Market Equilibrium

D. Bennett
 • the link between buyers’ willingness to
pay for a good and the demand curve
• how to define and measure consumer

We Will surplus
• the link between sellers’ costs of
producing a good and the supply curve

Learn: • how to define and measure producer

surplus
• that the equilibrium of supply and
demand maximizes total surplus in a
market
 • Do the equilibrium price and quantity
maximize the total welfare of buyers and
Revisiting •
sellers?
Market equilibrium reflects the way
the Market markets allocate scarce resources.
Equilibrium • Whether the market allocation is desirable
can be addressed by welfare economics.
 • welfare economics: the study of
how the allocation of resources
affects economic well-being.
Welfare • Buyers and sellers receive benefits from
Economics taking part in the market.
• The equilibrium in a market maximizes the
total welfare of buyers and sellers
 • Equilibrium in the market results in
maximum benefits, and therefore
maximum total welfare for both the
consumers and the producers of the
Welfare product.
•
Economics Consumer surplus measures economic
welfare from the buyer’s side.
• Producer surplus measures economic
welfare from the seller’s side.
 willingness to pay: the maximum
amount that a buyer will pay for
a good.

Consumer It measures how much the buyer

Surplus values the good or service.

consumer surplus: a buyer’s

willingness to pay minus the
amount the buyer actually pays.
Four Possible
Buyers’ •Here we have a set of buyer’s and
the maximum they are willing to
Willingness to pay for a particular good.
Pay
 • The market demand curve depicts the
Consumer various quantities that buyers would be
willing and able to purchase at different
Surplus prices.
The Demand Schedule and the Demand Curve
 The Demand Schedule and
Price of
the Demand Curve
Album

$100 John’s willingness to pay

80 Paul’s willingness to pay

70 George’s willingness to pay

50 Ringo’s willingness to pay

Demand

0 1 2 3 4 Quantity of
Albums
 Measuring Consumer Surplus
with the Demand Curve
(a) Price = $80
Price of
Album

$100
John ’s consumer surplus ($20)

80

70

50

Demand

0 1 2 3 4 Quantity of
Albums
 Measuring Consumer Surplus with the
Demand Curve
(b) Price = $70
Price of
Album
$100

John ’ s consumer surplus ($30)

80
Paul ’s consumer
70 surplus ($10)

Total
50 consumer
surplus ($40)

Demand

0 1 2 3 4 Quantity of
Albums
Using Demand Curve to
Measure Consumer
Surplus

• The area below the demand curve

and above the price measures the
consumer surplus in the market.
 (a) Consumer Surplus at Price P
Price
A

How the
Price Consumer

Affects P1
surplus

Consumer
B C

Surplus
Demand

0 Q1 Quantity
 (b) Consumer Surplus at Price P
Price
A

How the
Price Initial
consumer

Affects P1
B
surplus
C Consumer surplus

Consumer
to new consumers

Surplus P2
D E
F

Additional consumer Demand

surplus to initial
consumers
0 Q1 Q2 Quantity
 • Consumer surplus, the amount that
What Does buyers are willing to pay for a good minus
Consumer the amount they actually pay for it,
measures the benefit that buyers receive
Surplus from a good as the buyers themselves
Measure? perceive it.
Producer Surplus
Producer surplus is the amount a
seller is paid for a good minus the
seller’s cost.

It measures the benefit to sellers

participating in a market.

cost: the value of everything a

seller must give up to produce a
good.
The Cost of
Four
Possible
Sellers
Using
Supply • Just as consumer surplus is related to the
Curve to demand curve, producer surplus is closely
related to the supply curve.
Measure
Producer
Surplus
The Supply Schedule and the Supply Curve
The Supply
Schedule
and the
Supply
Curve
Using
Supply • The area below the price and above the
Curve to supply curve measures the producer surplus
in a market.
Measure
Producer
Surplus
 (a) Price = $600

Price of
House
Painting Supply

Measuring $900
Producer 800

Surplus 600

with the 500

Grandma ’s producer
surplus ($100)
Supply
Curve
0 1 2 3 4
Quantity of
Houses Painted
 Measuring Producer Surplus with the Supply
Curve
(b) Price = $800

Price of
House
Painting Supply
Total
producer
$900 surplus ($500)

800

600 Georgia ’s producer

500 surplus ($200)

Grandma ’s producer
surplus ($300)

0 1 2 3 4
Quantity of
Houses Painted
 As price rises, producer surplus
increases for two reasons:
How a
Higher Those already selling the product will
Price receive additional producer surplus
because they are receiving more for the
Raises product than before
Producer
Surplus
Since the price is now higher, some new
sellers will enter the market and receive
producer surplus on these additional
units of output sold
 (a) Producer Surplus at Price P

Price
Supply

How the
Price
Affects P1
B

Producer Producer
surplus
C

Surplus
A

0 Q1 Quantity
 How the Price Affects Producer Surplus
(b) Producer Surplus at Price P

Price
Additional producer Supply
surplus to initial
producers

D E
P2 F

B
P1
Initial C
Producer surplus
producer to new producers
surplus

0 Q1 Q2 Quantity
 • Consumer surplus and producer surplus may
be used to address the following question:
• Is the allocation of resources determined by free
Market markets in any way desirable?
Consumer Surplus = Value to Buyers – Amount
Efficiency Paid by Buyers
Producer Surplus = Amount Received by Sellers -
Cost to Sellers
 • The economic well-being of everyone in
society can be measured by total surplus
• Total Surplus = Consumer Surplus +
Producer Surplus
• Total Surplus = (Value to Buyers –
Market Amount Paid by Buyers) +
(Amount Received by Sellers – Costs of
Efficiency Sellers)
Because Amount Paid By Buyers =
Amount Received By Sellers,
Total Surplus = Value to Buyers - Costs of
Sellers
 Market Efficiency

EFFICIENCY: THE PROPERTY OF A RESOURCE IN ADDITION TO MARKET EFFICIENCY, A SOCIAL PLANNER

ALLOCATION OF MAXIMIZING THE TOTAL SURPLUS MIGHT ALSO CARE ABOUT EQUITY: THE FAIRNESS OF THE
RECEIVED BY ALL MEMBERS OF SOCIETY DISTRIBUTION OF WELL-BEING AMONG THE MEMBERS
OF SOCIETY.
 Consumer and Producer Surplus
in the Market Equilibrium
Price A

D
Supply

Consumer
surplus

Equilibrium E
price
Producer
surplus

Demand
B

0 Equilibrium Quantity
quantity
 • At the market equilibrium price:
• Buyers who value the product more
than the equilibrium price will purchase
the product. In other words, the free
market allocates the supply of a good
Evaluating to the buyers who value it most highly.
the Market 1. Sellers whose costs are less than the
equilibrium price will produce the
Equilibrium product. In other words, the free
market allocates the demand for goods
to the sellers who can produce it at the
lowest cost.
 • Total surplus is maximized at the market
Evaluating equilibrium
the Market • Free markets produce the quantity of goods that
maximizes the sum of consumer and producer
Equilibrium surplus.
 Price
Supply

Total
surplus is Value
to
buyers
Cost
to
sellers

maximized
at the Cost Value

market to
sellers
to
buyers Demand

equilibrium 0 Equilibrium
quantity
Quantity

Value to buyers is greater Value to buyers is less

than cost to sellers. than cost to sellers.
 • At any quantity of output smaller than
the equilibrium quantity, the value of the
Total product to buyers is greater than the
cost to sellers so total surplus would rise
surplus is if output increases
maximized • At any quantity of output greater than
the equilibrium quantity, the value of the
at the product to buyers is less than the cost to
market sellers so total surplus would rise if
output decreases.
equilibrium
 • Because the equilibrium outcome is an
efficient allocation of resources, the social
Evaluating planner can leave the market outcome as
the Market he/she finds it.
• This policy of leaving well enough alone goes
Equilibrium by the French expression laissez faire.
 • Consumer surplus equals buyers’ willingness
to pay for a good minus the amount they
actually pay for it.
• Consumer surplus measures the benefit
Summary buyers get from participating in a market.
• Consumer surplus can be computed by
finding the area below the demand curve
and above the price.
 • Producer surplus equals the amount sellers
receive for their goods minus their costs of
production.
• Producer surplus measures the benefit
Summary sellers get from participating in a market.
• Producer surplus can be computed by
finding the area below the price and above
the supply curve.
 • An allocation of resources that maximizes
the sum of consumer and producer surplus
is said to be efficient.
Summary • Policymakers are often concerned with the
efficiency, as well as the equity, of economic
outcomes.
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.
• Markets do not allocate resources
efficiently in the presence of
market failures.