Chapter 7 Consumers Producers and the Efficiency of Markets Welfare economics the study of how the allocation of resources affects economic well being examining the benefits that buyers and sellers receive from market transactions 7 1 Consumer Surplus Willingness to pay each buyer s maximum price he would pay o Consumer surplus amount a buyer is willing to pay for a good amount he actually pays o Calculate total consumer surplus from adding all the buyers consumer surpluses in the market for that good Use demand curve to measure consumer surplus o Evaluate the demand schedule quantity demanded at certain prices based off of willingness to pay o At any quantity on the demand curve the price given by the curve shows the willingness to pay of the marginal buyer the buyer who would leave the market first if the price were higher o Calculate consumer surplus by finding the area above the price and below the demand curve In a market with many buyers the steps from each buyer dropping out makes a smooth curve o When price drops then consumer surplus becomes 3 parts initial consumer surplus triangle rectangle of additional consumer surplus to initial consumers who are now paying less and the triangle of consumer surplus to new customers who are now willing to buy the good at the lower price o Consumer surplus is a good measure of economic well being 7 2 Producer Surplus expenses value of time Cost value of everything a seller must give up to produce a good seller s total opportunity cost o This is the lowest price a seller would sell his goods services willingness to sell services o Producer surplus amount a seller is paid cost of production Measures the benefit sellers receive from participating in a market Using supply curve to measure producer surplus o Height of supply curve is related to sellers costs o At any quantity price given by supply curve shows the cost of the marginal seller seller who would leave the market first if price were any lower o Area below the price and above the supply curve measures the producer surplus in a market When price of a good sold increases you have the triangle of the initial producer surplus the rectangle of the additional producer surplus to initial producers who are getting more for what they sell and the producer surplus to new producers who are willing to produce the good at the higher price o With an increase in price there is an increase in quantity supplied and increase in producer surplus 7 3 Market Efficiency One way to measure economic well being of a society is by looking at total surplus o Total surplus consumer surplus producer surplus o Total surplus value to buyers cost to sellers o If allocation of resources maximizes total surplus we say allocation exhibits efficiency Efficiency looks at making the pie as big as possible If not then some of potential gains from trade among buyers and sellers are not being realized Ex good is not being produced by sellers with lowest cost Moving production from a high cost producer to a low cost producer will lower total cost to sellers and increase total surplus Ex allocation is inefficient if a good is not being consumed by the buyers who value it highly Moving consumption of a good from a buyer with low valuation to high valuation will raise total surplus having a higher WTP eventually selling at higher cost o Equality whether buyers and sellers in the market have a similar level of economic well being Looking at how equally the pie is shared and distributed among people Some benefits would come from equally sharing the gains from trade Evaluating market equilibrium o Free markets allocate the supply of goods to buyers who value them most highly when looking at WTP surplus o Free markets allocate the demand for goods to the sellers who can produce them at the lowest cost o Free markets produce the quantity of goods that maximizes the sum of consumer and producer Ex at a quantity below the equilibrium level value to the marginal buyer exceed cost to marginal seller increase the quantity produced to raise total surplus At a quantity higher than equilibrium level cost to sellers is higher than value to marginal buyer decrease the quantity to raise total surplus o Leaving the free market alone is fine because it will naturally go towards the market equilibrium equilibrium outcome efficient allocation of resources A central planner who would try to allocate resources efficiently and maximize total surplus would have a lot of trouble because he would have to know every seller s cost and buyer s WTP This chapter was based on the concepts that markets are perfectly competitive despite the fact that there are influences like market power that can change the price and other externalities that may lead to market failure