Consumers, Producers, and the Efficiency of Markets

1
Consumers, Producers, and the Efficiency of
Markets

• Outline
• Positive economics Allocation of scarce
  resources using forces of demand and supply
• Normative economics Whether these allocations
  are desirable leads to the study of welfare
  economics
• Welfare economics is the study of how the
  allocation of resources affects economic
  wellbeing
• Examine the benefits that buyers and sellers
  receive from participating in the market
• Willingness to pay is the maximum amount that a
  buyer will pay for a good

2
Consumer Surplus and Demand Curve

• Consumer surplus is a buyers willingness to pay
  minus the amount the buyer actually pays
• Using the willingness to pay of the buyers one
  can derive the demand schedule and the demand
  curve
• The height of the demand curve shows the
  willingness to pay of the marginal buyer
• Consumer surplus in a market is measured as the
  area below the demand curve and above the market
  price

Consumer Surplus
P
DD
Q
3
Consumer Surplus and Demand Curve

• A lower price raises consumer surplus
• Existing buyers see an increase in their consumer
  surplus due to a reduction in price
• New buyers enjoy consumer surplus as they can now
  enter the market
• Consumer surplus is a good measure of economic
  well-being and respects preferences of consumers.
  Is it always a good measure?
• Important assumption in economics- consumers are
  rational

4
Producer Surplus and Supply Curve

• Cost is the value of everything a seller must
  give up to produce. It includes the cost of raw
  materials and the opportunity cost (value of her
  time). Cost is a measure of the sellers
  willingness to sell.
• Producer surplus is the amount a seller is paid
  for a good minus the sellers cost. It measures
  the benefit to the sellers for participating in a
  market.
• The willingness to sell or cost is used to derive
  the supply schedule and graph the supply curve.

5
Producer Surplus and Supply Curve

• The height of the supply curve measures the
  sellers costs. The price on the supply curve
  denotes the cost of the marginal seller
• Producer surplus in a market is the area below
  the price and above the supply curve
• A higher price raises producers surplus by
• Existing producers receive a higher price
• New producers enter the market at a higher price

6
Market Efficiency

• Consumer surplus value to buyers- amount paid by
  buyers
• Producer surplus amount received by sellers-
  cost to sellers
• Therefore, market surplus value to buyers- cost
  to sellers
• If the allocation of resources maximizes total
  surplus then that allocation is efficient
• Efficiency is the property of a resource
  allocation of maximizing the total surplus
  received by all members of society
• Equity is the fairness of the distribution of
  well-being among the members of society

7
Market Efficiency

• Free markets allocate the supply of goods to the
  buyers who value them most
• Free markets allocate the demand for goods to the
  sellers who produce them at least cost
• Free markets produce the quantity of goods that
  maximizes total surplus in the market
• Conclusion Free markets result in efficient
  market outcomes but are the market outcomes
  equitable?

8
Market Failure

• Efficiency of markets is based on two major
  assumptions
• Markets are perfectly competitive
• Market outcomes matter only to the buyers and
  sellers in the market
• Assumptions are invalid in some cases and result
  in market failure- the inability of some
  unregulated markets to allocate resources
  efficiently
• Causes for market failure
• Existence of market power
• Presence of externalities
• Free markets produce the quantity of goods that
  maximizes total surplus in the market
• Conclusion Free markets result in efficient
  market outcomes but are the market outcomes
  equitable?