Consumers, Producers, and Market Efficiency PDF

Consumers, Producers, and the 7 Efficiency of Markets Copyright © 2011 Cengage Learning  REVISITING THE MARKET EQUILIBRIUM Do the equilibrium price and quantity maximize the total welfare of buyers and sellers? Market equilibrium reflects th...

Consumers, Producers, and the 7 Efficiency of Markets Copyright © 2011 Cengage Learning  REVISITING THE MARKET EQUILIBRIUM Do the equilibrium price and quantity maximize the total welfare of buyers and sellers? Market equilibrium reflects the way markets allocate scarce resources. Whether the market allocation is desirable can be addressed by welfare economics. Copyright © 2011 Cengage Learning  Welfare Economics Welfare economics is the study of how the allocation of resources affects economic well- being. Buyers and sellers receive benefits from taking part in the market. The equilibrium in a market maximizes the total welfare of buyers and sellers. Copyright © 2011 Cengage Learning  Welfare Economics Equilibrium in the market results in maximum benefits, and therefore maximum total welfare for both the consumers and the producers of the product. Copyright © 2011 Cengage Learning  Welfare Economics Consumer surplus measures economic welfare from the buyers’ side. Producer surplus measures economic welfare from the sellers’ side. Copyright © 2011 Cengage Learning  CONSUMER SURPLUS Willingness to pay is the maximum amount that a buyer will pay for a good. It measures how much the buyer values the good or service. Copyright © 2011 Cengage Learning  CONSUMER SURPLUS Consumer surplus is the buyer’s willingness to pay for a good minus the amount the buyer actually pays for it. Copyright © 2011 Cengage Learning Air Jordan Copyright © 2011 Cengage Learning What is your willing to pay for these sneakers? Copyright © 2011 Cengage Learning Copyright © 2011 Cengage Learning Table 1 Four Possible Buyers’ Willingness to Pay Copyright©2011 South-Western  CONSUMER SURPLUS The market demand curve depicts the various quantities that buyers would be willing and able to purchase at different prices. Copyright © 2011 Cengage Learning The Demand Schedule and the Demand Curve Copyright © 2011 Cengage Learning  Figure 1 The Demand Schedule and the Demand Curve Price of Album €100 Liam’s willingness to pay 80 Paul’s willingness to pay 70 Noel’ s willingness to pay 50 Paul’s willingness to pay Demand 0 1 2 3 4 Quantity of Albums Copyright©2011 South-Western Figure 2 Measuring Consumer Surplus with the Demand Curve (a) Price = €80 Price of Album €100 Liam’s consumer surplus (€20) 80 70 50 Demand 0 1 2 3 4 Quantity of Albums Copyright©2011 South-Western Figure 2 Measuring Consumer Surplus with the Demand Curve (b) Price = €70 Price of Album €100 Liam ’s consumer surplus (€30) 80 Paul’s consumer 70 surplus (€10) Total 50 consumer surplus (€40) Demand 0 1 2 3 4 Quantity of Albums Copyright©2011 South-Western Using the Demand Curve to Measure Consumer Surplus The area below the demand curve and above the price measures the consumer surplus in the market. Copyright © 2011 Cengage Learning Figure 3 How the Price Affects Consumer Surplus (a) Consumer Surplus at Price P Price A Consumer surplus P1 B C Demand 0 Q1 Quantity Copyright©2011 South-Western Figure 3 How the Price Affects Consumer Surplus (b) Consumer Surplus at Price P Price A Initial consumer surplus C Consumer surplus P1 B to new consumers F P2 D E Additional consumer Demand surplus to initial consumers 0 Q1 Q2 Quantity Copyright©2011 South-Western What Does Consumer Surplus Measure? Consumer surplus, the amount that buyers are willing to pay for a good minus the amount they actually pay for it, measures the benefit that buyers receive from a good as the buyers themselves perceive it. Copyright © 2011 Cengage Learning  Quick test 1. Alexis, Bruno, and Camila each want an ice- cream cone. Alexis is willing to pay $12, Bruno is willing to pay $8, and Camila is willing to pay $4. The market price is $6. Consumer surplus equals a. $6. b. $8. c. $14. d. $18 Copyright © 2011 Cengage Learning 1. Alexis, Bruno, and Camila each want an ice- cream cone. Alexis is willing to pay $12, Bruno is willing to pay $8, and Camila is willing to pay $4. The market price is $6. Consumer surplus equals a. $6. b. $8. c. $14. d. $18 Copyright © 2011 Cengage Learning 2. If the price of an ice-cream cone falls to $3, the consumer surplus of Alexis, Bruno, and Camila increases by a. $6. b. $7. c. $8. d. $9. Copyright © 2011 Cengage Learning 2. If the price of an ice-cream cone falls to $3, the consumer surplus of Alexis, Bruno, and Camila increases by a. $6. b. $7. c. $8. d. $9. Copyright © 2011 Cengage Learning 3. The demand curve for cookies is downward- sloping. When the price of cookies is $3, the quantity demanded is 100. If the price falls to $2, what happens to consumer surplus? a. It falls by less than $100. b. It falls by more than $100. c. It rises by less than $100. d. It rises by more than $100. Copyright © 2011 Cengage Learning 3. The demand curve for cookies is downward- sloping. When the price of cookies is $3, the quantity demanded is 100. If the price falls to $2, what happens to consumer surplus? a. It falls by less than $100. b. It falls by more than $100. c. It rises by less than $100. d. It rises by more than $100. Copyright © 2011 Cengage Learning  PRODUCER SURPLUS Producer surplus is the amount a seller is paid for a good minus the seller’s cost. It measures the benefit to sellers participating in a market. Copyright © 2011 Cengage Learning Apple iPhone 14 Plus 512 GB Copyright © 2011 Cengage Learning Table 2 The Costs of Four Possible Sellers Copyright©2011 South-Western Using the Supply Curve to Measure Producer Surplus Just as consumer surplus is related to the demand curve, producer surplus is closely related to the supply curve. Copyright © 2011 Cengage Learning The Supply Schedule and the Supply Curve Copyright © 2011 Cengage Learning Figure 4 The Supply Schedule and the Supply Curve Copyright©2011 South-Western Using the Supply Curve to Measure Producer Surplus The area below the price and above the supply curve measures the producer surplus in a market. Copyright © 2011 Cengage Learning Figure 5 Measuring Producer Surplus with the Supply Curve (a) Price = €600 Price of House Painting Supply €900 800 600 500 Nana’s producer ’ surplus (€100) 0 1 2 3 4 Quantity of Houses Painted Copyright©2011 South-Western Figure 5 Measuring Producer Surplus with the Supply Curve (b) Price = €800 Price of House Painting Supply Total producer €900 surplus (€500) 800 600 Georgia’s producer 500 surplus (€200) Nana’s producer ’ surplus (€300) 0 1 2 3 4 Quantity of Houses Painted Copyright©2010 South-Western Figure 6 How the Price Affects Producer Surplus (a) Producer Surplus at Price P Price Supply B P1 C Producer surplus A 0 Q1 Quantity Copyright©2011 South-Western Figure 6 How the Price Affects Producer Surplus (b) Producer Surplus at Price P Price Additional producer Supply surplus to initial producers D E P2 F B P1 Initial C Producer surplus producer to new producers surplus A 0 Q1 Q2 Quantity Copyright©2011 South-Western  Quick quiz 4. Diego, Emi, and Finn are available to work as tutors for the semester. The opportunity cost of tutoring is $100 for Diego, $200 for Emi, and $400 for Finn. The university is hiring tutors at a price of $300. Producer surplus equals a. $100. b. $200. c. $300. d. $400. Copyright © 2011 Cengage Learning 4. Diego, Emi, and Finn are available to work as tutors for the semester. The opportunity cost of tutoring is $100 for Diego, $200 for Emi, and $400 for Finn. The university is hiring tutors at a price of $300. Producer surplus equals a. $100. b. $200. c. $300. d. $400. Copyright © 2011 Cengage Learning 5. Gavin has been working full-time as a gardener for $300 a week. When the market price of gardeners rises to $400, Hector becomes a gardener as well. How much does producer surplus rise as a result of this price increase? a. by less than $100 b. between $100 and $200 c. between $200 and $300 d. by more than $300 Copyright © 2011 Cengage Learning 5. Gavin has been working full-time as a gardener for $300 a week. When the market price of gardeners rises to $400, Hector becomes a gardener as well. How much does producer surplus rise as a result of this price increase? a. by less than $100 b. between $100 and $200 c. between $200 and $300 d. by more than $300 Copyright © 2011 Cengage Learning 6. The supply curve for a product is Qs=2P, and the market price is $10. What is producer surplus? (Hint: Graph the supply curve and recall the formula for the area of a triangle.) a. $5 b. $20 c. $100 d. $200 Copyright © 2011 Cengage Learning 6. The supply curve for a product is Qs =2P ,and the market price is $10. What is producer surplus? (Hint: Graph the supply curve and recall the formula for the area of a triangle.) a. $5 b. $20 c. $100 d. $200 Copyright © 2011 Cengage Learning  MARKET EFFICIENCY Consumer surplus and producer surplus may be used to address the following question: Is the allocation of resources determined by free markets in any way desirable? Copyright © 2011 Cengage Learning  MARKET EFFICIENCY Consumer Surplus = Value to buyers – Amount paid by buyers and Producer Surplus = Amount received by sellers – Cost to sellers Copyright © 2011 Cengage Learning  MARKET EFFICIENCY Total surplus = Consumer surplus + Producer surplus or Total surplus = Value to buyers – Cost to sellers Copyright © 2011 Cengage Learning  MARKET EFFICIENCY Efficiency is the property of a resource allocation of maximizing the total surplus received by all members of society. Copyright © 2011 Cengage Learning  MARKET EFFICIENCY In addition to market efficiency, a social planner might also care about equity – the fairness of the distribution of well-being among the various buyers and sellers. Copyright © 2011 Cengage Learning  Figure 7 Consumer and Producer Surplus in the Market Equilibrium Price A D Supply Consumer surplus Equilibrium E price Producer surplus Demand B C 0 Equilibrium Quantity quantity Copyright©2011 South-Western  MARKET EFFICIENCY Three Insights Concerning Market Outcomes Free markets allocate the supply of goods to the buyers who value them most highly, as measured by their willingness to pay. Free markets allocate the demand for goods to the sellers who can produce them at least cost. Free markets produce the quantity of goods that maximizes the sum of consumer and producer surplus. Copyright © 2011 Cengage Learning Figure 8 The Efficiency of the Equilibrium Quantity Price Supply Value Cost to to 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. Copyright©2011 South-Western Evaluating the Market Equilibrium Because the equilibrium outcome is an efficient allocation of resources, the social planner can leave the market outcome as he/she finds it. This policy of leaving well enough alone goes by the French expression laissez faire. Copyright © 2011 Cengage Learning Evaluating the Market Equilibrium Market Power If a market system is not perfectly competitive, market power may result. Market power is the ability to influence prices. Market power can cause markets to be inefficient because it keeps price and quantity from the equilibrium of supply and demand. Copyright © 2011 Cengage Learning Evaluating the Market Equilibrium Externalities created when a market outcome affects individuals other than buyers and sellers in that market. cause welfare in a market to depend on more than just the value to the buyers and cost to the sellers. When buyers and sellers do not take externalities into account when deciding how much to consume and produce, the equilibrium in the market can be inefficient. Copyright © 2011 Cengage Learning  Quick quiz 7. Isabelle values her time at $60 an hour. She spends 2 hours giving Jayla a massage. Jayla was willing to pay as much as $300 for the massage, but they negotiated a price of $200. In this transaction, a. consumer surplus is $20 larger than producer surplus. b. consumer surplus is $40 larger than producer surplus. c. producer surplus is $20 larger than consumer surplus. d. producer surplus is $40 larger than consumer surplus. Copyright © 2011 Cengage Learning 7. Isabelle values her time at $60 an hour. She spends 2 hours giving Jayla a massage. Jayla was willing to pay as much as $300 for the massage, but they negotiated a price of $200. In this transaction, a. consumer surplus is $20 larger than producer surplus. b. consumer surplus is $40 larger than producer surplus. c. producer surplus is $20 larger than consumer surplus. d. producer surplus is $40 larger than consumer surplus. Copyright © 2011 Cengage Learning 8. An efficient allocation of resources maximizes a. consumer surplus. b. producer surplus. c. consumer surplus plus producer surplus. d. consumer surplus minus producer surplus. Copyright © 2011 Cengage Learning 8. An efficient allocation of resources maximizes a. consumer surplus. b. producer surplus. c. consumer surplus plus producer surplus. d. consumer surplus minus producer surplus. Copyright © 2011 Cengage Learning 9. Producing a quantity larger than the equilibrium of supply and demand is inefficient because the marginal buyer’s willingness to pay is a. negative. b. zero. c. positive but less than the marginal seller’s cost. d. positive and greater than the marginal seller’s cost. Copyright © 2011 Cengage Learning 9. Producing a quantity larger than the equilibrium of supply and demand is inefficient because the marginal buyer’s willingness to pay is a. negative. b. zero. c. positive but less than the marginal seller’s cost. d. positive and greater than the marginal seller’s cost. Copyright © 2011 Cengage Learning  Summary Consumer surplus equals buyers’ willingness to pay for a good minus the amount they actually pay for it. Consumer surplus measures the benefit buyers get from participating in a market. Consumer surplus can be computed by finding the area below the demand curve and above the price. Copyright © 2011 Cengage Learning  Summary Producer surplus equals the amount sellers receive for their goods minus their costs of production. Producer surplus measures the benefit sellers get from participating in a market. Producer surplus can be computed by finding the area below the price and above the supply curve. Copyright © 2011 Cengage Learning  Summary An allocation of resources that maximizes the sum of consumer and producer surplus is said to be efficient. Policy makers are often concerned with the efficiency, as well as the equity, of economic outcomes. Copyright © 2011 Cengage Learning  Summary The equilibrium of demand and supply maximizes the sum of consumer and producer surplus. This is as if the invisible hand of the marketplace leads buyers and sellers to allocate resources efficiently. Markets do not allocate resources efficiently in the presence of market failures. Copyright © 2011 Cengage Learning