Chapter 7 Consumers Producers and the Efficiency of Markets Willingness to Pay each buyer s willingness to pay Willingness to pay the maximum amount the buyer will pay for that good measures how much the buyer values the good Consumer Surplus the amount a buyer is willing to pay for a good minus the amount the buyer actually pays measures the benefit that buyers receive from a good as the buyers themselves perceive it Marginal buyer buyer who would leave the market first if the price were any higher The area below the demand curve and above the price measures the consumer surplus in a market The lower the price the higher the consumer surplus because more people are willing to pay the product and at a higher price than they are willing to pay Lower more buyers higher consumer surplus Producer Surplus Producer Surplus the amount a seller is paid minus the cost of production Cost the value of everything a seller must give up to produce a good A seller s cost is the lowest price he she would accept for his her work therefore a measure of willingness to sell his her services Every seller wants to sell one s service at a price higher than one s cost and refuse to sell at a price lower Eg Marginal Seller the seller who would leave the market first if the price was any lower In this case Mary is the marginal seller The area below the price and above the supply curve measures the producer surplus in a market The higher the price the higher the surplus market and new producer enter the market Producer surplus measure the well being of sellers consumer surplus measures the well being of buyers The benevolent social planner an all knowing all powerful well intentioned dictator Since amount paid by buyers amount received by sellers If a good is not being produced by the sellers with lowest cost an allocation is inefficient An allocation is also inefficient if a good is not being consumed by the buyers who value it most highly When a market is in equilibrium the price determines which buyers and sellers participate in the market Market Outcomes 1 Free markets allocate the supply of goods to the buyers who value them most highly as measured by their willingness to pay 2 Free markets allocate the demand for goods to the sellers who can produce them at the lowest cost 3 Free markets produce the quantity of goods that maximizes the sum of consumer and producer surplus The social planner cannot increase economic well being by changing the allocation of consumption among buyers or the allocation of production among sellers Efficiency is measured by total surplus Since market give us maximum surplus market is efficient