Consumers, Producers, and the

Efficiency of Markets

Chapter 7
 LEARNING OBJECTIVES
By the end of this chapter, you should be able to:
• Define key concepts (welfare economics, willingness to pay,
total expenditure, consumer surplus, total cost, total
revenue, producer surplus, total economic surplus)
• IdenDfy and calculate consumer surplus, producer surplus,
and total surplus, as measured in a demand/supply
diagram
• Use a demand/supply diagram to show the circumstances
when economic efficiency is and is not achieved in a
compeDDve market.
 Welfare Economics
• The study of how the allocaDon of resources affects
economic well-being.
• The study of welfare economics begins by looking at
the benefits buyers and sellers receive from
parDcipaDng in a market.
 Consumer Surplus

• Willingness to pay: The maximum amount that a

buyer will pay for a good.
Four Possible Buyers’ Willingness to Pay

• What benefit does John receive from buying

the Elvis Presley album?
• Consumer surplus: A buyer’s willingness to
pay minus the amount the buyer actually
pays.
The Demand Schedule and the Demand Curve
 Using the the Demand Curve to Measure
Consumer Surplus
• Because the demand curve reflects buyers’
willingness to pay, it can also be used to
measure consumer surplus.
Measuring Consumer Surplus with the
Demand Curve
 Using the the Demand Curve to
Measure Consumer Surplus
• The area below the demand curve and above
the price measures the consumer surplus in a
market.
• The difference between this willingness to pay
and the market price is each buyer’s
consumer surplus.
• How much does buyers’ well-being rise in
response to a lower price?
How the Price Affects Consumer Surplus
 What Consumer Surplus Measures?
• Consumer surplus measures the benefit that buyers
receive from a good as the buyers themselves perceive
it.

• Thus, consumer surplus is a good measure of economic

well-being (if policymakers want to
respect the preferences of buyers).

• In some circumstances, policymakers might choose not

to care about consumer surplus because they do not
respect the preferences that drive buyer behavior.
(Drug addicts)
 Quick Quiz

ü Draw a demand curve for turkey. In your

diagram, show a price of turkey and the
consumer surplus that results from that
price.
ü Explain in words what this consumer
surplus measures.
 AcHve Learning
Consumer Surplus
AcHve Learning
Answers
 PRODUCER SURPLUS
• Let’s consider the benefits that sellers receive
from parDcipaDng in a market.
• Cost: The value of everything a seller must
give up to produce a good (i.e., the producers’
opportunity cost).
• Producer surplus: The amount
a seller is paid for a good minus
the seller’s cost.
The Costs of Four Possible Sellers
The Supply Schedule and the Supply Curve
Measuring Producer Surplus with the Supply Curve
 PRODUCER SURPLUS
• The area above the supply curve and below
the price measures the producer surplus in a
market.
• The logic is straigh\orward: The height of the
supply curve measures sellers’ costs, and the
difference between the price and the cost of
producDon is each seller’s producer surplus.
• How much does sellers’ well-being rise in
response to a higher price?
How the Price Affects Producer Surplus
 Quick Quiz

ü Draw a supply curve for turkey. In your

diagram, show a price of turkey and the
producer surplus
that results from that price.
ü Explain in words what this producer
surplus measures.
 MARKET EFFICIENCY
• Consumer surplus and producer surplus are
the basic tools that economists use to study
the welfare of buyers and sellers in a market.
• If an allocaDon of resources maximizes total
surplus, we say that the allocaDon exhibits
efficiency.
• Efficiency: The property of a resource
allocaDon of maximizing the total surplus
received by all members of society.
Consumer and Producer Surplus in
the Market Equilibrium
 Classroom AcHvity (Value of a Time
Machine)
A new technology has been developed that
allows individuals to travel backward or
forward in Dme. We want to idenDfy the value
this Dme machine provides to consumers. Let’s
assume the four consumers who most desire
this product are in this class.
 Classroom AcHvity (Value of a Time
Machine)
1. A is the consumer who most values this
product. He wants to go back to the
Dme of the dinosaurs. He is willing to
pay $3000.
2. B is the consumer with the next highest
willingness to pay. She would like to see
200 years in the future. She’d pay
$2500.
 Classroom AcHvity (Value of a Time
Machine)
3. C is the next highest bidder. He’d like to
relive this enDre semester. He’ll pay up
to $800.
4. D is our fourth consumer. She’d pay
$200 to move the clock forward to the
end of this class period.
 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 parDcipaDng in a market.
• Consumer surplus can be computed by finding
the area below the demand curve and above
the price.
 Summary
• Producer surplus equals the amount sellers
receive for their goods minus their costs of
producDon.
• Producer surplus measures the benefit sellers
get from parDcipaDng in a market.
• Producer surplus can be computed by finding
the area below the price and above the supply
curve.
 Summary
• The equilibrium of demand and supply
maximizes the sum of consumer and producer
surplus.