Chapter 7 Consumers Producers and the Efficiency of Markets Welfare economics the study of how the allocation of resources affects economic well being You begin by examining the benefits that buyers and sellers receive from taking part in a market You then examine how society can make these benefits as large as possible This analysis leads to a profound conclusion the equilibrium of supply and demand in a market maximizes the total benefits received by buyers and sellers Consumer surplus Each buyer s maximum is called his willingness to pay and it measures how much that buyer values the good The maximum amount that a buyer will pay for a good Each buyer would be eager to buy a product at a price less than his willingness to pay and he would refuse to buy it at a price greater then his willingness to pay At a price equal to his willingness to pay the buyer would be indifferent about buying the good if the price is exactly the same as the value he places on the item he would be equally happy buying it or keeping his money Consumer surplus is the amount a buyer is willing to pay for a good minus the amount the buyer actually pays for it Consumer surplus measures the benefit buyers receive from participating in a market At any quantity the price given by the demand curve shows the willingness to pay of the marginal buyer the buyer who would leave the market first if the price were any higher Finish typing this The area below the demand curve and above the price measures the consumer surplus in a market Consumer surplus measures the benefit that buyers receive from a good as the buyers themselves perceive it Thus consumer surplus is a good measure of economic well being if policymakers want to respect the preferences of buyers Though sometimes policymakers may not choose to care about consumer surplus in cases of buying drugs etc in most markets consumer surplus does reflect economic well being Economists normal assume that buyers are rational when they make decisions And rational people do the best they can to achieve their objectives given their opportunities Economists also assume that people s preferences should be respected In this case consumers are the best judges of how much benefit they receive from the goods they buy Producer Surplus Every seller is willing to take a job if the price they receive exceeds their cost of doing the work The term cost should be interpreted as the painters opportunity cost it includes the painters out of pocket expenses as well as the value that the painters place on their own time Because a painter s cost is the lowest price they will accept for their work cost is a measure of their willingness to sell their services Each painter would be eager to sell their services at a price greater than their cost and would refuse to sell their services at a price less than their cost At a price exactly equal to their cost they would be indifferent about selling their services they would be equally happy getting the job or using their time and energy for another purpose The job goes to the painter who can do the work at the lowest cost Producer Surplus is the amount a seller is paid minus the cost of production Producer surplus measures the benefit sellers receive from participating in a market Just as consumer surplus is closely related to the demand curve producer surplus is closely related to the supply curve 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 The area below the price and above the supply curve measures the producer surplus in a market The height of the supply curve measures seller s costs and the difference between the price and the cost of production is each seller s producer surplus Thus the total area is the sum of the producer surplus of all sellers Market Efficiency Consumer surplus and producer surplus are the basic tools that economists use to study the welfare of buyers and sellers in a market To evaluate market outcomes hypothetical character called the benevolent social planner The benevolent social planner is an all knowing all powerful well intentioned dictator The planner wants to maximize the economic well being of everyone in the society The planner must first decide how to measure the economic well being of a One possible measure is the sum of consumer and producer surplus which Consumer surplus is the benefit that buyers receive from participating in a society market we call total surplus Producer surplus is the benefit that sellers receive Consumer surplus Value to buyers Amount paid by buyers Producer Surplus Amount received by seller Cost to sellers When you add consumer and producer surplus together you get Total Surplus Total Surplus Value to buyers Cost to sellers Total surplus in a market is the total value to buyers of the good as measured by their willingness to pay minus the total cost to sellers of providing those goods Efficiency is when if an allocation of resources maximizes total surplus one would say that the allocation exhibits efficiency If an allocation is not efficient then some of the potential gains from trade among buyers and sellers are not being realized For example an allocation is inefficient if a good is not being produced by the sellers with lowest cost In this case moving production from a high cost producer to a low cost producer will lower the total cost to sellers and raise total surplus Equality whether the various buyers and sellers in the market have a similar level of economic well being In essence the gains from trade in a market are like a pie to be shared among the market participants The question of efficiency concerns whether pie is as big as possible The question of equality concerns how the pie is sliced and how the portions are distributed among members of society Consumer surplus equals the area above the price and under the demand curve and producer surplus equals the area below the price and above the supply curve Thus the total are between the supply and demand curves up to the point of equilibrium represents the total surplus in the market Recall that when a market is in equilibrium the price determines which buyers and sellers participate in the market Those buyers who value the good more than the price choose to buy the good buyers who value it less than the price do not Those sellers whose costs are less than the price choose to produce and sell the good
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