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Consumers,

Producers, and
the Efficiency of
Markets

In this chapter you will


Examine
Examinethe
thelink
linkbetween
betweenbuyers
buyerswillingness
willingnessto
to
pay
payfor
foraagood
goodand
andthe
thedemand
demand curve.
curve.
Learn
Learn how
how to
todefine
defineand
andmeasure
measureconsumer
consumer
surplus.
surplus.
Examine
Examinethe
thelink
linkbetween
betweensellers
sellerscost
cost of
of
producing
producingaagood
good and
and the
thesupply
supplycurve.
curve.
Learn
Learn how
how to
todefine
defineand
andmeasure
measureconsumer
consumer
surplus.
surplus.
See
Seethat
that the
theequilibrium
equilibrium of
of supply
supplyand
anddemand
demand
maximizes
maximizestotal
total surplus
surplusin
inaamarket.
market.

CONSUMERS, PRODUCERS, AND THE


EFFICIENCY OF MARKETS
Do
Do the
the equilibrium
equilibrium price
price and
and quantity
quantity
maximize
maximize the
the total
total welfare
welfare of
of buyers
buyers and
and
sellers?
sellers?
Market
Market equilibrium
equilibrium reflects
reflects the
the way
way
markets
markets allocate
allocate scarce
scarce resources.
resources.
Whether
Whether the
the market
market allocation
allocation is
is desirable
desirable
can
can be
be addressed
addressed by
by welfare
welfare economics.
economics.

CONSUMERS, PRODUCERS, AND THE


EFFICIENCY OF MARKETS
Welfare
Welfareeconomics
economics is
isthe
thestudy
studyof
of how
how the
the
allocation
allocationof
of resources
resourcesaffects
affectseconomic
economicwellwellbeing.
being.
Buyers
Buyersand
andsellers
sellersreceive
receivebenefits
benefits from
from taking
taking
part
partin
inthe
themarket.
market.
The
Theequilibrium
equilibrium in
inaamarket
marketmaximizes
maximizesthe
thetotal
total
welfare
welfareof
ofbuyers
buyersand
andsellers.
sellers.
Equilibrium
Equilibriumin
inthe
themarket
market results
resultsin
inmaximum
maximum
benefits,
benefits,and
andtherefore
thereforemaximum
maximumtotal
totalwelfare
welfarefor
for
both
boththe
theconsumers
consumersand
andthe
the producers
producersof
of the
the
product.
product.

CONSUMERS, PRODUCERS, AND THE


EFFICIENCY OF MARKETS
Consumer
Consumer surplus
surplus measures
measures economic
economic
welfare
welfare from
from the
the buyers
buyers side
side

Producer
Producer surplus
surplus measures
measures economic
economic
welfare
welfare from
from the
the sellers
sellers side.
side.

CONSUMER SURPLUS
Willingness
Willingness to
to pay
pay is
is the
the maximum
maximum
amount
amount that
that aa buyer
buyer will
will pay
pay for
for aa good.
good.
ItIt measures
measures how
how much
much the
the buyer
buyer values
values
the
the good
good or
or service.
service.

Consumer
Consumer surplus
surplus is
is the
the buyers
buyers
willingness
willingness to
to pay
pay for
for aa good
good minus
minus the
the
amount
amount the
the buyer
buyer actually
actually pays
pays for
for it.
it.

Table 7-1: Four Possible Buyers Willingness


to Pay

CONSUMER SURPLUS
The
The market
market demand
demand curve
curve depicts
depicts the
the
various
various quantities
quantities that
that buyers
buyers would
would be
be
willing
willing and
and able
able to
to purchase
purchase at
at different
different
prices.
prices.

Table 7-2: The Demand Schedule for the


Buyers in Table 7-1
Price

Buyers

Quantity
Demanded

More than $100

None

$80 to $100

John

$70 to $80

John, Paul

$50 to $70

John, Paul, George

$50 or less

John, Paul, George, Ringo

Figure 7-1: The Demand Curve


Price of
Album

$100

Johns willingness to pay

$80

Pauls willingness to pay

$70

Georges willingness to pay

$50

Ringos willingness to pay

Demand

Quantity
of Albums

Figure 7-2: Measuring Consumer Surplus


with the(a)Demand
Curve
Price = $80
(b) Price = $70
Price of
Album

Price of
Album

$100
Johns consumer surplus ($20)

$100
Johns consumer surplus ($30)

$80

$80

$70

$70

$50

$50

Pauls consumer surplus ($10)

Total consumer
surplus ($40)
Demand
Demand

Quantity
of Albums

Quantity
of Albums

Using the Demand Curve to Measure


Consumer Surplus
The
The area
area below
below the
the demand
demand curve
curve and
and
above
above the
the price
price measures
measures the
the consumer
consumer
surplus
surplus in
in the
the market.
market.

Figure 7-3: How the Price Affects Consumer


Surplus
(b) Consumer Surplus at a Price of P
(a) Consumer Surplus at a Price of P
1

Price

Price

Consumer surplus for new


consumers

P1

P1

C
Demand

B
F

P2

Additional
consumer
surplus to initial
consumers

Q1

Quantity

Q1

Q2

Quantity

What Does Consumer Surplus Measure?


Consumer
Consumer surplus,
surplus, the
the amount
amount that
that
buyers
buyers are
are willing
willing to
to pay
pay for
for aa good
good minus
minus
the
the amount
amount they
they actually
actually pay
pay for
for it,
it,
measures
measures the
the benefit
benefit that
that buyers
buyers receive
receive
from
from aa good
good as
as the
the buyers
buyers themselves
themselves
perceive
perceive it.
it.

PRODUCER SURPLUS

Producer
Producer surplus
surplus is
is the
the amount
amount aa
seller
seller is
is paid
paid for
for aa good
good minus
minus the
the
sellers
sellers cost.
cost.
ItIt measures
measures the
the benefit
benefit to
to sellers
sellers
participating
participating in
in aa market.
market.

Table 7-3: The Cost of Four Possible Sellers

Using the Supply Curve to Measure


Producer Surplus
Just
Just as
as consumer
consumer surplus
surplus is
is related
related to
to the
the
demand
demand curve,
curve, producer
producer surplus
surplus is
is closely
closely
related
related to
to the
the supply
supply curve.
curve.

Table 7-4: The Supply Schedule for the


Sellers in Table 7-3
Price

Sellers

Quantity
Supplied

$900 or more

Mary, Frida, Georgia, Grandma

$800 to $900

Frida, Georgia, Grandma

$600 to $800

Georgia, Grandma

$500 to $600

Grandma

Less than $500

None

Figure 7-4: The Supply Curve


Price of
House
Painting

Supply

Marys
cost

$900
$800

Fridas cost

Georgias cost

$600

$500

Grandma cost

Using the Supply Curve to Measure


Producer Surplus
The
The area
area below
below the
the price
price and
and above
above the
the
supply
supply curve
curve measures
measures the
the producer
producer
surplus
surplus in
in aa market.
market.

Figure 7-5: Measuring Producer Surplus with


the Supply
Curve
(b) Price = $800
(a) Price = $600
Price of
House
Painting

Supply

Price of
House
Painting

Supply
Total producer
surplus ($500)

$900

$900

$800

$800

$600

$600

$500

$500
Georgias producer surplus ($200)
Grandpas producer
surplus ($100)

4
Quantity of
Houses Painted

Grandpas producer
surplus ($300)

4
Quantity of
Houses Painted

Figure 7-6: How the Price Affects Producer


Surplus
(b) Producer Surplus at a Price of P
(a) Producer Surplus at a Price of P
1

Price

Price

Supply

Supply
Additional
producer surplus
to initial
producers

D
P2
B

P1

P1

C
Producer surplus
for new producers

Initial
producer
surplus

Producer
surplus

A
0

Q1

Quantity

Q1

Q2

Quantity

MARKET EFFICIENCY
Consumer
Consumer surplus
surplus and
and producer
producer surplus
surplus
may
may be
be used
used to
to address
address the
the following
following
question:
question:
Is
Is the
the allocation
allocation of
of resources
resources
determined
determined by
by free
free markets
markets in
in any
any way
way
desirable?
desirable?

MARKET EFFICIENCY
Consumer
Consumer Surplus
Surplus
== Value
Value to
to buyers
buyers Amount
Amount paid
paid by
by buyers
buyers
and
and
Producer
Producer Surplus
Surplus
== Amount
Amount received
received by
by sellers
sellers Cost
Cost to
to
sellers
sellers

MARKET EFFICIENCY
Total
Total surplus
surplus
== Consumer
Consumer surplus
surplus ++ Producer
Producer surplus
surplus
or
or
Total
Total surplus
surplus
== Value
Value to
to buyers
buyers Cost
Cost to
to sellers
sellers

MARKET EFFICIENCY
Efficiency
Efficiency is
is the
the property
property of
of aa resource
resource
allocation
allocation of
of maximizing
maximizing the
the total
total surplus
surplus
received
received by
by all
all members
members of
of society.
society.
In
In addition
addition to
to market
market efficiency,
efficiency,aa social
social
planner
planner might
might also
also care
care about
about equity
equity the
the
fairness
fairness of
of the
the distribution
distribution of
of well-being
well-being
among
among the
the various
various buyers
buyers and
and sellers.
sellers.

Figure 7-7: Consumer and Producer Surplus


in the Market Equilibrium
Price

Supply

Consumer surplus

Equilibrium
price

Producer surplus

B
C
0

Equilibrium
quantity

Demand

Quantity

MARKET EFFICIENCY
Three
Three Insights
Insights Concerning
Concerning Market
Market
Outcomes
Outcomes
Free
Freemarkets
marketsallocate
allocatethe
thesupply
supplyof
of goods
goodsto
to
the
thebuyers
buyerswho
whovalue
valuethem
themmost
mosthighly,
highly,as
as
measured
measuredby
bytheir
their willingness
willingnessto
topay.
pay.
Free
Freemarkets
marketsallocate
allocatethe
thedemand
demandfor
forgoods
goodsto
to
the
thesellers
sellerswho
whocan
canproduce
producethem
themat
atleast
least
cost.
cost.
Free
Freemarkets
marketsproduce
produce the
thequantity
quantityof
ofgoods
goods
that
thatmaximizes
maximizesthe
thesum
sumof
ofconsumer
consumerand
and
producer
producersurplus.
surplus.

Figure 7-8: The Efficiency of the Equilibrium


Quantity
Price

Supply

Value to
buyers

Cost to
sellers

Cost to
sellers

Value to
buyers

Equilibrium
quantity

Value to buyers is greater


than cost to sellers

Value to buyers is less


than cost to sellers

Demand

Quantity

Evaluating the Market Equilibrium


Because
Because the
the equilibrium
equilibrium outcome
outcome is
is an
an
efficient
efficient allocation
allocation of
of resources,
resources, the
the social
social
planner
planner can
can leave
leave the
the market
market outcome
outcome as
as
he/she
he/she finds
finds it.
it.
This
This policy
policy of
of leaving
leaving well
well enough
enough alone
alone
goes
goes by
by the
the French
French expression
expression laissez
laissez
faire.
faire.

Evaluating the Market Equilibrium


Market
Market Power
Power
IfIf aa market
market system
system is
is not
not perfectly
perfectly
competitive,
competitive, market
market power
power may
may result.
result.
Market
Marketpower
power is
isthe
theability
abilityto
to influence
influence
prices.
prices.
Market
Marketpower
power can
can cause
causemarkets
marketsto
tobe
be
inefficient
inefficientbecause
becauseitit keeps
keepsprice
priceand
and
quantity
quantityfrom
fromthe
the equilibrium
equilibrium of
of supply
supplyand
and
demand.
demand.

Evaluating the Market Equilibrium


Externalities
Externalities
created
createdwhen
whenaamarket
market outcome
outcomeaffects
affects
individuals
individualsother
otherthan
thanbuyers
buyersand
andsellers
sellersin
in
that
thatmarket.
market.
cause
causewelfare
welfarein
inaamarket
marketto
todepend
dependon
onmore
more
than
thanjust
just the
thevalue
valueto
tothe
thebuyers
buyersand
andcost
cost to
to
the
thesellers.
sellers.
When
Whenbuyers
buyersand
andsellers
sellersdo
donot
not take
takeexternalities
externalities
into
intoaccount
account when
whendeciding
decidinghow
how much
muchto
to
consume
consumeand
andproduce,
produce, the
theequilibrium
equilibriumin
inthe
the
market
market can
canbe
beinefficient.
inefficient.

Summary
Consumer
Consumer surplus
surplus equals
equals buyers
buyers
willingness
willingness to
to pay
pay for
for aa good
good minus
minus the
the
amount
amount they
they actually
actually pay
pay for
for it.
it.
Consumer
Consumer surplus
surplus measures
measures the
the benefit
benefit
buyers
buyers get
get from
from participating
participating in
in aa market.
market.
Consumer
Consumer surplus
surplus can
can be
be computed
computed by
by
finding
finding the
the area
area below
below the
the demand
demand curve
curve
and
and above
above the
the price.
price.

Summary
Producer
Producer surplus
surplus equals
equals the
the amount
amount
sellers
sellers receive
receive for
for their
their goods
goods minus
minus their
their
costs
costs of
of production.
production.
Producer
Producer surplus
surplus measures
measures the
the benefit
benefit
sellers
sellers get
get from
from participating
participating in
in aa market.
market.
Producer
Producer surplus
surplus can
can be
be computed
computed by
by
finding
finding the
the area
area below
below the
the price
price and
and above
above
the
the supply
supply curve.
curve.

Summary
An
An allocation
allocation of
of resources
resources that
that maximizes
maximizes
the
the sum
sum of
of consumer
consumer and
and producer
producer
surplus
surplus is
is said
said to
to be
be efficient.
efficient.
Policymakers
Policymakers are
are often
often concerned
concerned with
with the
the
efficiency,
efficiency,as
as well
well as
as the
the equity,
equity,of
of
economic
economic outcomes.
outcomes.

Summary
The
The equilibrium
equilibrium of
of demand
demand and
and supply
supply
maximizes
maximizes the
the sum
sum of
of consumer
consumer and
and
producer
producer surplus.
surplus.
This
This is
is as
as ifif the
the invisible
invisible hand
hand of
of the
the
marketplace
marketplace leads
leads buyers
buyers and
and sellers
sellers to
to
allocate
allocate resources
resources efficiently.
efficiently.
Markets
Markets do
do not
not allocate
allocate resources
resources
efficiently
efficiently in
in the
the presence
presence of
of market
market
failures.
failures.

The End

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