Ch07.Consumers, Producers, and The Efficiency of Markets

Chapter 7
Consumers, Producers and

the Efficiency of Markets
© 2002 by Nelson, a division of Thomson Canada Limited
Principles of Microeconomics & Principles of Macroeconomics: Ch.7 Second Canadian Edition

Overview
 Welfare Economics
 Consumer Surplus
 Producer Surplus
 Market Efficiency

Market Equilibrium Revisited
Does the equilibrium price and quantity result in
the maximum total welfare of buyer and seller?
S
PE
QE
Market Equilibrium Revisited
Does the equilibrium price and quantity result in
the maximum total welfare of buyer and seller?
Market equilibrium illustrates the way

markets allocate scarce resources.
But does it answer whether that market
allocation is desirable?
Turn to Welfare Economics to answer
the question.
Welfare Economics
Is the study of how the allocation of
resources affects economic well being.
– Buyers and sellers receive benefits from
taking part in the market.
– The equilibrium in a market makes the
sum of these benefits as large as
possible.

Welfare Economics
 Equilibrium in the market results in
maximum benefits, and therefore total
welfare for both the buyer and the seller.
 Welfare Economics from the Buyer Side
and the Seller Side:
– Consumer Surplus
– Producer Surplus

Overview
 Welfare Economics
 Consumer Surplus

Welfare Economics: Consumer Surplus
Market Demand Curve: depicts the
various quantities that buyers would
want to purchase at different prices.
What determines how much a
consumer would be willing to pay (the
maximum price) for a good or service?
– Answer: The expected benefits received
or Utility.

Utility is...
… the satisfaction
(benefit) that a
consumer expects to
receive from
consuming a good or
service.
…the power to satisfy
a want.

Marginal Utility (MU) is...
…the amount of utility (satisfaction)
that one more or one less unit of
consumption adds to or subtracts from
total utility.
– Consumers try to obtain the largest
possible total satisfaction (utility) from
the mix of goods and services they buy
with their incomes.

Consumer Surplus is...
…the maximum amount a consumer
will be willing to pay for a good
depends upon the expected utility
(benefits) of that good.
– Willingness to Pay:
The maximum price that a buyer is willing
and able to pay for a good.
Measures how much the buyer values the
good or service.

Consumer Surplus: Verbal Definition
P
 The amount a buyer
is willing to pay for a
good minus the
amount the buyer
actually pays for it.
Q
Consumer Surplus: Graphical
Pmax S
Q
Pmax S
PE
QE
Pmax S
PE
QE
Pmax S
Consumer
PE Surplus
QE
Consumer Surplus and Market Price
Thearea below the demand curve and

above the market price measures the
consumer surplus in a market. Hence,
– A lower market price will increase
consumer surplus
– A higher market price will reduce
consumer surplus

Consumer Surplus: Mathematically
Maximum Price = $11
Market Price = $6
Quantity Purchased = 6
Assume: Price drops $1 for every
additional unit sold.
Consumer Surplus = $15
$51 - $36 = $15
($11+$10+$9+$8+$7+$6) - ($6 x 6) = $15
$11
$10
$9
$8
$7
Market $6
Price
D
1 2 3 4 5 6
Quantity Purchased
P
$11
$10
Total Consumer
$9 Benefits
$8
$7
$6
D
1 2 3 4 5 6 Q
P
$11
$10
$9
$8
$7 Consumer’s
Expense
$6
D
1 2 3 4 5 6 Q
P
$11 Consumer Benefit
-Consumer Expense
$10
CONSUMER SURPLUS!
$9
$8
$51 - $36 =
$7 $15
$6
D
1 2 3 4 5 6 Q
Quick Quiz
 Illustrate,
with a demand
curve, the consumer
surplus for turkey.
 Explain in words what
consumer surplus
measures.
 Discuss changes in
consumer surplus as price
changes.

Overview
 Consumer Surplus

Producer Surplus
Market Supply Revisited:
– Depicts the various quantities that
suppliers would be willing to sell at
different prices.
– May be viewed as a measure of supplier
costs, i.e.. the opportunity cost to the
seller of supplying various quantities of
the good.

Producer Surplus
Market Supply: The marginal
opportunity cost of production
increases as market output expands.
Because the producer’s cost is the
lowest price he/she would accept it
may be considered a measure of
his/her willingness to sell.

Producer Surplus: Verbal Definition
P
 The amount a seller is S
paid minus the cost
of production.
 Producer surplus
measures the benefit
to sellers of
participating in a
market.
Q
Producer Surplus: Graphical
S
PE
QE
S
PE
QE
S
PE
Producer
Surplus
QE
Producer Surplus: Mathematically
Minimum Price = $1
Quantity Sold = 6
Assume: Price increases $1 for every
Producer Surplus = $15
$36 - $21 = $15
($6 x 6) - ($1 +$2 + $3 + $4 + $5 + $6) = $15
Producer Surplus: Mathematically
Minimum Price = $1
Quantity Sold = 6
Assume: Price increases $1 for every
Producer Surplus = $15
$36 - $21 = $15
($6 x 6) - ($1 +$2 + $3 + $4 + $5 + $6) = $15
P S
$6
$5
$4
$3
$2
$1
1 2 3 4 5 6 Q
P Total Producer S
Benefits
$6
$5
$4
$3
$2
$1
1 2 3 4 5 6 Q
P Producer S
Surplus =$15
$6
$5
$4 Producer
$3 Costs
$2
$1
1 2 3 4 5 6 Q
Overview
 Producer Surplus

Market Efficiency
Under the assumptions of perfect
competition and no externalities, the
economic well-being of a society is
measured as the sum of consumer
surplus and producer surplus.
Market Efficiency is attained when total
surplus is maximized, a point where
resource allocation is efficient.

Market Efficiency
S
PE
Q
Market Efficiency
Consumer S
Surplus
PE
Producer
Surplus D
Q
Market Efficiency: Three observations
Free markets allocate the supply of
goods to the buyers who value them
most highly.
Free markets allocate the demand for
goods to the sellers who can produce
them at least cost.
Free markets produce the quantity of
goods that maximizes the sum of
consumer and producer surplus.

Market Efficiency: Invisible Hand
 Ina free market system the many buyers
and sellers are interested in their own
well-being, self-interest.
 As market participants are motivated by
self-interest a process of coordination
and communication takes place so that
buyers and sellers are directed to the
most efficient outcome.
 As if by an Invisible Hand, the free
market system reaches efficiency.

Quick Quiz
 Draw the supply and
demand for turkey.
 In the equilibrium,
show the producer
and consumer
surplus.
 Explain why
producing more turkey
will lower total
surplus.

Market Failure
If a market system is not one of perfect
competition, control over prices leads
to Market Power.
– The ability by one buyer or seller to
control market price.
Market Power causes markets to be
inefficient, and thus fail.

Market Failure
If a market system affects individuals
other than buyers and sellers of that
market, side-effects are created and
called Externalities.
– Benefits or costs imposed on a third
party who is not the consumer or the
producer.
Externalities cause markets to be
inefficient, and thus fail.
Overview
 Producer Surplus
 Market Efficiency

Ch07.Consumers, Producers, and The Efficiency of Markets

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Ch07.Consumers, Producers, and The Efficiency of Markets

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Chapter 7

Consumers, Producers and

© 2002 by Nelson, a division of Thomson Canada Limited

Principles of Microeconomics & Principles of Macroeconomics: Ch.7 Second Canadian Edition

Principles of Microeconomics & Principles of Macroeconomics: Ch.7 Second Canadian Edition

Market equilibrium illustrates the way

Principles of Microeconomics & Principles of Macroeconomics: Ch.7 Second Canadian Edition

Principles of Microeconomics & Principles of Macroeconomics: Ch.7 Second Canadian Edition

Principles of Microeconomics & Principles of Macroeconomics: Ch.7 Second Canadian Edition

Principles of Microeconomics & Principles of Macroeconomics: Ch.7 Second Canadian Edition

Principles of Microeconomics & Principles of Macroeconomics: Ch.7 Second Canadian Edition

Principles of Microeconomics & Principles of Macroeconomics: Ch.7 Second Canadian Edition

Principles of Microeconomics & Principles of Macroeconomics: Ch.7 Second Canadian Edition

Thearea below the demand curve and

Principles of Microeconomics & Principles of Macroeconomics: Ch.7 Second Canadian Edition

Principles of Microeconomics & Principles of Macroeconomics: Ch.7 Second Canadian Edition

Principles of Microeconomics & Principles of Macroeconomics: Ch.7 Second Canadian Edition

Principles of Microeconomics & Principles of Macroeconomics: Ch.7 Second Canadian Edition

Principles of Microeconomics & Principles of Macroeconomics: Ch.7 Second Canadian Edition

Principles of Microeconomics & Principles of Macroeconomics: Ch.7 Second Canadian Edition

Principles of Microeconomics & Principles of Macroeconomics: Ch.7 Second Canadian Edition

Principles of Microeconomics & Principles of Macroeconomics: Ch.7 Second Canadian Edition

Principles of Microeconomics & Principles of Macroeconomics: Ch.7 Second Canadian Edition

Principles of Microeconomics & Principles of Macroeconomics: Ch.7 Second Canadian Edition

Principles of Microeconomics & Principles of Macroeconomics: Ch.7 Second Canadian Edition

Principles of Microeconomics & Principles of Macroeconomics: Ch.7 Second Canadian Edition

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