subsidies, you can always make a useful analytical point about the
Factors affecting price elasticity of supply: BRITS

1. Barriers to entry – e.g. Patents or high cost of advertising could make it

hard for new firms to enter the market
2. Raw materials – If raw materials are readily available, it will be relatively
easy to expand production
3. Inventory – Businesses with plenty of stock can increase supply easily.
4. Time – Many agricultural products take time to make so supply is fixed in
the short term.
5. Spare Capacity – If businesses are not running to full capacity they are
more able to increase supply. The supply of goods and services is often
most elastic in a recession when there is plenty of spare labour and
capital resource
Interaction of demand and supply– markets in
equilibrium and disequilibrium
• Equilibrium price: the price where demand and supply are equal,
where the market clears.
• Equilibrium quantity: the amount that is traded at the equilibrium
price.
• Disequilibrium: a situation where demand and supply are not equal.
• Equilibrium: a situation where there is no tendency for change.
Equilibrium and efficiency, the margin and
change:
• Equilibrium and efficiency, the margin and change:
• It should now be clear that markets operate in a dynamic way, moving
from equilibrium to disequilibrium and back again to equilibrium; the
market moves from an efficient position to being inefficient and then
adjusts naturally to again being efficient.
• The causes are many. The time taken for these changes to come
about is highly variable.
• The various elasticity measures provide some answers as to why this
is so and how consumers react to change.
Why does the market move from
disequilibrium to equilibrium and vice versa
• Whenever markets experience imbalances—
creating disequilibrium prices, surpluses, and shortages—
market forces drive prices toward equilibrium. A surplus exists when
the price is above equilibrium, which encourages sellers to lower
their prices to eliminate the surplus.
Test your understanding:
Short-run and long-run PES for selected
agricultural commodities
• 1 (a) Explain why the PES for many
primary commodities is relatively
low and for many manufactured
products is relatively higher.
• (b) Use the concept of PES to explain
why agricultural product prices are
volatile over the short term.
• 2 Why is it important to make a
distinction between short-run and
long-run price elasticities of supply?
a summary of key characteristics of all the
elasticities considered
Shifts in the market demand curve
• Change in demand: when there is a shift in the demand curve due to
a change in factors other than the price of the particular product.
• A rightward shift indicates an increase in demand; a left ward shift
indicates a decrease in demand.
• Notice how the language changes here when we are talking about a
shift in the whole curve rather than simply a movement along it – a
change in demand rather than a change in the quantity demanded
Causes of shifts in the demand curve
Shifts in the market supply curve
• A rightward shift indicates an increase in supply; a left ward shift
indicates a decrease in supply.
• Notice again how the language changes when we are talking about a
shift in the whole curve rather than simply a movement along it – a
change in supply rather than a change in the quantity supplied
Causes of shifts in the supply curve
Joint supply: when two items are
produced together.

Joint supply
Market equilibrium
• If quantity demanded of a good is smaller than
quantity supplied, the difference between the two is
called a surplus, where there is excess supply; if
quantity demanded of a good is larger than quantity
supplied, the difference is called a shortage, where
there is excess demand. The existence of a surplus or a
shortage in a free market will cause the price to change
so that the quantity demanded will be made equal to
quantity supplied. In the event of a shortage, price will
rise; in the event of a surplus, price will fall. When a
market is in equilibrium, quantity demanded equals
quantity supplied, and there is no tendency for the
price to change.
Changes in market equilibrium
• Analyse, using diagrams and with reference to excess demand or
excess supply, how changes in the determinants of demand and/or
supply result in a new market equilibrium.
Changes in demand and the new
equilibrium price and quantity:
Increase in demand
• (a) D1 intersects S at point a, resulting in equilibrium
price and quantity P1 and Q1. Consider an increase
in consumer income in the case of a normal good,
causes the demand curve to shift to the right from
D1 to D2. at the initial price, P1, there is a
movement to point b, which results in excess
demand equal to the horizontal distance between
points a and b. Point b represents a disequilibrium,
where quantity demanded is larger than quantity
supplied, thus exerting an upward pressure on price.
The price therefore begins to increase, causing a
movement up D2 to point c, where excess demand
is eliminated and a new equilibrium is reached. At c,
there is a higher equilibrium price, P2, and greater
equilibrium quantity, Q2, given by the intersection
of D2 with S.
Decrease in demand
• A decrease in demand, shown in Figure 2.10(b), leads to a leftward
shift in the demand curve from D1 to D3 (for example, due to a
decrease in the number of consumers). Given D3, at price P1, there is
a move from the initial equilibrium (point a) to point b, where
quantity demanded is less than quantity supplied, and therefore a
disequilibrium where there is excess supply equal to the horizontal
difference between a and b. This exerts a downward pressure on
price, which falls, causing a movement down D3 to point c, where
excess supply is eliminated, and a new equilibrium is reached. At c,
there is a lower equilibrium price, P3, and a lower equilibrium
quantity, Q3, given by the intersection of D3 with S.
Changes in supply and the new equilibrium
price and quantity
Changes in the equilibrium
• The equilibrium will change if there is a disturbance to the present
market conditions – this could come about through a change in supply
conditions (the supply curve shifts) or a change in demand conditions
(the demand curve shifts).
The workings of the price mechanism – final
thoughts
• Prices act as a signal to both producers and consumers. A rise in the
quantity demanded results in an increase in price, signaling to
producers that they should put more of their products onto the
market. In turn, if consumers withhold their demand, prices can be
expected to fall.
• This signals that less should be produced. The price mechanism works
in such a way that the outcome is a new equilibrium position with
consumers’ demand equal to producers’ supply.
• The price system can ration products in the market.
 •The Bugatti Centodieci is the French automaker's
most powerful supercar yet — coming in a skosh
Bugatti Centodieci above the Chiron at 1,600 horsepower. But it's not
just the power — or the $8.9 million price tag — that
makes the Centodieci stand out.
How many Bugatti Centodieci are there?
• Bugatti will only produce 10 of the Centodieci and they're already
sold!
• Bugatti reveals its most powerful supercar yet: The $10
million Centodieci. Centodieci is Bugatti's most powerful car with
1,600 horsepower. Its design honors the Bugatti EB110 of the 1990s
for Bugatti's 110th anniversary. Only 10 Centodiecis will be made at
about $10 million apiece after taxes.
Consumer surplus
• In England, to watch Premier League football clubs, such as Liverpool
or Manchester United, where all tickets are sold out.
• The stated price may well be $40 per ticket, but there will always be
some people who are willing to pay more than $40 to obtain a ticket.
To the economist, such situations introduce the concept of consumer
surplus.
Premier league
• Most fans (53 per cent) continue to pay £30 or less per match.
- The average price paid for a Premier League ticket is £32, compared
with £31 in 2018/19 and £32 in 2017/18.
- 21 per cent of fans pay £20 or less per match.
- 52 per cent pay between £20 and £40.
- 20 per cent pay between £40 and £60.
- Only six per cent pay £60 or more.
- Almost half of season tickets (47 per cent) are sold below full price,
saving fans £16.3million.
Consumer and producer surplus in a
competitive market
Consumer surplus: Explain the concept of consumer surplus. Identify
consumer surplus on a demand and supply diagram.

• Consumer surplus is defined as the highest price consumers are

willing to pay for a good minus the price actually paid. In a
competitive market, the price actually paid is determined at the
market equilibrium by supply and demand.
Consumer surplus arises because some consumers are willing to pay
more than the given price for all but the last unit they buy.
• Consumer surplus is derived whenever the price a consumer actually pays is less
than they are prepared to pay.
• A demand curve indicates what price consumers are prepared to pay for a
hypothetical quantity of a good, based on their expectation of private benefit.
• Consumer surplus generally declines with consumption. One explanation for this
is the law of diminishing marginal utility, which suggests that the first unit of a
good or service consumed generates much greater utility than the second, which
generates greater utility than the third and subsequent units.
• A very thirsty consumer will be prepared to pay a relatively high price for their
first soft drink, but, as they drink more, less utility is derived and the price they
would be prepared to pay falls. prepared to pay declines, causing the demand
curve to slope down from A to B.
Marginal utility: measuring the level
of satisfaction from consumption
How elasticity of demand affects consumer surplus?

• If demand is price inelastic, then there is a bigger gap between the

price consumers are willing to pay and the price they actually pay.
• Monopolies are able to reduce consumer surplus by setting higher
prices
• Price Discrimination is an attempt to extract consumer surplus by
setting.
Consumer surplus and marginal utility
theory
• The demand curve illustrates the
marginal utility a consumer gets
from consuming a product. At
quantity 500 litres, the marginal
utility is £0.80 – which indicates
the marginal utility is 80p.
However, with a price of 50p,
the consumer surplus is the
difference.
Producer surplus
• Producer surplus is a similar concept to consumer surplus. Here,
however, we are looking at a situation from the producer’s or
supplier’s perspective.
• This is the difference between the price a firm receives and the price
it would be willing to sell it at.
• Therefore it is the difference between the supply curve and the
market price
Airfares from Bangkok (BANGKOK INT' $454
L) to London (LHR)
• the difference between the price a producer is willing to accept and
what is actually paid.
• Producer surplus is a measure of producer welfare.
• Producer surplus is the additional private benefit to producers, in
terms of profit, gained when the price they receive in the market is
more than the minimum they would be prepared to supply for. In
other words they received a reward that more than covers their costs
of production.
• The producer surplus derived by all firms in the market is the area
from the supply curve to the price line, EPB.
Economic welfare
• Economic welfare is the total benefit available to society from an
economic transaction or situation.
• Economic welfare is also called community surplus. Welfare is
represented by the area ABE in the diagram below, which is made up
of the area for consumer surplus, ABP plus the area for producer
surplus, PBE.
Economic welfare
• Economic welfare is the total
benefit available to society from
an economic transaction or
situation.
• Economic welfare is also
called community surplus.
Welfare is represented by the
area ABE in the diagram below,
which is made up of the area for
consumer surplus, ABP plus the
area for producer surplus, PBE.
• In market analysis economic welfare at equilibrium can be calculated
by adding consumer and producer surplus.
• Welfare analysis considers whether economic decisions by
individuals, organisations, and the government increase or decrease
economic welfare.
•Qd = Quantity demanded at equilibrium, where demand and supply are
equal
•ΔP = Pmax – P
•Pmax = Price the buyer is willing to pay
•Pd = Price at equilibrium, where demand and supply are equal
Deadweight loss
Effect of tax on consumer surplus, producer
surplus and welfare loss
Calculating consumer surplus and producer
surplus and welfare loss before and after tax
Elasticity, tax and consumer/ producer surlus
Subsidy consumer surplus, producer surplus
and welfare loss/ gain
Calculating the effects of subsidies on
consumer and producer surplus