1、 2009 South-Western,a part of Cengage Learning,all rights reservedC H A P T E REconomics7What 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
2、 improved upon?1.2Welfare EconomicsRecall,the allocation of resources refers to:how much of each good is producedwhich producers produce itwhich consumers consume itWelfare economics studies how the allocation of resources affects economic well-being.First,we look at the well-being of consumers.3Wil
3、lingness to Pay(WTP)A buyers willingness to pay for a good is the maximum amount the buyer will pay for that good.WTP measures how much the buyer values the good.nameWTPAnthony$250Chad175Flea300John125Example:4 buyers WTP for an iPod.4WTP and the Demand CurveQ:If price of iPod is$200,who will buy an
4、 iPod,and what is quantity demanded?A:Anthony&Flea will buy an iPod,Chad&John will not.Hence,Qd=2 when P=$200.nameWTPAnthony$250Chad175Flea300John125.5WTP and the Demand CurveDerive the demand schedule:4John,Chad,Anthony,Flea 0 1253Chad,Anthony,Flea126 1752Anthony,Flea176 2501Flea251 3000nobody$301&
5、upQdwho buysP(price of iPod)nameWTPAnthony$250Chad175Flea300John125.6WTP and the Demand CurvePQd$301&up0251 3001176 2502126 1753 0 1254PQ.7About the Staircase ShapeThis D curve looks like a staircase with 4 steps one per buyer.PQIf there were a huge#of buyers,as in a competitive market,there would b
6、e a huge#of very tiny steps,and it would look more like a smooth curve.8WTP and the Demand CurveAt any Q,the height of the D curve is the WTP of the marginal buyer,the buyer who would leave the market if P were any higher.PQFleas WTPAnthonys WTPChads WTPJohns WTP.9Consumer Surplus(CS)Consumer surplu
7、s is the amount a buyer is willing to pay minus the amount the buyer actually pays:CS =WTP PnameWTPAnthony$250Chad175Flea300John125Suppose P=$260.Fleas CS=$300 260=$40.The others get no CS because they do not buy an iPod at this price.Total CS=$40.10CS and the Demand CurvePQFleas WTPP=$260 Fleas CS=
8、$300 260=$40Total CS=$40.11CS and the Demand CurvePQFleas WTPAnthonys WTPInstead,suppose P=$220 Fleas CS=$300 220=$80Anthonys CS=$250 220=$30Total CS=$110.12CS and the Demand CurvePQThe lesson:Total CS equals the area under the demand curve above the price,from 0 to Q.13PQ$CS with Lots of Buyers&a S
9、mooth D CurveThe demand for shoesD1000s of pairs of shoesPrice per pairAt Q=5(thousand),the marginal buyer is willing to pay$50 for pair of shoes.Suppose P=$30.Then his consumer surplus=$20.14PQCS with Lots of Buyers&a Smooth D CurveThe demand for shoesDCS is the area b/w P and the D curve,from 0 to
10、 Q.Recall:area of a triangle equals x base x heightHeight=$60 30=$30.So,CS=x 15 x$30 =$225.h$.15PQHow a Higher Price Reduces CSDIf P rises to$40,CS=x 10 x$20 =$100.Two reasons for the fall in CS.1.Fall in CS due to buyers leaving market2.Fall in CS due to remaining buyers paying higher P16PQdemand c
11、urveA.Find marginal buyers WTP at Q=10.B.Find CS for P=$30.Suppose P falls to$20.How much will CS increase due to C.buyers entering the marketD.existing buyers paying lower price$.17Cost and the Supply CurvenamecostJack$10Janet20Chrissy35A seller will produce and sell the good/service only if the pr
12、ice exceeds his or her cost.Hence,cost is a measure of willingness to sell.Cost is the value of everything a seller must give up to produce a good(i.e.,opportunity cost).Includes cost of all resources used to produce good,including value of the sellers time.Example:Costs of 3 sellers in the lawn-cut
13、ting business.18Cost and the Supply Curve335&up220 34110 190$0 9QsPDerive the supply schedule from the cost data:namecostJack$10Janet20Chrissy35.19Cost and the Supply CurvePQPQs$0 9010 19120 34235&up3.20Cost and the Supply CurvePQAt each Q,the height of the S curve is the cost of the marginal seller
14、,the seller who would leave the market if the price were any lower.Chrissys costJanets costJacks cost.21Producer SurplusPQProducer surplus(PS):the amount a seller is paid for a good minus the sellers costPS=P cost.22Producer Surplus and the S CurvePQPS=P costSuppose P=$25.Jacks PS=$15Janets PS=$5Chr
15、issys PS=$0Total PS=$20Janets costJacks costTotal PS equals the area above the supply curve under the price,from 0 to Q.Chrissys cost.23PQPS with Lots of Sellers&a Smooth S CurveThe supply of shoesS1000s of pairs of shoesPrice per pairSuppose P=$40.At Q=15(thousand),the marginal sellers cost is$30,a
16、nd her producer surplus is$10.24PQPS with Lots of Sellers&a Smooth S CurveThe supply of shoesSPS is the area b/w P and the S curve,from 0 to Q.The height of this triangle is$40 15=$25.So,PS=x b x h =x 25 x$25 =$312.50h.25PQHow a Lower Price Reduces PSIf P falls to$30,PS=x 15 x$15 =$112.50Two reasons
17、 for the fall in PS.S1.Fall in PS due to sellers leaving market2.Fall in PS due to remaining sellersgetting lower PPQsupply curveA.Find marginal sellers cost at Q=10.B.Find total PS for P=$20.Suppose P rises to$30.Find the increase in PS due to C.selling 5 additional unitsD.getting a higher price on
18、 the initial 10 units26.27CS,PS,and Total SurplusCS =(value to buyers)(amount paid by buyers)=buyers gains from participating in the marketPS =(amount received by sellers)(cost to sellers)=sellers gains from participating in the marketTotal surplus=CS+PS=total gains from trade in a market=(value to
19、buyers)(cost to sellers).28The Markets Allocation of ResourcesIn a market economy,the allocation of resources is decentralized,determined by the interactions of many self-interested buyers and sellers.Is the markets allocation of resources desirable?Or would a different allocation of resources make
20、society better off?To answer this,we use total surplus as a measure of societys well-being,and we consider whether the markets allocation is efficient.(Policymakers also care about equality,though are focus here is on efficiency.).29EfficiencyAn allocation of resources is efficient if it maximizes t
21、otal surplus.Efficiency means:The goods are consumed by the buyers who value them most highly.The goods are produced by the producers with the lowest costs.Raising or lowering the quantity of a good would not increase total surplus.=(value to buyers)(cost to sellers)Total surplus.30Evaluating the Ma
22、rket EquilibriumMarket eqm:P=$30 Q=15,000Total surplus =CS+PSIs the market eqm efficient?PQSDCSPS.31Which Buyers Consume the Good?PQSDEvery buyer whose WTP is$30 will buy.Every buyer whose WTP is$30 will not.So,the sellers with the lowest cost produce the good.33Does Eqm Q Maximize Total Surplus?PQS
23、DAt Q=20,cost of producing the marginal unit is$35 value to consumers of the marginal unit is only$20Hence,can increase total surplus by reducing Q.This is true at any Q greater than 15.34Does Eqm Q Maximize Total Surplus?PQSDAt Q=10,cost of producing the marginal unit is$25 value to consumers of th
24、e marginal unit is$40Hence,can increase total surplus by increasing Q.This is true at any Q less than 15.35Does Eqm Q Maximize Total Surplus?PQSDThe market eqm quantity maximizes total surplus:At any other quantity,can increase total surplus by moving toward the market eqm quantity.36Adam Smith and
25、the Invisible Hand“Man has almost constant occasion for the help of his brethren,and it is vain for him to expect it from their benevolence only.Adam Smith,1723-1790Passages from The Wealth of Nations,1776 He will be more likely to prevail if he can interest their self-love in his favor,and show the
26、m that it is for their own advantage to do for him what he requires of themIt 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.37Adam Smith and the Invisible Hand“Every individualneither intends to promote the pu
27、blic interest,nor knows how much he is promoting it.Adam Smith,1723-1790Passages from The Wealth of Nations,1776He intends only his own gain,and he is in this,as in many other cases,led by an invisible hand to promote an end which was no part of his intention.Nor is it always the worse for the socie
28、ty 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.”an invisible hand.38The Free Market vs.Govt InterventionThe market equilibrium is efficient.No other outcome achieves higher total surplus.
29、Govt cannot raise total surplus by changing the markets allocation of resources.Laissez faire(French for“allow them to do”):the notion that govt should not interfere with the market.39The free market vs.central planningSuppose resources were allocated not by the market,but by a central planner who c
30、ares about societys well-being.To allocate resources efficiently and maximize total surplus,the planner would need to know every sellers cost and every buyers WTP for every good in the entire economy.This is impossible,and why centrally-planned economies are never very efficient.40CONCLUSIONThis cha
31、pter used welfare economics to demonstrate one of the Ten Principles:Markets are usually a good way to organize economic activity.Important note:We derived these lessons assuming perfectly competitive markets.In other conditions we will study in later chapters,the market may fail to allocate resourc
32、es efficiently.41CONCLUSIONSuch market failures occur when:a buyer or seller has market power the ability to affect the market price.transactions have side effects,called externalities,that affect bystanders.(example:pollution)Well use welfare economics to see how public policy may improve on the ma
33、rket outcome in such cases.Despite the possibility of market failure,the analysis in this chapter applies in many markets,and the invisible hand remains extremely important.The height of the D curve reflects the value of the good to buyerstheir willingness to pay for it.Consumer surplus is the diffe
34、rence between what buyers are willing to pay for a good and what they actually pay.On the graph,consumer surplus is the area between P and the D curve.42The height of the S curve is sellers cost of producing the good.Sellers are willing to sell if the price they get is at least as high as their cost
35、.Producer surplus is the difference between what sellers receive for a good and their cost of producing it.On the graph,producer surplus is the area between P and the S curve.43To measure of societys well-being,we use total surplus,the sum of consumer and producer surplus.Efficiency means that total surplus is maximized,that the goods are produced by sellers with lowest cost,and that they are consumed by buyers who most value them.Under perfect competition,the market outcome is efficient.Altering it would reduce total surplus.44
