Download Economics questions for Unit 3, page 71, numbers 4 and 5 Kaiya

Economics questions for Unit 3, page 71, numbers 4 and 5
Kaiya Yamada
Sept. 21, 2012
4. Using a diagram, explain the concept of community surplus.
Community surplus is the welfare of society, and it is made up of consumer surplus plus
producer surplus. It refers to the total surplus that both producers and consumers experience
when they reach a market clearing price.
Equation: Community Surplus = Consumer Surplus + Producer Surplus
Consumer Surplus:
Consumer surplus is the benefit consumers receive when they pay a price below what they are
willing to pay. On the graph the consumer surplus is the area (B) between the demand curve and
the market price (P). The consumer surplus can be calculated as the difference between what
consumers are willing to pay and the market price they actually pay. A decrease in price will
increase consumer surplus and an increase in price will decrease consumer surplus.
Producer Surplus
Producer Surplus is the benefit producers receive when they receive a price above the one at
which they were willing to supply a good. On the graph the producer surplus is the area(E)
between the supply curve and the market price(P). The producer surplus can be calculated as the
difference between the prices of what producers actually receive for a good and what they are
willing to provide a good for. A decrease in price will decrease producer
surplus and an increase in price will increase producer surplus.
Community Surplus:
Putting consumer surplus and producer surplus together, we can see the community surplus on
the graph. To calculate the community surplus, we have to calculate the consumer surplus and
the producer surplus and add them together.
Consumer surplus = Area of the yellow triangle
!
Area=! 𝑏ℎ
!
=! (5)(5)
=$12.5
Producer Surplus=Area of the blue triangle
!
Area=! 𝑏ℎ
!
=! (5)(5)
=$12.5
Community Surplus= Consumer Surplus + Producer Surplus
= $12.5 + $12.5
= $25
Therefore, community surplus is $25.
Community surplus is maximized at market equilibrium where supply is equal to demand and
MB=MC=P. The easiest way to say it is where P=MC. Please see the graph for question 5 for the
explanation of why community surplus is not maximized when marginal cost is greater than or
less than marginal benefit.
5. Describe the concept of allocative efficiency and explain why it is achieved at the competitive
market equilibrium.
Allocative efficiency refers to the efficiency with which markets allocate resources. Allocative
efficiency occurs when it is impossible to improve the overall economic welfare by reallocating
resources. The best allocation of resources is at competitive market equilibrium where
community surplus (consumer surplus+producer surplus) is maximized. This means that the
marginal benefit and marginal cost are equal. Marginal benefit is the additional utility or
satisfaction derived by an increase or a decrease in the amount of an item consumed or an
activity enjoyed. Marginal cost is the increase in total cost of producing an extra unit of output.
To put it another way, allocative efficiency occurs at market equilibrium and market equilibrium
is where the demand equals the supply and there are no shortages or surpluses. Basically the
demand curve is a measure of the marginal benefit to the consumer. The demand curve measures
the maximum price consumers are willing to pay for a given quantity of a good. The supply
curve is a measure of the marginal cost to the producer. The supply curve shows the maximum
producers are willing to supply at that price.
Allocative efficiency is at an output level where the price equals the marginal cost of
production. This is because the price consumers are willing to pay is equal to the marginal utility
they get. Optimal distribution is achieved when marginal utility of a good equals marginal
benefit. Basically it is where MC=MB, and since it is the output level where MB=P we can say
that it is where MC=P. At equilibrium the maximum willingness to pay by the consumer equals
the minimum acceptable price of the supplier. The total of the consumer and producer surplus is
maximized.
Looking at the graph we see that market equilibrium is at Q0 and P. This is where supply is equal
to demand and marginal cost is equal to marginal benefit. There are no shortages or surpluses
and community surplus is maximized. (The black areas would not be there). Resources are
efficiently allocated.
If more is supplied than demanded as in Q1 on the graph there will be a surplus. Supply and
demand will not be in equilibrium. Supply exceeds demand. Marginal costs will exceed marginal
benefit and resources will not be effectively allocated. Community surplus will not be
maximized. The black triangle on the right side of the graph shows the deadweight loss from
consumer and producer surplus here. Here the price consumers pay for a product is less than the
marginal cost of the firms producing the product so a message is sent to the producer that less
output is demanded so fewer resources will be allocated to the production of the product until
marginal cost is equal to the price and of course the marginal benefit. It would be in the best
interests of society to decrease the supply and cut marginal costs here. If less is supplied than
demanded at Q2 on the graph there will be a shortage. Supply and demand are not in equilibrium.
Demand exceeds supply. Marginal benefits exceed marginal costs and resources are not
effectively allocated. Community surplus will not be maximized. The black triangle on the left
side of the graph shows the deadweight loss from consumer and producer surplus here. Here the
price consumers pay for a product is greater than marginal costs of firms producing it (basically
the benefits attained by the consumer from consumption of another unit of good or service
exceeds the opportunity cost of the allocation of an additional input into the production of the
good) so the message is sent to producers that more output is demanded so more resources will
be allocated to the production of the product until the marginal cost and price are equal and the
marginal benefit will be equal too. It would be in the best interests of society to increase the
supply. All of this shows that allocative efficiency is achieved at market equilibrium because this
is where supply equals demand and there are no surpluses or shortages so resources are
efficiently allocated. To put it another way allocative efficiency occurs at market equilibrium and
market equilibrium is where MB=MC=P. Market equilibrium shows that we can’t improve the
overall economic welfare by reallocating resources. Consumer and producer surplus are
maximized.