Post on 22-Dec-2015
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Consumer Surplus
Welfare EconomicsHow the allocation of resources affects economic
well-being
Willingness to PayHow much are you willing to pay to acquire a good?
If you pay less than the amount you were willing to pay – you have a surplus.
The same principle applies in an auction market.
Consumer Surplus
Lower prices lead to consumer surpluses; e.g. Wal-Mart "Always low prices…"Consumer surplus as a measure of "well being"
Economic rationality: Seeking to maximize the surplus
$100
8070
50
Price ofAlbums
The Demand Curve
4
The graph shows the corresponding demand curve. Note that the height of the demand curve reflects buyers’ willingness to pay
0 431 2Quantity of Albums
John’s willingness to pay
Paul’s willingness to pay
George’s willingness to pay
Ringo’s willingness to pay
Demand
$100
8070
50
Price ofAlbums
Measuring Consumer Surplus
5
In panel (a), the price of the good is $80, and the consumer surplus is $20. In panel (b), the price of the good is $70, and the consumer surplus is $40.
0 431 2Quantity of Albums
John’s consumersurplus ($20)
Demand
(a) Price = $80
$100
8070
50
Price ofAlbums
0 431 2Quantity of Albums
John’s consumersurplus ($30)
(b) Price = $70
Paul’s consumersurplus ($10)
Total consumersurplus ($40)
Demand
Price and Consumer Surplus
6
Price
In panel (a), the price is P1, the quantity demanded is Q1, and consumer surplus equals the area of the triangle ABC. When the price falls from P1 to P2, as in panel (b), the quantity demanded rises from Q1 to Q2, and the consumer surplus rises to the area of the triangle ADF. The increase in consumer surplus (area BCFD) occurs in part because existing consumers now pay less (area BCED) and in part because new consumers enter the market at the lower price (area CEF).
0 Quantity
(a) Consumer surplus at price P1 (b) Consumer surplus at price P2
Demand
P1
Q1
Consumersurplus
B
C
A
Price
0 Quantity
Demand
P1
Q1
Initialconsumer
surplus
A
P2
Q2
B
D
C
E
F
Additional consumer surplus to initial
consumers
Consumer surplusto new consumers
Producer Surplus
Willingness to SellCovering your costs is Job #1.
Producer Surplus = Amount Received – Costs
Measuring Producer SurplusHigher prices – increase producer surplus
Surplus = Sell Price minus Cost to Produce
The Supply Curve
8
$900
800
600500
Price ofHouse
Painting
The graph shows the corresponding supply curve. Note that the height of the supply curve reflects sellers’ costs.
0 431 2Quantity of Houses Painted
Mary’s cost
Frida’s cost
Georgia’s cost
Grandma’s cost
Supply
$900
800
600500
Price ofHouse
Painting
Measuring Producer Surplus
9
$900
800
600500
Price ofHouse
Painting
In panel (a), the price of the good is $600, and the producer surplus is $100. In panel (b), the price of the good is $800, and the producer surplus is $500.
0 431 2Quantity of Houses Painted
Grandma’s producersurplus ($100)
Supply
(a) Price = $600 (b) Price = $800
Supply
Grandma’s producersurplus ($300)
Georgia’s producersurplus ($200)
Total producersurplus ($500)
0 431 2Quantity of Houses Painted
Price and Producer Surplus
10
Price
In panel (a), the price is P1, the quantity supplied is Q1, and producer surplus equals the area of the triangle ABC. When the price rises from P1 to P2, as in panel (b), the quantity supplied rises from Q1 to Q2, and the producer surplus rises to the area of the triangle ADF. The increase in producer surplus (area BCFD) occurs in part because existing producers now receive more(area BCED) and in part because new producers enter the market at the higher price (area CEF).
0 Quantity
(a) Producer surplus at price P1 (b) Producer surplus at price P2
Supply
P1
Q1
Producersurplus
B
C
A
Price
0 Quantity
Supply
P1
Q1
Initialconsumer
surplus
A
P2
Q2
B
D
C
E F
Additional producer surplus to initial
producers
Producer surplusto new producers
Market Efficiency
Three DefinitionsConsumer Surplus = Value Received – Amount Paid
Producer Surplus = Amount Received – Cost to seller
Total Surplus = C.S. + P.S.
When T.S. maximizes, markets are efficient.A market in equilibrium maximizes T.S. (See Figure 7)
Problem of Equity arises if surpluses are not evenly distributed
Market Efficiency
Allocation of Resources in Fee MarketsAllocate supply of goods to buyers that value them most
highly.
Allocate demand for goods to sellers than produce at the least cost.
Free markets produce the quantity of goods that maximizes CS and PS.
Supply and Demand Curves as measures of ValueSupply Curve represents value to producers.
Demand curve represents value to consumers
Market Efficiency
Importance of Equilibrium to ValueAt quantities below equilibrium, consumer value is
greater than producer cost.
At quantities above equilibrium, cost to sellers is greater than value to buyers.
Market Efficiency And Market Failure
Market Efficiency assumes perfectly competitive markets.
Market Efficiency reduced if P or C has market power – ability to influence price.
Impact of ExternalitiesSide effects that impair total welfare; e.g. pollution
Failure to monitor and protect property rights; e.g. patents and copyrights
Market Failure = when resources inefficiently allocated