Chapter 7: Consumers, Producers, and the Efficiency of Markets Principles of Economics, 5th Edition N Gregory Mankiw Page 1 Introduction a So far, our analysis has been positive (what is) rather than normative (what should be) b In this chapter, we take up welfare economics, which is the study of how the allocation of resources affects economic well being P 137 c Mankiw continues to argue that markets are usually a good way to organize economic activity Consumer Surplus Measures the Benefit to Buyers of Participating in the Market a Def: Willingness to pay is the maximum amount that a buyer will pay for a good P 138 i Table 1: Four Possible Buyers’ Willingness to Pay P 138 ii Def: Consumer surplus is a buyer’s willingness to pay minus the amount the buyer actually pays P 139 b Using The Demand Curve To Measure Consumer Surplus i The area below the demand curve and above the price measures the consumer surplus in a market ii Figure 1: The Demand Schedule and the Demand Curve P 140 iii Figure 2: Measuring Consumer Surplus with the Demand Curve P 141 c How A Lower Price Raises Consumer Surplus i Existing consumers and ii New Consumers d What Does Consumer Surplus Measure? i Consumer surplus, the amount that buyers are willing to pay for a good minus the amount that they actually pay for it, measures the benefit that buyers receive from a good as the buyers themselves perceive it ii Figure 3: How the Price Affects Consumer Surplus P 142 Producer Surplus Measures the Benefit to Sellers of Participating in the Market a Cost And The Willingness To Sell i Def: Cost is the value of everything a seller must give up to produce a good P 143 ii Def: Producer surplus: the amount a seller is paid for a good minus the seller’s (incremental) cost of providing it P 144 iii Table 2: The Costs of Four Possible Sellers P 143 b Using The Supply Curve To Measure Producer Surplus i The area below the price and above the supply curve measures the producer surplus in a market (1) Producer surplus only considers incremental costs, so is not Chapter 7: Consumers, Producers, and the Efficiency of Markets Principles of Economics, 5th Edition N Gregory Mankiw Page c the same thing as profit that has to also take into consideration fixed costs (2) However, if the advantage of the lower cost firms can be bought and sold (good managers or fertile land) then the value of that will be bid up and the producer surplus will disappear ii Figure 4: The Supply Schedule and the Supply Curve P 144 iii Figure 5: Measuring Producer Surplus with the Supply Curve P 145 How A Higher Price Raises Producer Surplus i Existing suppliers and ii New suppliers iii Figure 6: How the Price Affects Producer Surplus P 146 Market Efficiency a CS and PS are the basic tools that economists use to study the welfare of buyers and sellers in a market b The Benevolent Social Planner i Def: Efficiency is the property of a resource allocation of maximizing the total surplus received by all members of society P 147 ii Def: Equity is the fairness of the distribution of well being among the members of society P 148 iii Efficiency is easier to evaluate than equity c Evaluating The Market Equilibrium i Three insights about market outcomes: (1) Markets allocate the supply of goods to the buyers who value them the most (2) Markets allocate output to the lowest cost producers (3) Markets produce the quantity of goods that maximizes the sum of consumer and producer surplus ii Figure 7: Consumer and Producer Surplus in the Market P 148 iii Figure 8: The Efficiency of the Equilibrium Quantity P 149 iv Case Study: Should There be a Market in Organs? P 150 (1) Many economists believe that there would be large benefits to allowing a free market in organs v In the News: Ticket Scalping, P 151 vi In the News: The Miracle of the Market P 153 (1) This is an important article as it points out all the invisible activities that have to occur to make a Thanksgiving dinner Chapter 7: Consumers, Producers, and the Efficiency of Markets Principles of Economics, 5th Edition N Gregory Mankiw Page possible Conclusion: Market Efficiency And Market Failure a To conclude that markets are efficient, we made several assumptions about how markets work: i they are competitive and ii there are no external effects b Market failure exists with i Market power and ii Externalities Summary