Download Mankiw:Chapter 7

Chapter 7
Consumers, Producers and
the Efficiency of Markets
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Market Equilibrium Revisited
Does the equilibrium price and quantity result in
the maximum total welfare of buyer and seller?
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PE
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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?
We can turn to Welfare Economics to
answer the question.
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Welfare Economics
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.
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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
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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.
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Utility is...
… the satisfaction
(benefit) that a
consumer expects to
receive from
consuming a good or
service.
…the power to satisfy
a want.
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Marginal Utility (MU) is...
…the amount of utility (satisfaction)
that one more unit of consumption
adds to total utility.
– Consumers try to obtain the largest
possible total satisfaction (utility) from
the mix of goods and services they buy
with their incomes.
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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.
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Consumer Surplus: Verbal Definition
 The
amount a buyer
is willing to pay for a
good minus the
amount the buyer
actually pays for it.
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Consumer Surplus: Graphical
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Consumer Surplus: Graphical
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Consumer
Surplus
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Consumer Surplus and Market Price
The
area 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
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$11
CONSUMER
SURPLUS
$10
$9
$8
Consumers
Expense
$7
$6
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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.
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Producer Surplus: Verbal Definition
 The
amount a seller is
paid minus the cost
of production.
 Producer surplus
measures the benefit
to sellers of
participating in a
market.
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Producer Surplus: Graphical
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Producer Surplus: Graphical
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Producer
Surplus
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Producer
Surplus
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$6
$5
$4
Producer
Costs
$3
$2
$1
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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.
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Market Efficiency
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Market Efficiency
Consumer
Surplus
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Producer
Surplus
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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.
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Market Efficiency: Invisible Hand
 In
a 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.
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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.
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