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WELCOME TO

FHBM1024
Microeconomics
and
Macroeconomics
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MAIN TEXT
Irvin B. Tucker (2011)
Economics For Todays
World 7th edition
Publisher: Thomson
South Western

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Method of Assessment
Mid

Term Test (Week 8-tentatively)


Group Report (Week 10)
Group Presentation (Week 5 &6 )
Total Coursework
Final Examination
TOTAL

15%
15%
10%
40%
60%
100%

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COURSE MATERIALS
Lecture

Notes
Tutorial Questions
Assignment Question
Unit Plan
Obtain

from WBLE
http://wble.utar.edu.my
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OVERVIEW

1 Consumer and Producer surplus


Topic 2 Consumer Choice Theory
Topic 3 Production and Cost
Topic 4 Market Structure (Part 1): Perfect
Competition
Topic 5 Market Structure (Part 2):
Monopoly
Topic 6 Market Structure (Part 3):
Monopolistic Competition & Oligopoly
Topic

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OVERVIEW Continued..
7 Macroeconomic Problems (Part 2)
Topic 8 Aggregate Demand (AD) and
Aggregate Supply (AS)
Topic 9 Fiscal Policy
Topic 10 Monetary Policy
Topic

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Chapter 1
Consumer and
Producer Surplus

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Learning Objective
Consumer surplus
2. Producer surplus
3. Market efficiency and Deadweight
Loss
4. Price Floors and Ceilings
1.

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1. Consumer Surplus
Measures

the value between the price


consumers are willing to pay for a
product along the demand curve and the
price they actually pay.

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Consumer Surplus
Using

the demand curve to measure


consumer surplus
Consumer surplus

Closely related to the demand curve


Demand schedule
Derived from the willingness to pay of the
possible buyers

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Consumer Surplus
Using

the demand curve to measure


consumer surplus
Demand curve
Reflects buyers willingness to pay
Measure consumer surplus
Consumer

surplus in a market

Area below the demand curve and above the

price
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Example: Consumer Surplus


for Ice Tea

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How the price affects consumer surplus


(b) Consumer surplus at price P2

(a) Consumer surplus at price P1


Price

Price
A

Consumer
surplus

Initial
consumer
surplus

P1

P1

C
new Consumer
surplus

P2
Demand

Q1

Quantity

Demand

Q1

Q2

Quantity

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)
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Consumer Surplus

What does consumer surplus mean?


Consumer surplus
Benefit that buyers receive from a good
As the buyers themselves perceive it
Good measure of economic well-being
Exception: Illegal drugs
Drug addicts
Willing to pay a high price for heroin
Societys standpoint
Drug addicts dont get a large benefit from
being able to buy heroin at a low price
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2. Producer Surplus

Measures

the value between the


actual selling price of a product and
the price along the supply curve at
which sellers are willing to sell the
product.

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Producer Surplus
Using

the supply curve to measure


producer surplus
Producer surplus

Closely related to the supply curve


Supply schedule
Derived from the willingness to sell of the
possible sellers

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Producer Surplus
Using

the supply curve to measure


producer surplus
Supply curve
Reflects sellers willingness to sell.
Measure producer surplus
Producer

surplus in a market

Area below the price and above the supply

curve

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How the price affects producer surplus


Price

(a) Producer surplus at price P1

(b) Producer surplus at price P2

Price

P2
P1

B
Producer
surplus

Supply

New producer
surplus

Supply

P1

D
B
Initial
consumer
surplus

Q1
Q2 Quantity
0
Quantity
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)
0

Q1

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3. Market Efficiency and Deadweight Loss


Efficiency

Property of a resource allocation


Maximizing the total surplus

Received by all members of society

Equality

Property of distributing economic prosperity


Uniformly distributing among the members of

society

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Consumer and producer surplus in the market


equilibrium
Price
Supply

Equilibrium
price

Consumer
surplus

E
Producer
surplus
B
C

Demand

Equilibrium
Quantity
quantity
Total surplusthe sum of consumer and producer surplusis the area
between the supply and demand curves up to the equilibrium quantity
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Market Efficiency
Adam

Smiths invisible hand

Takes all the information about buyers and

sellers into account


Guides everyone in the market to the best
outcome
Economic efficiency
Free

markets = best way to organize


economic activity

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Adam Smith and the Invisible Hand


Passages from The Wealth of Nations, 1776
Man has almost constant occasion
for the help of his brethren, and it is
vain for him to expect it from their
benevolence only. He will be more
likely to prevail if he can interest their
self-love in his favor, and show them
that it is for their own advantage to do
for him what he requires of them
It is not from the benevolence of the
butcher, the brewer, or the baker that
we expect our dinner, but from their
regard to their own interest.

Adam Smith
(1723 - 1790)
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Adam Smith and the Invisible Hand


Passages from The Wealth of Nations, 1776
Every individualneither intends to
promote the public interest, nor knows
how much he is promoting it.
He intends only his own gain, and he is
in this, as in many other cases, led by
to promote an end
which was no part of his intention.
Nor is it always the worse for the society
that it was no part of it. By pursuing his
own interest he frequently promotes
that of the society more effectually than
when he really intends to promote it.

Adam Smith
(1723 - 1790)
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Market Efficiency & Market Failure


Forces

of supply and demand allocate


resources efficiently
Several assumptions about how markets

work
1. Markets are perfectly competitive
2. Outcome in a market matters only to the
buyers and sellers in that market
When these assumptions do not hold
Our conclusion that the market equilibrium
is efficient may no longer be true
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Market Efficiency & Market Failure


In

the world

Competition - far from perfect

Market power
A single buyer or seller (small group)
Control market prices
Markets are inefficient
Keeps the price and quantity away
from the equilibrium of supply and
demand
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Market Efficiency & Market Failure


In

the world

Decisions of buyers and sellers

Affect people who are not participants in the


market at all
Externalities
Cause welfare in a market to depend on
more than just the value to the buyers and
the cost to the sellers
Inefficient equilibrium
From the standpoint of society as a whole
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Market Efficiency & Market Failure


Market

failure

E.g.: market power and externalities


The inability of some unregulated markets to

allocate resources efficiently


Public policy
Can potentially remedy the problem
Increase economic efficiency

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Deadweight Loss
Deadweight loss is the reduction in
economic surplus resulting from a
market not being in competitive
equilibrium.
The net loss of both consumer &
producer surplus resulting from
underproduction or overproduction of
a product.

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Deadweight Loss

FIGURE
4-7 Is Not in Equilibrium, There Is a Deadweight Loss
When
a Market
Economic surplus is maximized when a market is in competitive equilibrium. When a
market is not in equilibrium, there is a deadweight loss.
When the price of Thai tea is $2.20, instead of $2.00, consumer surplus declines from an
amount equal to the sum of areas A, B, and C to just area A. Producer surplus increases
from the sum of areas D and E to the sum of areas B and D. At competitive equilibrium,
there is no deadweight loss. At a price of $2.20, there is a deadweight loss equal to the
sum of areas C and E.

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4. Price Ceilings & Price Floors

A price ceiling is a legal maximum on the price of a good.


An example is rent control. If the price ceiling is below the
equilibrium price, it is binding and causes a shortage.

A price floor is a legal minimum on the price of a good. An


example is the minimum wage. If the price floor is above the
equilibrium price, it is binding and causes a surplus. The
labor surplus caused by the minimum wage is
unemployment.

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Price Ceiling
Price

Supply
Equilibrium
price
$3
Price
ceiling

Shortage

Demand
0

75
Quantity
supplied

125
Quantity
demanded

Quantity
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Price Floor
Price

Supply
Price
Floor

4
$3
Equilibrium
price

Demand
0

100
Equilibrium Quantity

Quantity
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Example of Price Floors: Government Policy in


Agricultural Markets
The Economic Effect of a Price
Floor in the Wheat Market
If wheat farmers convince the government
to impose a price floor of $3.50 per bushel,
the amount of wheat sold will fall from 2.0
billion bushels per year to 1.8 billion.
If we assume that farmers produce 1.8
billion bushels, producer surplus then
increases by the red rectangle Awhich is
transferred from consumer surplusand
falls by the yellow triangle C.
Consumer surplus declines by the red
rectangle A plus the yellow triangle B.
There is a deadweight loss equal to the
yellow triangles B and C, representing the
decline in economic efficiency due to the
price floor. In reality, a price floor of $3.50
per bushel will cause farmers to expand
their production from 2.0 billion to 2.2 billion
bushels, resulting in a surplus of wheat.

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Example of Price Floors in Labor Markets:


The Debate over Minimum Wage Policy

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Example Price Ceilings: Government Rent


Control Policy in Housing Markets
The Economic Effect of a Rent Ceiling
Without rent control, the equilibrium rent
is $1,500 per month. At that price,
2,000,000 apartments would be rented.
If the government imposes a rent ceiling
of $1,000, the quantity of apartments
supplied falls to 1,900,000,
and the quantity of apartments
demanded increases to 2,100,000,
resulting in a shortage of 200,000
apartments.
Producer surplus equal to the area of the
blue rectangle A is transferred from
landlords to renters, and there is a
deadweight loss equal to the areas of
yellow triangles B and C.

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Summary
Consumer

surplus equals buyers


willingness to pay for a good minus the
amount they actually pay for it.
Consumer surplus measures the benefit
buyers get from participating in a market.
Consumer surplus can be computed by
finding the area below the demand curve
and above the price.
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Summary
Producer

surplus equals the amount


sellers receive for their goods minus their
costs of production.
Producer surplus measures the benefit
sellers get from participating in a market.
Producer surplus can be computed by
finding the area below the price and above
the supply curve.
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Summary
The

equilibrium of demand and supply


maximizes the sum of consumer and
producer surplus.
This is as if the invisible hand of the
marketplace leads buyers and sellers to
allocate resources efficiently.
Deadweight loss is the reduction in
economic surplus resulting from a market
not being in competitive equilibrium.
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Summary

A price ceiling is a legal maximum on the price of a


good. An example is rent control. If the price
ceiling is below the equilibrium price, it is binding
and causes a shortage.

A price floor is a legal minimum on the price of a


good. An example is the minimum wage. If the
price floor is above the equilibrium price, it is
binding and causes a surplus. The labor surplus
caused by the minimum wage is unemployment.
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