Ch07 Consumers, Producers, and The Efficiency of Markets PDF

ECON-UA 2 INTRODUCTION TO MICROECONOMICS CHAPTER 07 HANDOUT
DR. ANDREW PAIZIS - NYU
N. GREGORY MANKIW NINTH EDITION
PRINCIPLES OF
MICRO
ECONOMICS
CHAPTER
Consumers, Producers, and
7 the Efficiency of Markets
Interactive PowerPoint Slides by:
V. Andreea Chiritescu
Eastern Illinois University
© 2021 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 1
IN THIS CHAPTER
• What is consumer surplus? How is it related
to the demand curve?
• What is producer surplus? How is it related

to the supply curve?
• Do markets produce a desirable allocation of

resources? Or could the market outcome be
improved upon?
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
2
1
Welfare Economics
• Allocation of resources refers to:
– How much of each good is produced
– Which producers produce it
– Which consumers consume it
• Welfare economics
– Studies how the allocation of resources affects
economic well-being
• Conclusion: the equilibrium of supply and
demand maximizes the total benefits received by
all buyers and sellers combined.
© 2021 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a 3
Consumer Surplus
• Willingness to pay, WTP
– Maximum amount the buyer will pay for
that good
– How much the buyer values the good
• Consumer surplus, CS = WTP – P
– Amount a buyer is willing to pay minus the
amount the buyer actually pays
– Benefits buyers receive from participating
in a market.
2
EXAMPLE 1A: Willingness to pay

You work at the local store that sells refurbished
iPads. The store is running a sale on the refurbished
iPad mini 3. Each of your roommates wants to buy
an iPad mini 3. Their willingness to pay is given in
the table below.
Name WTP Q: If the sale price is $200, who
will buy an iPad, and what is the
Alexis $250 quantity demanded?
Cameron 175 A: Alexis & Fatima will buy an iPad
Fatima 300 mini. Cameron & Jamir will not.
• Hence, Qd = 2 when P = $200
Jamir 125
5
EXAMPLE 1B: WTP and the demand curve

Derive the
demand P (price
who buys Qd
schedule: of iPad)
$301 & up nobody 0
Name WTP
251 – 300 Fatima 1
Alexis $250
176 – 250 Alexis, Fatima 2
Cameron 175
Cameron, Alexis,
Fatima 300 126 – 175 3
Fatima
Jamir 125 Jamir, Cameron,
0 – 125 4
Alexis, Fatima
6
3
EXAMPLE 1C: The demand curve

P
$350
P Qd
$300
$250 $301 & up 0
$200 251 – 300 1

$150 176 – 250 2
$100
126 – 175 3
$50
0 – 125 4
$0
0 1 2 3 4 Q
© 2021 Cengage Learning . May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
®
7
About the staircase shape…

P This D curve looks like
$350 a staircase with 4
$300 steps – one per buyer.
$250 If there were a huge #
of buyers, as in a
$200
competitive market,
$150 there would be a huge
$100 # of very tiny steps,
and it would look more
$50 like a smooth curve.
$0
0 1 2 3 4 Q
8
4
EXAMPLE 1C: The demand curve

P Fatima’s At any Q, the height of
$350 WTP the D curve is the
$300 Alexis’ WTP WTP of the marginal
$250 buyer, the buyer who
$200 would leave the
$150 Cameron’s market if P were any
WTP
$100 higher.
Jamir’s
$50 WTP
$0
Q
0 1 2 3 4
9
EXAMPLE 1D: Calculating consumer surplus

CS = WTP - P
Suppose P = $260.
Name WTP • Fatima’s CS = $300 – 260
Alexis $250 = $40.
Cameron 175
Fatima 300 • The others get no CS
because they do not buy
Jamir 125 an iPad mini at this price.
• Total CS = $40.
10
5
EXAMPLE 1E: CS and the demand curve

P
$350
Fatima’s P = $260
WTP
$300 Fatima’s CS =
$250 $300 – 260 = $40
$200
$150 Total CS = $40
$100
$50
$0
0 1 2 3 4 Q
®
11
EXAMPLE 1E: A lower price increases CS

P
Fatima’s Suppose P = $220
$350 WTP
$300 Fatima’s CS =
$250 $300 – 220 = $80
$200
Alexis’ Alexis’ CS = $250 –
$150 WTP
220 = $30
$100
$50 Total CS = $110
$0
0 1 2 3 4Q
12
6
Consumer Surplus
• Total consumer surplus
– The area below the demand curve and
above the price
• The height of the demand curve = the value
buyers place on the good (WTP)
• Each buyer’s CS = WTP – P
• The sum of the consumer surplus of all

buyers in the market
EXAMPLE 2: Consumer surplus for one buyer

Price
per unit
P The demand for T-shirts
$ 60
At Q = 5, the
marginal buyer is 50
willing to pay $50 for 40
a T-shirt.
30
20 T-shirts
Suppose P = $30.
10
D
Then his consumer 0 Q
surplus = $20. 0 5 10 15 20 25 30
14
7
EXAMPLE 2A: Total consumer surplus

CS is the area P The demand for T-shirts
between P and the $ 60 P = $30, Qd = 15
D curve, from 0 to Q.
50
Recall: area of h
a triangle equals 40
½ x base x height 30
Height =
20
$60 – 30 = $30.
So, 10
D
CS = ½ x 15 x $30 0 Q
= $225. 0 5 10 15 20 25 30
15
EXAMPLE 2B: A higher price reduces CS

P If P rises to $40,
60 CS = ½ x 10 x $20
1. Fall in CS due
= $100.
to buyers leaving 50
the market Two reasons for
40
the fall in CS.
30
2. Fall in CS due 20
to remaining 10
buyers paying the D
higher P 0 Q
0 5 10 15 20 25 30
16
8
Active Learning 1: Consumer surplus

A. Find marginal P
50
demand curve
buyer’s WTP at $ 45
Q = 10. 40
B. Find CS for P = $30 35
30
Suppose P falls to $20. 25
How much will CS 20
increase due to… 15
C. buyers entering 10
the market 5
D. existing buyers 0
paying lower price 0 5 10 15 20 Q
25
®
17
Active Learning 1: Answers

A. At Q = 10, marginal P
50
demand curve
buyer’s WTP is $30. $ 45
40
B. CS = ½ x 10 x $10
35
= $50
30
P falls to $20. 25
C. CS for the 20
additional buyers 15
= ½ x 10 x $10 = $50 10
D. Increase in CS 5
on initial 10 units 0
= 10 x $10 = $100
0 5 10 15 20 Q
25
18
9
Producer Surplus
• Cost
– Value of everything a seller must give up
to produce a good
• Including opportunity cost
• Willingness to sell, WTS
– The lowest price accepted by a seller for
one unit of a good or service
• The cost is a measure of willingness to sell:
produce and sell the good/service only if the
price > cost
Producer Surplus
• Producer surplus, PS = P - cost
– Amount a seller is paid for a good minus
the seller’s cost of providing it
– Price received minus willingness to sell
– Measures the benefit sellers receive from

participating in a market
10
EXAMPLE 3A: Cost and willingness to sell

You are the lucky owner of 3 properties with
identical lawns that need mowing. There are 3
lawn-mowing business in town that you can hire.
The table below shows their willingness to sell:
Q: Derive the supply schedule
P Qs
from the cost data.
$0 – 9 0
Name cost
10 – 19 1
Jin $10
Jada 20 20 – 34 2
Chris 35 35 & up 3
21
EXAMPLE 3B: The supply curve

P
$40 P Qs
$0 – 9 0
$30
10 – 19 1
$20
20 – 34 2
$10 35 & up 3
$0
Q
0 1 2 3
22
11
EXAMPLE 3B: The supply curve

P At each Q, the
$40 height of the S
Chris’ curve is the cost of
cost the marginal
$30
seller, the seller
Jada’s who would leave
$20 cost
the market if the
price were any
$10 Jin’s cost
lower.
$0 Q
0 1 2 3
23
EXAMPLE 3C: Producer surplus & the S curve

P PS = P – cost
$40 Suppose P = $25.
Chris’
cost Jin’s PS = 25 – 10
$30
= $15
Jada’s
$20 cost Jada’s PS = 25 –
20 = $5
$10 Jin’s cost
Chris’ PS = $0
$0 Total PS = $20
0 1 2 3 Q
24
12
Producer Surplus
• Producer surplus, PS = P - cost
– The area below the price and above the
supply curve
• The height of the supply curve measures
sellers’ costs
• Each seller’s PS = P – cost
• Total area is the sum of the producer surplus

of all sellers
EXAMPLE 4A: Producer surplus for one sellers

Price P The supply of T-shirts
per unit
60
Suppose P = $40. 50 S
40
At Q = 15, the 30
marginal seller’s cost
is $30, and her 20 T-shirts
producer surplus is 10
$10.
0 Q
0 5 10 15 20 25 30
26
13
EXAMPLE 4B: Total producer surplus

PS is the area The supply of T-shirts
P
between P and the
S curve, from 0 to 60
Q. 50 S
The height of this 40
triangle is $40 – 15 30
= $25. h
20
So,
10
PS = ½ x b x h
= ½ x 25 x $25 0 Q
= $312.50 0 5 10 15 20 25 30
27
EXAMPLE 4C: A lower price reduces PS

If P falls to $30, 1. Fall in PS
P
PS = ½ x 15 x $15 60 due to sellers
= $112.50 leaving market
50 S
Two reasons for the
40
fall in PS.
30
2. Fall in PS due to 20
remaining sellers 10
getting lower P
0 Q
0 5 10 15 20 25 30
28
14
Active Learning 2: Producer surplus

A. Find marginal seller’s P
50
supply curve
cost at Q = 10. 45
B. Find total PS for 40
P = $20. 35
Suppose P rises to $30. 30
Find the increase in PS 25
due to: 20
C. selling 5 additional 15
units 10
5
D. getting a higher price
on the initial 10 units 0
0 5 10 15 20 Q
25
29
Active Learning 2: Answers

A. At Q = 10, P
50
supply curve
marginal cost = $20 45
B. PS = ½ x 10 x $20 40
= $100 35
P rises to $30. 30
25
C. PS on
additional units sold 20
= ½ x 5 x $10 = $25 15
10
D. Increase in PS
on initial 10 units 5
= 10 x $10 = $100 0
0 5 10 15 20 Q
25
30
15
The Benevolent Social Planner

• The benevolent social planner
– Hypothetical character: an all-knowing, all-
powerful, well-intentioned dictator
– Wants to maximize the economic well-

being of everyone in society
– Evaluate market outcomes
– Cares about efficiency and equality

The Benevolent Social Planner

• Allocation of resources – desirable?
– Decentralized (in a market economy)
• Determined by interactions of many self-
interested buyers and sellers
– Total surplus – measure of society’s well-

being
• To consider whether the market’s allocation is
efficient
16
Market Efficiency
• Total surplus = CS + PS
– Consumer surplus = Value to buyers –
Amount paid by buyers
• Buyers’ gains from participating in the market
– Producer surplus = Amount received by

sellers – Cost to sellers
• Sellers’ gains from participating in the market
Total surplus = Value to buyers – Cost to sellers

Market Efficiency
• Efficiency
– The allocation of resources maximizes
total surplus
– Is the pie as big as possible?
• Equality
– Distribute economic prosperity uniformly
among the members of society
– Every member of society gets an equal
slice of the pie?
17
Market’s Allocation of Resources

Free Market Outcomes:
1. Allocate the supply of goods to the buyers who
value them most, as measured by their WTP
2. Allocate the demand for goods to the sellers who

can produce them at the lowest cost
3. Produce the quantity of goods that maximizes the

sum of consumer and producer surplus
– Raising or lowering the quantity of a good
would not increase total surplus
EXAMPLE 5: Evaluating the market equilibrium

Market equilibrium: P
P = $30 60
Q = 15
50 S
Total surplus
40
= CS + PS CS
30
PS
20
Is the market
equilibrium 10
D
efficient? 0 Q
0 5 10 15 20 25 30
36
18
EXAMPLE 5A: Which buyers consume the good?

Every buyer whose
P
WTP is ≥ $30 will
buy. 60
50 S
Every buyer whose
WTP is < $30 will not. 40
30
The buyers who
value the good most 20
highly are the ones 10
who consume it. D
0 Q
0 5 10 15 20 25 30
37
EXAMPLE 5B: Which sellers produce the good?

Every seller whose P
cost is ≤ $30 will
60
produce the good.
50 S
Every seller whose 40

cost is > $30 will not. 30
20
The sellers with the
10
lowest cost produce D
the good. 0 Q
0 5 10 15 20 25 30
38
19
EXAMPLE 5C: Does eq’m Q maximize TS?

At Q = 20, cost of
producing the P
marginal unit is $35; 60
the value to 50 S
consumers of the
marginal unit is only 40
$20 30
Hence, can increase 20
total surplus by
10
reducing Q. D
This is true at any Q 0 Q
greater than 15. 0 5 10 15 20 25 30
39
EXAMPLE 5C: Does eq’m Q maximize TS?

At Q = 10, cost of P
producing the
60
marginal unit is $25;
the value to 50 S
consumers of the 40
marginal unit is $40
30
Hence, can increase
total surplus by 20
increasing Q. 10
D
This is true at any Q 0 Q
less than 15. 0 5 10 15 20 25 30
40
20
Market Efficiency & Market Failure

• Forces of supply and demand
– Allocate resources efficiently
• 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
– “Market equilibrium is efficient” may no
longer be true
Market Efficiency & Market Failure

• Market failures
– Market power: a single buyer or seller
(small group) control market prices
• Markets are inefficient
– Externalities: decisions of buyers and

sellers affect people who are not
participants in the market at all
• Inefficient equilibrium - from the standpoint of
society as a whole
21

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ECON-UA 2 INTRODUCTION TO MICROECONOMICS CHAPTER 07 HANDOUT

DR. ANDREW PAIZIS - NYU

N. GREGORY MANKIW NINTH EDITION

• What is producer surplus? How is it related

• Do markets produce a desirable allocation of

EXAMPLE 1A: Willingness to pay

EXAMPLE 1B: WTP and the demand curve

EXAMPLE 1C: The demand curve

$200 251 – 300 1

About the staircase shape…

EXAMPLE 1C: The demand curve

EXAMPLE 1D: Calculating consumer surplus

EXAMPLE 1E: CS and the demand curve

EXAMPLE 1E: A lower price increases CS

• Each buyer’s CS = WTP – P

• The sum of the consumer surplus of all

EXAMPLE 2: Consumer surplus for one buyer

EXAMPLE 2A: Total consumer surplus

EXAMPLE 2B: A higher price reduces CS

Active Learning 1: Consumer surplus

Active Learning 1: Answers

– Price received minus willingness to sell

– Measures the benefit sellers receive from

EXAMPLE 3A: Cost and willingness to sell

EXAMPLE 3B: The supply curve

EXAMPLE 3B: The supply curve

EXAMPLE 3C: Producer surplus & the S curve

• Each seller’s PS = P – cost

• Total area is the sum of the producer surplus

EXAMPLE 4A: Producer surplus for one sellers

EXAMPLE 4B: Total producer surplus

EXAMPLE 4C: A lower price reduces PS

Active Learning 2: Producer surplus

Active Learning 2: Answers

The Benevolent Social Planner

– Wants to maximize the economic well-

– Evaluate market outcomes

– Cares about efficiency and equality

The Benevolent Social Planner

– Total surplus – measure of society’s well-

– Producer surplus = Amount received by

Total surplus = Value to buyers – Cost to sellers

Market’s Allocation of Resources

2. Allocate the demand for goods to the sellers who

3. Produce the quantity of goods that maximizes the

EXAMPLE 5: Evaluating the market equilibrium

EXAMPLE 5A: Which buyers consume the good?

EXAMPLE 5B: Which sellers produce the good?

Every seller whose 40

EXAMPLE 5C: Does eq’m Q maximize TS?

EXAMPLE 5C: Does eq’m Q maximize TS?

Market Efficiency & Market Failure

Market Efficiency & Market Failure

– Externalities: decisions of buyers and

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