Ch X Consumer and Producer Surplus 04 24 2014 1 Demand Curve a Think about the demand curve as Willingness to Pay WTP and not simple downward sloping curve b A consumer places a value of a good and is willing to pay that value i Price corresponding to a specific quantity demanded is the highest price consumers are willing to pay 1 Shown by the height of the demand curve c A consumer is willing to pay less for each additional good consumed because of decreasing marginal utility This gives the D curve the negative slope 2 Supply curve a Supply curve is upward sloping because increasing marginal cost leads to higher production costs i Increasing marginal cost is due to diminishing marginal productivity b If each additional unit costs more to produce than the last the firm will only accept a higher price for each additional unit produced c For supply think of willingness to sell at a given price or the lowest price a producer is willing to accept for a unit produced d Price corresponding to a specific quantity supplied is the lowest price producers are willing to accept i Shown by height of supply curve 3 Height of demand vs height of supply curve a Height of demand curve represents highest amount consumers are willing to pay for that specific QD b Height of supply represents the lowest price producers are willing to accept when producing and selling that specific QS 4 Connections between demand and supply 1 a Consumers often pay less than their maximum willingness to pay b Producers often receive a price higher than the minimum price they are willing to receive for goods they produce c Consumer Surplus difference between willingness to pay value and the price actually paid for the good i Graph area below the demand curve and above the price for all units produced ii Math CS WTP Price actually paid d Producer Surplus difference between price the good is sold at and the lowest price the producer would have been willing to sell the good at i Graph area above the supply curve and below the price for all units sold would accept and consumer surplus ii Math PS price good is actually sold at lowest price the firm e Total economic surplus or economic welfare the sum of producer f Efficiency we say market is efficient if economic welfare is maximized 5 Graph Pg 173 Consumer and producer surplus for a price of 10 graph paribus is to E 6 Graph pg 174 CS and PS for a price of 15 7 When price goes up CS decreases and PS increases ceteris 8 Graph pg 175 total economic surplus or welfare Assume price a Welfare W is maxed at P in competitive markets i Any other price lowers welfare 2 b Welfare has policy implications better to max W or CS i efficiency vs equity 9 Deadweight loss a Equilibrium price is the price that will maximize economic welfare where welfare W CS PS b Any other price will not maximize welfare i There will be the creation of a new area on the graph called Deadweight Loss c Deadweight Loss consumer surplus or producer surplus that disappears and is transferred to nobody i If DWL exists the market is not operating efficiently ii This happens with price ceilings and price floors iii Transactions are reduced d Price ceilings and price floors cause some DWL Why i They don t allow price to reach equilibrium ii Causes forgotten surplus iii Due to reduced of transactions e Reduced amount of quantities traded are the driving force for DWL 10 Graphical analysis of DWL created by a price ceiling pg 177 a deadweight loss occurs b c trades from F of trades actually occurring to equilibrium Q are no longer occurring b In terms of CS PS price ceiling will i Increase CS and decrease PS ii CS will increase if K M 3 11 Graphical Analysis of DWL created by a price Floor pg 178 a In terms of CS PS a price floor will i Increase PS decrease CS ii PS will increase if V transfer of CS to PS Z Producer DWL iii of trades here is F 12 Graph reduction in economic surplus caused by price floor ceiling pg 179 a government intervention in competitive markets redistributes surplus between buyers and sellers i but often creates overall losses so why do it 1 Gov policy is often motivated by a desire to help a specific group ex increase incomes of farmers b economists must carefully analyze the effects of such policies to determine the actual effects rather than what is desirable for political reasons 4 Ch 23 Perfect Competition 04 24 2014 1 Market Structure a Market Structure all features of a market that effect the behavior and performance of the firms within the market i of sellers extent of info entry barriers product differentiation b Helps predict i Firm behavior ii Output iii Efficiency iv Price costing margin 2 Market Power market power 3 Perfectly competitive firm a Market power a firm is said to have market power when the firm can influence the price of the product or the terms in which the product is sold i Competitive market each firm will have little or no market power ii Non competitive market an individual firm will have a lot of a Perfect Competition a market structure in which the decisions of individual buyers and sellers have no effect on market price b Perfectly competitive firm a firm that is such a small part of the total industry that it cannot affect the price of the product or service that it sells i Each firm 1 just a drop in the bucket 2 has no market power ii Price taker a competitive firm that must take the price of its product as given because the firm cannot influence its price 1 1 Firm chooses output a Based on market price b Independently from other firms i EX farmer growing corn iii Why is a perfect competitor a price taker 1 Large of buyers sellers 2 Homogenous product corn wheat 3 Everyone has full access to price information 4 No barriers to entry or exit iv Free entry examples 1 Sandwich shop sell crafts photography webpage android apps 2 Does not mean costless entry just means anyone can start a firm in the industry assuming they have the funds v Entry Barriers examples 1 Car manufacturing diamond mining gasoline production 2 Could try to create a firm but wouldn t be successful 3 Cost structure says large firms produce many outputs at low cost so your small and expensive firm wouldn t succeed 4 The demand curve of the perfect competitor a If the perfectly competitive firm is a price taker selling a homogenous commodity with perfect substitutes then i An individual firm faces a perfectly elastic demand at the going market price 1 Will not be able to sell at a higher price 2