Econ 103 Chapter 6: Markets and Welfare - Consumers, Producers, and Market Efficiency PDF

Principles of Microeconomics ECON 103 – 2024/25 Dr. Hussain Muhammad 1  CH 6: Markets and Welfare – Consumers, Producers, & Market’s Effi ciency Welfare Economics Welfare economics studies how the allocation of r...

Principles of Microeconomics ECON 103 – 2024/25 Dr. Hussain Muhammad 1  CH 6: Markets and Welfare – Consumers, Producers, & Market’s Effi ciency Welfare Economics Welfare economics studies how the allocation of resources affects economic well-being. The allocation of resources refers to: How much of each good is produced Which producers produce it Which consumers consume it Buyers and sellers receive benefits from taking part in the market. The Goal of Welfare Economics is to maximize total surplus, ensuring efficient outcomes for both consumers and producers. The equilibrium in a market maximizes the total welfare of buyers and sellers. 2  CH 6: Markets and Welfare – Consumers, Producers, & Market’s Effi ciency Willingness to Pay (WTP) 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. That is, WTP is the individual value for a good. 3  CH 6: Markets and Welfare – Consumers, Producers, & Market’s Effi ciency Willingness to Pay (WTP) 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. Buyer Willingness to pay John $100 Example: Paul 80 George 70 4 buyers’ WTP for a music Ringo 50 album 4  CH 6: Markets and Welfare – Consumers, Producers, & Market’s Effi ciency Willingness to Pay and the Demand Curve Q: If the price of an album is $80, who will buy it, and what will be the quantity demanded? Buyer Willingness to pay A: John & Paul will buy the album, but John $100 George & Ringo will not. Paul 80 George Ringo 70 50 Hence, Qd = 2 When P = $80. 5  CH 6: Markets and Welfare – Consumers, Producers, & Market’s Effi ciency Consumers Surplus Consumers Surplus The amount a buyer is willing to pay for a good minus the amount the buyer actually pays for it. CS = WTP - Price Consumer surplus measures the benefit buyers receive from participating in a market. 6  CH 6: Markets and Welfare – Consumers, Producers, & Market’s Effi ciency Using the Demand Curve to Measure Consumer Surplus Consumer surplus Closely related to the demand curve Demand schedule Derived from the willingness to pay of the possible buyers At any quantity The price given by the demand curve shows the willingness to pay of the marginal buyer - the buyer who will leave the market first if the price gets any higher. 7  CH : Markets and Welfare – Consumers, Producers, & Market’s Effi ciency The Demand Schedule Buyer Willingness to pay John $100 Example: Paul 80 4 buyers’ WTP for a music George 70 album Ringo 50 Quantity Price Buyers Demanded More than $100 None 0 $81 to $100 John 1 $71 to $80 John, Paul 2 $51 to $70 John, Paul, George 3 $50 or less John, Paul, George, 4 Ringo The table shows the demand schedule for the 8 buyers  CH 6: Markets and Welfare – Consumers, Producers, & Market’s Effi ciency Demand Curve Price of Albums John’s willingness to pay $100 Paul’s willingness to pay 80 George’s willingness to pay 70 Ringo’s willingness to pay 50 Demand 0 1 2 3 4 Quantity of Albums 9  CH 6: Markets and Welfare – Consumers, Producers, & Market’s Effi ciency Using the Demand Curve to Measure Consumer Surplus Demand curve Reflects buyers’ willingness to pay Also measure consumer surplus in a market The area below the demand curve and above the price measures the consumer surplus in a market. 10  CH 6: Markets and Welfare – Consumers, Producers, & Market’s Effi ciency How a Lower Price Raises Consumer Surplus (a) Price = $80 (b) Price = $70 Price of Price of Albums Albums John’s consumer John’s consumer surplus ($30) $100 surplus ($20) $100 Paul’s consumer 80 80 surplus ($10) 70 70 50 50 Total consumer surplus ($40) Demand Demand 0 1 2 3 4 0 1 2 3 4 Quantity of Albums Quantity of Albums In panel (a), the price of the good is $80, and the consumer surplus is $20. In 11 panel (b), the price of the good is $70, and the consumer surplus is $40.  CH : Markets and Welfare – Consumers, Producers, & Market’s Effi ciency How the price affects consumer surplus (b) Consumer surplus at price P2 Price Price (a) Consumer surplus at price P1 A A Additional consumer surplus to initial Initial consumers Consumer consumer surplus C surplus C P1 Consumer surplus P1 to new consumers B B F P2 Demand D E Demand 0 Q1 Quantity 0 Q1 Q2 Quantity In panel (a), the price is P1, the quantity demanded is Q1, and consumer surplus equals the area of the triangle ABC. When the price falls from P1 to P2, as in panel (b), the quantity demanded rises from Q 1 to Q2, and the consumer surplus rises to the area of the triangle ADF. The increase in consumer surplus (area BCFD) occurs in part because existing consumers now pay less (area BCED) and in part because new consumers enter the market at the lower price (area CEF). 12  CH : Markets and Welfare – Consumers, Producers, & Market’s Effi ciency Example – Consumer Surplus Willingness Suppose P = $260 Buyer to pay Dekel $250 Asad’s consumer Fahd 175 surplus = $300 – 260 Asad 300 = $40 Nasi 125 m The others get no CS because they do not buy at this price. 13 CH : Markets and Welfare – Consumers, Producers, & Market’s Effi ciency 14  CH : Markets and Welfare – Consumers, Producers, & Market’s Effi ciency P $350 Asad’s WTP Instead, suppose the $300 Dekel’s WTP price is reduced to $220. $250 P = $220 $200 $150 Asad’s CS = $300 – 220 = $80 $100 $50 Dekel’s CS = $250 – 220 $0 = $30 Q 0 1 2 3 4 Total CS = $110 15  CH : Markets and Welfare – Consumers, Producers, & Market’s Effi ciency Lesson 16  CH : Markets and Welfare – Consumers, Producers, & Market’s Effi ciency Producers Surplus Cost and the willingness to sell Cost is, The value of everything a seller must give up to produce a good. Includes the cost of all resources used to produce goods, including the value of the seller’s time. Producer surplus is, The amount a seller is paid for a good minus the seller’s cost of providing it. PS = WTS - Cost Producer surplus measures the benefit to sellers 17  CH : Markets and Welfare – Consumers, Producers, & Market’s Effi ciency Using the Supply Curve to Measure Producer Surplus Producer surplus, Closely related to the supply curve Supply schedule, Derived from the cost of the suppliers At any quantity, The price given by the supply curve shows the cost of the marginal seller, the seller who would leave the market first if the price were any lower. 18  CH : Markets and Welfare – Consumers, Producers, & Market’s Effi ciency Supply Schedule Example: The Costs of Four Possible Sellers for House Painting Table 1 Seller Cost Mary $900 Frida 800 Georgia 600 Grandma 500 Table 2 Price of House Sellers Quantity Supplied Painting The table $901 or more Mary, Frida, Georgia, 4 shows the $801 to $900 Grandma 3 supply $601 to $800 Frida, Georgia, Grandma 2 schedule for $501 to $600 Georgia, Grandma 1 Less than $500 Grandma 0 19 the sellers None  CH : Markets and Welfare – Consumers, Producers, & Market’s Effi ciency Supply Curve Price of House Supply Painting $900 Mary’s cost 800 Frida’s cost 600 Georgia’s cost 500 Grandma’s cost 0 1 2 3 4 Quantity of Houses Painted 20 The graph shows the corresponding supply curve.  CH : Markets and Welfare – Consumers, Producers, & Market’s Effi ciency Using the supply curve to measure producer surplus Supply curve Reflects sellers’ costs Measure producer surplus in the market Producer surplus in a market is, The area below the price and above the supply curve 21  CH : Markets and Welfare – Consumers, Producers, & Market’s Effi ciency Using the supply curve to measure producer surplus Price of (a) Price = $600 Price of (b) Price = $800 House Supply House Supply Painting Painting Total producer surplus ($500) $900 $900 800 800 600 600 500 Grandma’s producer 500 Georgia’s producer surplus ($100) surplus ($200) Grandma’s producer surplus ($300) 0 1 2 3 4 0 1 2 3 4 Quantity of Houses Painted Quantity of Houses Painted In panel (a), the price of the good is $600, and the producer surplus is $100. In 22 panel (b), the price of the good is $800, and the producer surplus is $500.  CH : Markets and Welfare – Consumers, Producers, & Market’s Effi ciency How the price affects producer surplus (a) Producer surplus at price P1 (b) Producer surplus at price P2 Price Price Supply Additional producer Supply surplus to initial producers D E F P2 Producer surplus B B to new producers P1 P1 C Initial C Producer surplus consumer surplus A A 0 Q1 Quantity 0 Q1 Q2 Quantity In panel (a), the price is P1, the quantity supplied is Q1, and producer surplus equals the area of the triangle ABC. When the price rises from P1 to P2, as in panel (b), the quantity supplied rises from Q 1 to Q2, and the producer surplus rises to the area of the triangle ADF. The increase in producer surplus (area BCFD) occurs in part because existing producers now receive 23 more(area  CH : Markets and Welfare – Consumers, Producers, & Market’s Effi ciency Another Example: Costs of 3 sellers in the lawn-cutting business. Name Cost A seller will produce and sell the Jack $10 good/service only if the Janet 20 price exceeds his or her cost. Chrissy 35 Hence, cost is a 24  CH : Markets and Welfare – Consumers, Producers, & Market’s Effi ciency The Supply Schedule Derive the supply schedule from the cost data: P Qs Name Cost $0 - 9 0 Jack $10 10 - 19 1 Janet 20 20 - 34 2 Chrissy 35 35 & Above 3 25  CH : Markets and Welfare – Consumers, Producers, & Market’s Effi ciency The Supply Schedule and Curve P $40 P Qs $0 – 9 0 $30 10 – 19 1 $20 20 – 34 2 $10 35 & up 3 $0 Q 0 1 2 3 26  CH : Markets and Welfare – Consumers, Producers, & Market’s Effi ciency The Supply Curve P $40 At each Q, Chrissy’s the height of the S curve $30 cost is the cost of the Janet’s marginal seller, $20 cost the seller who would leave $10 Jack’s cost the market if the price were $0 Q any lower. 0 1 2 3 27  CH : Markets and Welfare – Consumers, Producers, & Market’s Effi ciency Producer Surplus & the Supply Curve P PS = P – cost $40 Suppose P = $25. Chrissy’s $30 Jack’s PS = $15 cost Janet’s PS = $5 Janet’s $20 cost Chrissy’s PS = $0 Total PS = $20 $10 Jack’s cost Total Total PS PS equals equals the the area area above above $0 Q the the supply supply curve curve under under the the price, price, 0 1 2 3 from 0 to Q. from 0 to Q. 28  CH : Markets and Welfare – Consumers, Producers, & Market’s Effi ciency Market Efficiency The economic well-being of a society is measured as the sum of consumer surplus and producer surplus Total Surplus = Consumer surplus + Producer surplus Efficiency means: The goods are consumed by the buyers who value them most highly. The goods are produced by the producers with the lowest costs. 29  CH : Markets and Welfare – Consumers, Producers, & Market’s Effi ciency Consumer and Producer Surplus in the Market Equilibirum 30  CH : Markets and Welfare – Consumers, Producers, & Market’s Effi ciency 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 the least cost. Free markets produce the quantity of goods that maximizes the sum of consumer and producer 31  CH : Markets and Welfare – Consumers, Producers, & Market’s Effi ciency Summary Consumer surplus equals buyers’ willingness to pay for a good minus the amount they actually pay, and it 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. Producer surplus equals the amount sellers receive for their goods minus their costs of production, and it measures the benefit sellers get from participating in a market. Producer surplus can be 32  CH : Markets and Welfare – Consumers, Producers, & Market’s Effi ciency Summary An allocation of resources that maximizes the sum of consumer and producer surplus is said to be efficient. Policymakers are often concerned with the efficiency of economic outcomes. The equilibrium of supply and demand maximizes the sum of consumer and producer surplus. That is the marketplace where buyers and sellers allocate resources 33