CONSUMER SURPLUS. Consumers, Producers and the Efficiency of Markets

Transcription

1 In this chapter, look for the answers these questions: What is consumer? How is it related the demand curve? What is producer? How is it related the supply curve? Do markets produce a desirable allocation of resources? Or could the market outcome be improved upon? onsumers, Producers and the Efficiency of Markets Revisiting the Market Equilibrium Do the equilibrium price and quantity maximize the tal 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. onsumers, Producers and the Efficiency of Markets Welfare Economics Welfare economics is the study of how the allocation of resources affects economic well-being. uyers and sellers receive benefits from taking part in the market. The equilibrium in a market maximizes the tal welfare of buyers and sellers. Equilibrium in the market results in maximum benefits, and therefore maximum tal welfare for both the consumers and the producers of the product. onsumer measures economic welfare from the buyer s side. Producer measures economic welfare from the seller s side. ONSUMER SURPLUS Willingness pay is the maximum amount that a buyer will pay for a good. It measures how much the buyer values the good or service. onsumer is the buyer s willingness pay for a good minus the amount the buyer actually pays for it. Table 1: Four Possible uyers Willingness Pay 1

2 WTP and the urve Q: If price of ipod is $2, who will buy an ipod, and what is quantity demanded? name had Flea John WTP nthony $ : nthony & Flea will buy an ipod, had & John will not. Hence, Q d = 2 when P = $2. Using the urve Measure onsumer Surplus The market demand curve depicts the various quantities that buyers would be willing and able purchase at different prices. The Schedule and the urve Figure 1 The Schedule and the urve of lbum $1 John s willingness pay 8 Paul s willingness pay 7 George s willingness pay 5 Ringo s willingness pay of lbums Figure 2 Measuring onsumer Surplus with the urve Figure 2 Measuring onsumer Surplus with the urve of lbum $1 (a) = $8 John s consumer ($2) of lbum $1 (b) = $7 John s consumer ($3) Paul s consumer ($1) 5 5 Total consumer ($4) of lbums of lbums 2

3 Using the urve Measure onsumer Surplus The area below the demand curve and above the price measures the consumer in the market. onsumer is the amount the buyer is willing pay minus the price the buyer actually pays. Figure 3 How the ffects onsumer Surplus onsumer (a) onsumer Surplus at P Figure 3 How the ffects onsumer Surplus Initial consumer (b) onsumer Surplus at P onsumer new consumers What Does onsumer Surplus Measure? onsumer, the amount that buyers are willing 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. P 2 D E dditional consumer initial consumers Q 2 F PRODUER SURPLUS Table 2: The osts of Four Possible Sellers Producer is the amount a seller is paid for a good minus the seller s cost. It measures the benefit sellers participating in a market. 3

4 Using the urve Measure Producer Surplus The Schedule and the urve Just as consumer is related the demand curve, producer is closely related the supply curve. Figure 4 The Schedule and the urve Using the urve Measure Producer Surplus The area below the price and above the supply curve measures the producer in a market. The producer is the actual price received by the seller minus the minimum price the seller is willing accept. Figure 5 Measuring Producer Surplus with the urve (a) = $6 Figure 5 Measuring Producer Surplus with the urve (b) = $8 of House Painting $9 8 of House Painting $9 8 Total producer ($5) 6 5 Grandma s producer ($1) 6 5 Grandma s producer ($3) Georgia s producer ($2) of Houses Painted of Houses Painted 4

5 Figure 6 How the ffects Producer Surplus (a) Producer Surplus at P Figure 6 How the ffects Producer Surplus (b) Producer Surplus at P dditional producer initial producers P 2 D E F Producer Initial producer Producer new producers Q 2 MRKET EFFIIENY onsumer and producer may be used address the following question: Is the allocation of resources determined by free markets in any way desirable? The enevolent Social Planner onsumer Surplus = Value buyers mount paid by buyers Producer Surplus = mount received by sellers ost sellers Total = onsumer + Producer = (value buyers) (amount paid by buyers) + (amount received by sellers) (cost sellers) Total = Value buyers ost sellers The enevolent Social Planner Efficiency is the property of a resource allocation of maximizing the tal received by all members of society. In addition market efficiency, a social planner might also care about equity the fairness of the distribution of well-being among the various buyers and sellers. Efficiency Total = (value buyers) (cost sellers) Efficiency means making the pie as big as possible. In contrast, equity refers whether the pie is divided fairly. What s fair is subjective, harder evaluate. Hence, we focus on efficiency as the goal, even though policymakers in the real world usually care about equity, o. 5

6 Figure 7 onsumer and Producer Surplus in the Market Equilibrium Equilibrium price onsumer Producer E D Equilibrium quantity Evaluating the Market Equilibrium Three Insights oncerning Market Outcomes Free markets allocate the supply of goods the buyers who value them most highly, as measured by their willingness pay. Free markets allocate the demand for goods the sellers who can produce them at least cost. Free markets produce the quantity of goods that maximizes the sum of consumer and producer. Figure 8 The Efficiency of the Equilibrium Value buyers ost sellers ost sellers Value buyers Evaluating the Market Equilibrium ecause 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 (French for allow them do ). Equilibrium quantity Value buyers is greater than cost sellers. Value buyers is less than cost sellers. Why Non-Market llocations re Usually ad Suppose the allocation of resources were instead determined by a central planner (e.g., the ommunist leaders of the former Soviet Union.) To choose an efficient allocation, the planner would need know every seller s cost and every buyer s WTP, for each of the thousands of goods produced in the economy. This is practically impossible, so centrally planned economies are never very efficient. Evaluating the Market Equilibrium Market Power If a market system is not perfectly competitive, market power may result. Market power is the ability influence prices. Market power can cause markets be inefficient because it keeps price and quantity from the equilibrium of supply and demand. 6

7 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 depend on more than just the value the buyers and cost the sellers. When buyers and sellers do not take externalities in account when deciding how much consume and produce, the equilibrium in the market can be inefficient. 7