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Chapter 5 - Efficiency. In this chapter you will learn: Use willingness to pay and sell to determine supply and demand at a given price, define and calculate surpluses, define and identify efficiency, describe the distribution of benefits that results from a policy decision, define and calculate deadweight loss, explain why correcting a missing market can make everyone better off.
Chapter5 Efficiency â2014byMcGrawHillEducation Whatwillyoulearninthischapter? ã Usewillingnesstopayandselltodetermine supplyanddemandatagivenprice ã Defineandcalculatesurpluses • Define and identify efficiency • Describe the distribution of benefits that results from a policy decision • Define and calculate deadweight loss • Explain why correcting a missing market can make everyone better off © 2014 by McGraw‐Hill Education Willingness to pay and sell • Consumers many times are willing to pay more than the market price – A consumer is willing to purchase a good if the price is below their maximum willingness to pay. • Producers likewise are willing to sell for less than the market price – A producer is willing to sell a good if the price is above their minimum willingness to sell. • Voluntary exchanges create value and can make everyone involved better off © 2014 by McGraw‐Hill Education Willingness to pay and the demand curve Maximum willingness to pay shapes the demand curve Price ($) Price ($) 600 600 500 500 Bird watcher Each step represents a camera bought by the additional buyer who becomes interested at that price 400 400 300 300 Amateur photographer 200 200 Real estate agent Journalist 100 Teacher 100 Demand Potential buyers Five potential buyers’ willingness to pay forms demand curve 10 20 30 40 50 60 Quantity of cameras (millions) Many buyers’ willingness to pay forms demand curve © 2014 by McGraw‐Hill Education Willingness to sell and the supply curve Minimum willingness to sell shapes the supply curve Price ($) Price ($) 600 600 500 400 Each step represents the additional camera sold by a seller who becomes interested as the price increases 300 500 Supply Art teacher Sales rep (small company) Nature photographer 200 Sales rep (big company) 100 400 300 200 100 Collector Potential sellers Five potential sellers’ willingness to sell forms demand curve 10 20 30 40 50 60 70 Quantity of cameras (millions) Manysellerswillingnesstosell formssupplycurve â2014byMcGrawHillEducation Measuringsurplus ã Whenaconsumerbuysagoodbelowthemarket price, this creates value – Known as consumer surplus, a measure of consumers’ benefit from the purchase • When a producer sells a good above the market price, this creates value – Known as producer surplus, a measure of producers’ benefit fromthesale ã Surplus ismeasuredasthedifferencebetween thepriceatwhichatwhichabuyerorseller wouldbewillingtotradeandtheactualprice â2014byMcGrawHillEducation Consumer surplus The consumer surplus can be calculated by summing up individuals’ consumer surplus Price ($) 600 Bird watcher’s surplus 500 Price ($) 600 Total consumer surplus at a price of $160 500 400 400 Amateur photographer’s surplus 300 200 160 300 Real estate agent’s surplus Additional surplus for buyers who would have bought at $160 Consumer surplus for the new buyers 200 100 100 Potential buyers At a price of $160, the consumer surplus equals ($500‐$160) + ($250‐$160) + ($200‐$160) = $470 3 Potential buyers At a price of $100, the consumer surplus equals $470 + $60*3 + $50*1 = $700 © 2014 by McGraw‐Hill Education Active Learning: Calculating consumer surplus Use the following demand schedule to calculate consumer surplus if the market price is $5 Price Quantity 280 260 240 220 200 180 160 140 Consumer Surplus © 2014 by McGraw‐Hill Education Producer surplus The producer surplus can be calculated by summing up individuals’ producer surplus Price ($) 600 Price ($) 600 500 500 400 400 300 200 160 100 300 Collector’s surplus 200 Big-company rep’s surplus 1 Potential sellers At a price of $160, the producer surplus equals ($160‐$50) + ($160‐$5) = $170 © 2014 by McGraw‐Hill Education Surplus lost by collector and bigcompany rep 100 1 Collector’s surplus 50 Potential sellers At a price of $100, the producer surplus equals $110 Active Learning: Calculating producer surplus Use the following supply schedule to calculate producer surplus if the market price is $5 Price Quantity 130 260 390 520 650 780 910 1040 Producer Surplus © 2014 by McGraw‐Hill Education 10 Total surplus Total surplus is the combined benefits that everyone receives from participating in an exchange of goods or services • Price ($) 600 Producer surplus 500 Consumer surplus Total consumer surplus is equal to the area underneath the demand curve and above the equilibrium price CS=ẵ*30M*($500$200)=$4.5B 400 S ã 300 $ 4.5 billion 200 Total producer surplus is equal to the area above the supply curve and below the equilibrium price – PS=½*30M * ($200‐$0) = $3B $ billion 100 • Total surplus = CS + PS D 10 15 20 25 30 35 40 45 50 55 60 65 © 2014 by McGraw‐Hill Education Quantity of cameras (millions) 11 Market equilibrium and efficiency The market equilibrium is the point that maximizes total well‐being (total surplus) of all participants in the market • Price ($) 600 Producer surplus 500 Consumer surplus 400 Prices above market equilibrium reduce total surplus 200 – – S 300 • • • 100 D 10 15 20 25 30 35 40 45 50 55 60 65 Quantity of cameras (millions) © 2014 by McGraw‐Hill Education Suppose the price increases from the equilibrium price of $200 to $300 Reduction in cameras sold by 10 million Reduces consumer surplus Reduces producer surplus Buyers pay a higher price, decreasing consumer surplus from areas 1, 2, & 4 to area 1 Sellers sell at a higher price, increasing producer surplus from areas 3 & 5 to 2 & 3 12 Active Learning: Calculating total surplus Use the following graph to calculate the difference in total surplus if the price increases from $200 to $300 Price ($) 600 500 400 S 300 200 100 D 10 15 20 25 30 35 40 45 50 55 60 65 Quantity of cameras (millions) © 2014 by McGraw‐Hill Education 13 Market equilibrium and efficiency Lowering the price from the market equilibrium price decreases total surplus Suppose the price decreases from the equilibrium price of $200 to $100 Reduction in cameras sold by 15 million • Price ($) Producer surplus 600 • Consumer surplus 500 – Deadweight loss Prices below market equilibrium reduce total surplus 400 – Buyers pay a lower price, changing consumer surplus from areas 1 & 4 to areas 1 & 2 Sellers sell at a lower price, decreasing producer surplus from areas 2, 3 & 5 to area 3 A market is efficient when it is at equilibrium • S 300 200 • 100 • D Reduces consumer and producer surplus Dead weight loss is areas 4 & 5 10 15 20 25 30 35 40 45 50 55 60 65 Quantity of cameras (millions) © 2014 by McGraw‐Hill Education 14 Changing the distribution of total surplus When an artificial price is imposed on a market, surplus is transferred between consumers and producers Price ($) 600 Price ($) 600 500 500 400 400 S 300 S 300 200 4 200 5 100 100 D 10 15 20 25 30 35 40 45 50 Quantity of cameras (millions) When the price is raised above $200, consumer surplus area 2 is transferred to producers © 2014 by McGraw‐Hill Education D 10 15 20 25 30 35 40 45 50 Quantity of cameras (millions) When the price is lowered below $200, producer surplus area 2 is transferred to consumers 15 Deadweight loss When an artificial price is imposed on a market, a deadweight loss occurs Price ($) 600 500 400 Deadweight loss S 300 Transactions that no longer take place at the new price 200 100 The deadweight loss is the loss of total surplus that results when the quantity of a good that is bought and sold is below the market equilibrium quantity • Reduction in cameras sold by 10 million • Reduces consumer and producer surplus • Deadweight loss is the gray triangle D 10 15 20 25 30 35 40 45 50 55 60 65 Quantity of cameras (millions) © 2014 by McGraw‐Hill Education 16 Missing markets • A market is missing when there are people who would like to make exchanges but cannot, for one reason or another, and opportunities for mutual benefit do not occur • This occurs due to: – Public policy – Lackofaccurateinformationorcommunication Lackoftechnologytofacilitateexchange â2014byMcGrawHillEducation 17 Summary ã Theconceptofwillingnesstopayand willingnesstosellareanalyzed Relationshiptodemandandsupply ã Consumerandproducersurplusare introduced ã Totalsurplusismaximizedatthemarket equilibriumpriceandquantity â2014byMcGrawHillEducation 18 ... individuals’ producer surplus Price ($) 600 Price ($) 600 500 500 400 400 300 200 160 100 300 Collector’s surplus 200 Big-company rep’s surplus 1 Potential sellers At a price of $160, the producer surplus equals ($160‐$50) + ($160‐$5) = $170... 60 65 © 2014 by McGraw‐Hill Education Quantity of cameras (millions) 11 Market equilibrium and? ?efficiency The market equilibrium is the point that maximizes total well‐being (total surplus) of all participants in the market... 60 65 Quantity of cameras (millions) © 2014 by McGraw‐Hill Education 13 Market equilibrium and? ?efficiency Lowering the price from the market equilibrium price decreases total surplus Suppose the price decreases from the