Download Mankiw:Chapter 7

Overview
Welfare Economics
 Consumer Surplus
 Producer Surplus
 Market Efficiency

Principles of Microeconomics & Principles of Macroeconomics: Ch.7
First Canadian Edition
Market Equilibrium Revisited
Does the equilibrium price and quantity result in
the maximum total welfare of buyer and seller?
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Principles of Microeconomics & Principles of Macroeconomics: Ch.7
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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?
Turn to Welfare Economics to answer
the question.
Principles of Microeconomics & Principles of Macroeconomics: Ch.7
First Canadian Edition
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.
Principles of Microeconomics & Principles of Macroeconomics: Ch.7
First Canadian Edition
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
Principles of Microeconomics & Principles of Macroeconomics: Ch.7
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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.
Principles of Microeconomics & Principles of Macroeconomics: Ch.7
First Canadian Edition
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.
Principles of Microeconomics & Principles of Macroeconomics: Ch.7
First Canadian Edition
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.
Principles of Microeconomics & Principles of Macroeconomics: Ch.7
First Canadian Edition
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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Principles of Microeconomics & Principles of Macroeconomics: Ch.7
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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
Principles of Microeconomics & Principles of Macroeconomics: Ch.7
First Canadian Edition
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
Principles of Microeconomics & Principles of Macroeconomics: Ch.7
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$11
$10
$9
$8
$7
Market
Price
$6
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Quantity Purchased
Principles of Microeconomics & Principles of Macroeconomics: Ch.7
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$11
$10
Total Consumer
Benefits
$9
$8
$7
$6
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$11
$10
$9
$8
Consumer’s
Expense
$7
$6
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$11
Consumer Benefit
-Consumer Expense
$10
CONSUMER SURPLUS!
$9
$8
$51 - $36 =
$7
$15
$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.
Principles of Microeconomics & Principles of Macroeconomics: Ch.7
First Canadian Edition
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.
Principles of Microeconomics & Principles of Macroeconomics: Ch.7
First Canadian Edition
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.
Principles of Microeconomics & Principles of Macroeconomics: Ch.7
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Producer Surplus: Graphical
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Principles of Microeconomics & Principles of Macroeconomics: Ch.7
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Producer Surplus: Graphical
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Principles of Microeconomics & Principles of Macroeconomics: Ch.7
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Producer Surplus: Mathematically
Minimum
Price = $1
Market Price = $6
Quantity Sold = 6
Assume: Price increases $1 for every
additional unit sold.
Producer Surplus = $15
$36 - $21 = $15
($6 x 6) - ($1 +$2 + $3 + $4 + $5 + $6) = $15
Principles of Microeconomics & Principles of Macroeconomics: Ch.7
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Total Producer
Benefits
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Producer
Surplus =$15
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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.
Principles of Microeconomics & Principles of Macroeconomics: Ch.7
First Canadian Edition
Market Efficiency
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Principles of Microeconomics & Principles of Macroeconomics: Ch.7
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Market Efficiency
Consumer
Surplus
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Producer
Surplus
Principles of Microeconomics & Principles of Macroeconomics: Ch.7
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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.
Principles of Microeconomics & Principles of Macroeconomics: Ch.7
First Canadian Edition
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.
Principles of Microeconomics & Principles of Macroeconomics: Ch.7
First Canadian Edition
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.
Principles of Microeconomics & Principles of Macroeconomics: Ch.7
First Canadian Edition
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.
Principles of Microeconomics & Principles of Macroeconomics: Ch.7
First Canadian Edition