consumers, producers, and the efficiency of markets

Principles of Economics Session V Consumers, Producers, and the Efficiency of Markets Overview What is consumer surplus? How is it related to the demand curve? What is producer surplus? How is it related to the supply curve? Do markets produce a desirable allocation of resources? Or could the market outcome be improved upon? 1 Learning Objectives By the end of this session, students should understand: –the link between buyers’ willingness to pay for a good and the demand curve. –how to define and measure consumer surplus. –the link between sellers’ costs of producing a good and the supply curve. –how to define and measure producer surplus. –that the equilibrium of supply and demand maximizes total surplus in a market. 2 3 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 Part I Willingness to Pay (WTP) and Consumer Surplus Consumers, Producers and the Efficiency of the Market 5 Willingness to Pay (WTP) A buyer’s willingness to pay for a good: the maximum amount the buyer will pay for that good. WTP measures how much the buyer values the good. name WTP John $250 Paul 175 George 300 Ringo 125 Example: 4 buyers’ Willingness-to-Pay for an iPod Source: Mankiw (2011) 6 WTP and the Demand Curve Q: If price of iPod is $200, who will buy an iPod, and what is quantity demanded? A: John & George will buy an iPod, Paul & Ringo will not. Hence, Q d = 2 when P = $200. name WTP John $250 Paul 175 George 300 Ringo 125 7 WTP and the Demand Curve Derive the demand schedule of iPod: 4 George, John, Paul, Ringo 0 – 125 3 George, John, Paul 126 – 175 2 George, John 176 – 250 1 George 251 – 300 0 nobody $301 & up Q d who buys P (price) name WTP John $250 Paul 175 George 300 Ringo 125 8 WTP and the Demand Curve $0 $50 $100 $150 $200 $250 $300 $350 0 1 2 3 4 P Q d $301 & up 0 251 – 300 1 176 – 250 2 126 – 175 3 0 – 125 4 P Q 9 About the Staircase Shape… $0 $50 $100 $150 $200 $250 $300 $350 0 1 2 3 4 P Q [...]... on the initial 10 units Source: Mankiw (2011) 0 5 10 15 20 Q 25 29 Consumers, Producers and the Efficiency of the Market Part III Efficiency of the Market The Market’s Allocation of Resources  Is the market’s allocation of resources desirable? Or would a different allocation of resources make the society better off?  To answer this, we use the total surplus as a measure of society’s well-being  And. .. price 0 5 10 15 20 Q 25 17 Consumers, Producers and the Efficiency of the Market Part II Cost, Supply Curve and Producer Surplus Cost and the Supply Curve  Cost is the value of everything a seller must give up to produce a good (i.e., opportunity cost) – Includes cost of all resources used to produce good, including value of the seller’s time  Example: Costs of 3 sellers in the lawn-cutting business... (value to buyers) – (cost to sellers) 33 Efficiency  An allocation of resources is efficient if it maximizes the total 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 – Raising or lowering the quantity of a good would not increase total surplus 34 Evaluating the Market Equilibrium Market equilibrium:...WTP and the Demand Curve P At any Q, the height of the D curve is the WTP of the marginal buyer George’s WTP $350 $300 John’s WTP $250 $200 Paul’s WTP Ringo’s WTP $150 $100 $50 $0 Q 0 1 2 3 4 10 Consumer Surplus (CS) Consumer surplus : the amount a buyer is willing to pay minus the amount the buyer actually pays: CS = WTP – P name WTP Suppose P =... produce and sell the good/service only if the price exceeds his or her cost Hence, cost is a measure of willingness to sell 20 Cost and the Supply Curve Derive the supply schedule from the cost data: cost P Qs Jack $10 $0 – 9 0 Janet 20 10 – 19 1 Chrissy 35 20 – 34 2 35 & up 3 name 21 Cost and the Supply Curve P $40 P Qs $30 $0 – 9 0 10 – 19 1 20 – 34 2 35 & up 3 $20 $10 $0 Q 0 1 2 3 22 Cost and the Supply... Chrissy’s PS = $0 Total PS = $20 Total PS equals the area above the supply curve under the price, from 0 to Q 25 PS with Lots of Sellers & a Smooth Supply Curve Price per pair P The supply of shoes 60 S 50 40 30 1000s of pairs of shoes 20 10 0 Q 0 5 10 15 20 25 30 26 PS with Lots of Sellers & a Smooth Supply Curve PS = ½ x b x h = ½ x 25 x $25 = $312.50 P The supply of shoes 60 S 50 40 30 h 20 10 0 Q 0 5 10... Supply Curve P $40 Chrissy’s cost $30 At each Q, the height of the S curve is the cost of the marginal seller Janet’s cost $20 $10 Jack’s cost $0 Q 0 1 2 3 23 Producer Surplus P PS = P – cost $40 Producer surplus (PS): the amount a seller is paid for a good minus the seller’s cost $30 $20 $10 $0 Q 0 Source: Mankiw (2011) 1 2 3 24 Producer Surplus and the Supply Curve PS = P – cost P $40 Chrissy’s cost... $250 – 220 = $30 $150 Total CS = $110 $100 $50 $0 Q 0 1 2 3 4 13 CS with Lots of Buyers & a Smooth Demand Curve Price per pair P The demand for shoes $ 60 50 40 30 1000s of pairs of shoes 20 10 D 0 Q 0 5 10 15 20 25 30 14 Source: Mankiw (2011) CS with Lots of Buyers & a Smooth Demand Curve CS = ½ x 15 x $30 = $225 P The demand for shoes $ 60 50 h 40 30 20 10 D 0 Q 0 5 10 15 20 25 30 15 How a Higher... = $260 John $250 George’s CS = $300 – 260 = $40 Paul 175 George 300 Ringo 125 The others get no CS because they do not buy an iPod at this price Total CS = $40 11 CS and the Demand Curve P George’s WTP $350 $300 P = $260 George’s CS = $300 – 260 = $40 $250 $200 Total CS = $40 $150 $100 $50 $0 Q 0 1 2 3 4 12 CS and the Demand Curve P George’s WTP $350 $300 Instead, suppose P = $220 John’s WTP George’s... surplus = CS + PS Is the market equilibrium efficient? P 60 S 50 40 CS 30 PS 20 10 D 0 Q 0 5 10 15 20 25 30 35 Source: Mankiw (2011) Which Buyers Consume the Good? Every buyer whose WTP is ≥ $30 will buy P 60 S 50 Every buyer whose WTP is < $30 will not 40 So, buyers who value the good the most highly are the ones who consume it 10 30 20 D 0 Q 0 5 10 15 20 25 30 36 Which Sellers Produce the Good? Every . understand: the link between buyers’ willingness to pay for a good and the demand curve. –how to define and measure consumer surplus. the link between sellers’ costs of producing a good and the. Surplus Part II Cost, Supply Curve and Producer Surplus Consumers, Producers and the Efficiency of the Market 20 Cost and the Supply Curve Cost is the value of everything a seller must give. $0 $50 $100 $150 $200 $250 $300 $350 0 1 2 3 4 P Q 10 WTP and the Demand Curve At any Q, the height of the D curve is the WTP of the marginal buyer $0 $50 $100 $150 $200 $250 $300 $350 0