Download Consumer Surplus, Producer Surplus, and Market Efficiency

Consumer Surplus, Producer
Surplus, and Market Efficiency
Consumer Surplus and the
Demand Curve

Example is the market for used textbooks,
concentrating on the buyers.

The example is going to show that the
demand curve is derived from people’s
tastes or preferences and these tastes
and preferences also determine how
much they gain from the opportunity to
buy used books.
Willingness to Pay
Maximum price at which he or she
would buy a good
 Individuals won’t buy the good if it
costs more than this among but eager
to do so if it cost less
 If the price is just equal to an
individual’s willingness to pay, he or
she is indifferent between buying and
not buying

The Demand Curve for Used Textbooks
Price of
book
$59
Aleisha
Potential
buyers
Brad
45
Claudia
35
Aleisha
Brad
$59
Claudia
35
Darren
Edwina
25
45
10
Darren
25
Edwina
10
D
0
Willingness
to pay
1
2
3
4
5
Quantity of books
A consumer’s willingness
to pay for a good is the
maximum price at which
he or she would buy that
good.
Willingness to Pay




Not a smooth curve because
it is only dealing with a small
number of consumers
Each horizontal segment =
how much one is willing to
pay
What is the quantity
demanded at $59?
What is the quantity
demanded at $45?
Willingness to Pay & Consumer
Surplus
 Campus
Bookstore
makes used
textbooks available
at a price of $30.
Who will buy books?
 Do they gain from
their purchase?
Consumer Surplus in the Used Textbook Market
Price of book
Aleisha’s consumer surplus:
$59-$39=$29
$59
Aleisha
Brad’s consumer surplus:
$45-$30=$15
45
Brad
Claudia’s consumer
surplus: $35-$30=$5
35
Claudia
30
Price = $30
25
Darren
10
Edwina
The total consumer
surplus is given by
the entire shaded
area - the sum of the
individual consumer
surpluses of Aleisha,
Brad, and Claudia equal to $29 + $15 +
$5 = $49.
D
0
1
2
3
4
5
Quantity of books
Willingness to Pay & Consumer
Surplus


Individual Consumer Surplus – net gain that a
buyer achieves from the purchase of a good
 Whenever a buyer pays a price less than his
or her willingness to pay, the buy achieves
an individual consumer surplus
Total Consumer Surplus – sum of the
individual consumer surpluses achieved by all
the buyers of a good
 Aleisha, Brad and Claudia: $29 +$15 +$5 =
$49
Consumer Surplus

Refers to both individual and total
consumer surplus
The total consumer surplus
generated by purchases of
a good at a given price is
equal to the area below the
demand curve but above
that price

Total consumer surplus is equal to the area
below the demand curve but above the price
Changing Prices Affects
Consumer Surplus
 Textbook
Example again…..
 BUT……the bookstore has now
decided to sell used textbooks
for $20 instead of $30. How
much would this fall in price
increase consumer surplus?
Consumer Surplus and a Fall in the Price of Used Textbooks
Price of
book
$59
Aleisha
Increase in Aleisha’s
consumer surplus
Increase in Brad’s
consumer surplus
45
Brad
Claudia
35
Increase in Claude’s
consumer surplus
30
Original price = $30
Darren
25
20
New price = $20
10
Darren’s
consumer
surplus
Edwina
D
0
1
2
3
4
5
Quantity of books
Changing Prices Affects
Consumer Surplus
 The
graph showed that when the
price of a good falls, the area under
the demand curve but not above the
price (which is equal to total
consumer surplus) increases
Producer Surplus and the
Supply Curve
 We
have buyers of goods that would
be willing to pay more for their
purchase than the price they actually
pay
 Some sellers of a good would have
been willing to sell it for less than the
price they actually receive
Producer Surplus and the
Supply Curve
 Seller’s
cost –
lowest price at
which a potential
seller is willing to
sell
 What is Andrew’s
cost? What is
Betty’s cost?
Producer Surplus and the
Supply Curve




Since the students don’t have to manufacture
the books, does it cost the student who sells a
book anything to make that book available for
sale?
YES!
You won’t have it later in your personal
collection – opportunity cost!
When saying “cost” of a good as a seller,
referring to selling that good even if you don’t
spend any money to sell the good
Producer Surplus and the
Supply Curve
Individual Producer Surplus – the net
gain, the difference between the price he
actually gets and his cost, the minimum
price at which he would have been willing
to sell
 Total Producer Surplus – the total net
gain to all sellers in the market
 Producer Surplus – refers to either the
total or individual producer surplus

Producer
Surplus in the Used Textbook Market
Total Producer Surplus is given by the entire shaded area,
the sum of the individual producer surpluses of Andrew,
Betty, and Carlos.
Price of book
$25 + $15 +
$5 = $45
S
$45
Engelbert
35
Donna
Price = $30
30
25
Betty
15
5
0
Carlos’s
producer
surplus
Carlos
Andrew’s
producer
surplus
Andrew
1
2
3
4
Betty’s
producer
surplus
5
Quantity of books
The total producer surplus from sales of a good at a given price
is the area above the supply curve but below that price.
How Changing Price Affects
Producer Surplus
When
the price of a good rises,
producer surplus increases through
two ways:
The
gains of those who would have
supplied the good even at the
original, lower price and
The gains of those who are induced
to supply the good by the higher
price
A Rise in the Price Increases Producer Surplus
Increase in producer
surplus to original
sellers
Consumer surplus
gained by new
sellers
S
Consumer Surplus, Producer
Surplus, and the Gains from Trade
 Total
Surplus generated in a market
is the total net gain to consumers
and producers from trading in the
market. It is the sum of the producer
and the consumer surplus
 This
also shows there are gains from
trade
Total Surplus
S
Consumer
surplus
Equilibrium
price
E
Producer
surplus
D
Equilibrium quantity
The Efficiency of Markets
 Markets
are usually “efficient”
 Are they?
 It is claimed that once the market has
produced its gains from trade, there
is no way to make some people
better off without making ofther
people worse off, except…..under
well-defined conditions
The Efficiency of Markets
A
committee wants to improve on the
market equilibrium by deciding who
gets and who gives up a used
textbook. The goal of the committee
– bypass the market outcome and
come up with another arrangement
that would produce higher total
surplus
The Efficiency of Markets
 Three
ways to increase the total
surplus:
1. Reallocate consumption among
consumers
2. Reallocate sales among sellers
3. Change the quantity traded
1. Reallocate consumption
among consumers
 Committee
tries to
increase
total surplus
by selling
books to
different
consumers
2. Reallocate sales among
sellers

Committee tried to
increase total surplus by
altering who sells their
books, taking sales away
from sellers who would
have sold their books in
the market equilibrium
and instead compelling
those who would not
have sold their books in
the market equilibrium to
sell them
3. Change the quantity traded

Committee tries to
increase total
surplus by
compelling
students to trade
either more books
or fewer books
than the market
equilibrium
quantity.
The Efficiency of Markets
 Key
Idea: once this market is in
equilibrium, there is no way to
increase the gains from trade
 An
efficient market performs four
important functions
The Efficiency of Markets
An efficient market performs four
important functions
1. It allocates consumption of the good to
the potential buyers who most value it,
as indicated by the fact that they have
the highest willingness to pay
2. It allocates sales to the potential sellers
who most value the right to sell the
good, as indicated by the fact that they
have the lowest cost

The Efficiency of Markets
3.
4.
It ensures that every consumer who
makes a purchase values the good more
than every seller who makes a sale, so
that all transactions are mutually
beneficial
It ensures that every potential buyer who
doesn’t make a purchase values the
good less than every potential seller who
doesn’t make a sale, so that no mutually
beneficial transaction are missed
The Efficiency of Markets
Three caveats:
1. Market can be efficient, it isn’t
necessarily fair
2. Markets sometimes fail
3. Even when market equilibrium
maximizes total surplus, this does not
mean that it results in the best outcome
for every individual consumer and
producer

The Efficiency of Markets
 Efficiency
is about how to
achieve goals, not what those
goals should be
Consumer Surplus, Producer
Surplus, and Market Efficiency
Notes
Willingness to Pay
Individuals won’t buy the good if it
costs more than this among but eager
to do so if it cost less
 If the price is just equal to an
individual’s willingness to pay, he or
she is indifferent between buying and
not buying

The Demand Curve for Used Textbooks
Price of
book
$59
Aleisha
Potential
buyers
Brad
45
Claudia
35
Darren
25
Edwina
10
D
0
1
2
3
4
5
Quantity of books
Willingness
to pay
Aleisha
Brad
$59
Claudia
35
Darren
Edwina
25
45
10
Willingness to Pay

What is the quantity
demanded at $59?

What is the quantity
demanded at $45?
Willingness to Pay & Consumer
Surplus
 Campus
Bookstore
makes used
textbooks available
at a price of $30.
Who will buy
books?
 Do they gain from
their purchase?
Consumer Surplus in the Used Textbook Market
Price of book
Aleisha’s consumer surplus:
$59-$39=$29
$59
Aleisha
Brad’s consumer surplus:
$45-$30=$15
45
Brad
Claudia’s consumer
surplus: $35-$30=$5
35
Claudia
30
Price = $30
25
Darren
10
Edwina
D
0
1
2
3
4
5
Quantity of books
Willingness to Pay & Consumer
Surplus

Individual Consumer Surplus – net gain that a
buyer achieves from the purchase of a good

Total Consumer Surplus – sum of the
individual consumer surpluses achieved by all
the buyers of a good
Consumer Surplus

Refers to both individual and total
consumer surplus
Consumer Surplus and a Fall in the Price of Used Textbooks
Price of
book
$59
Aleisha
Increase in Aleisha’s
consumer surplus
Increase in Brad’s
consumer surplus
45
Brad
Claudia
35
Increase in Claude’s
consumer surplus
30
Original price = $30
Darren
25
20
New price = $20
10
Darren’s
consumer
surplus
Edwina
D
0
1
2
3
4
5
Quantity of books
Changing Prices Affects
Consumer Surplus
 The
graph showed that when the
price of a good falls, the area under
the demand curve but not above the
price (which is equal to total
consumer surplus) increases
Producer Surplus and the
Supply Curve
 We
have buyers of goods that would
be willing to pay more for their
purchase than the price they actually
pay
Producer Surplus and the
Supply Curve
 Seller’s
cost –
lowest price at
which a potential
seller is willing to
sell
 What is Andrew’s
cost? What is
Betty’s cost?
Producer Surplus and the
Supply Curve


Since the students don’t have to manufacture
the books, does it cost the student who sells a
book anything to make that book available for
sale?
YES!
Producer Surplus and the
Supply Curve

Individual Producer Surplus –

Total Producer Surplus –

Producer Surplus –
Producer Surplus in the Used Textbook Market
Price of book
S
$45
Engelbert
35
Donna
Price = $30
30
25
Betty
15
5
0
Carlos’s
producer
surplus
Carlos
Andrew’s
producer
surplus
Andrew
1
2
3
4
Betty’s
producer
surplus
5
Quantity of books
How Changing Price Affects
Producer Surplus
When
the price of a good rises,
producer surplus increases through
two ways:
A Rise in the Price Increases Producer Surplus
Increase in producer
surplus to original
sellers
Consumer surplus
gained by new
sellers
S
Consumer Surplus, Producer
Surplus, and the Gains from Trade
 This
also shows there are gains from
trade
Total Surplus
S
Consumer
surplus
Equilibrium
price
E
Producer
surplus
D
Equilibrium quantity
The Efficiency of Markets
 Markets
are usually “efficient”
 Are they?
 It is claimed that once the market has
produced its gains from trade, there
is no way to make some people
better off without making ofther
people worse off, except…..under
well-defined conditions
The Efficiency of Markets
A
committee wants to improve on the
market equilibrium by deciding who
gets and who gives up a used
textbook. The goal of the committee
– bypass the market outcome and
come up with another arrangement
that would produce higher total
surplus
The Efficiency of Markets
 Three
ways to increase the total
surplus:
1. Reallocate consumption among
consumers
2. Reallocate sales among sellers
3. Change the quantity traded
1. Reallocate consumption
among consumers
 Committee
tries to
increase
total surplus
by selling
books to
different
consumers
2. Reallocate sales among
sellers

Committee tried to
increase total surplus by
altering who sells their
books, taking sales away
from sellers who would
have sold their books in
the market equilibrium
and instead compelling
those who would not
have sold their books in
the market equilibrium to
sell them
3. Change the quantity traded

Committee tries to
increase total
surplus by
compelling
students to trade
either more books
or fewer books
than the market
equilibrium
quantity.
The Efficiency of Markets
 Key
Idea: once this market is in
equilibrium, there is no way to
increase the gains from trade
 An
efficient market performs four
important functions
The Efficiency of Markets
An efficient market performs four
important functions
1. It allocates consumption of the good to
the potential buyers who most value it,
as indicated by the fact that they have
the highest willingness to pay
2. It allocates sales to the potential sellers
who most value the right to sell the
good, as indicated by the fact that they
have the lowest cost

The Efficiency of Markets
3.
4.
It ensures that every consumer who
makes a purchase values the good more
than every seller who makes a sale, so
that all transactions are mutually
beneficial
It ensures that every potential buyer who
doesn’t make a purchase values the
good less than every potential seller who
doesn’t make a sale, so that no mutually
beneficial transaction are missed
The Efficiency of Markets
Three caveats:
1. Market can be efficient, it isn’t
necessarily fair
2. Markets sometimes fail
3. Even when market equilibrium
maximizes total surplus, this does not
mean that it results in the best outcome
for every individual consumer and
producer

The Efficiency of Markets
 Efficiency
is about how to
achieve goals, not what those
goals should be