Consumers, Producers, and the Efficiency of Markets,Economics,P R I N C I P L E S O F,N. Gregory Mankiw,7,In this chapter, look for the answers to these questions:,What is consumer surplus? How is it related to the demand curve? What is producer surplus? How is it related to the supply curve? Do markets produce a desirable allocation of resources? Or could the market outcome be improved upon?,1,.,2,Welfare Economics,Recall, the allocation of resources refers to: how much of each good is produced which producers produce it which consumers consume it Welfare economics studies how the allocation of resources affects economic well-being. First, we look at the well-being of consumers.,.,3,Willingness to Pay (WTP),A buyers willingness to pay for a good is the maximum amount the buyer will pay for that good. WTP measures how much the buyer values the good.,Example: 4 buyers WTP for an iPod,.,4,WTP and the Demand Curve,Q:If price of iPod is $200, who will buy an iPod, and what is quantity demanded?,A:Anthony & Flea will buy an iPod, Chad & John will not. Hence, Qd = 2 when P = $200.,.,5,WTP and the Demand Curve,Derive the demand schedule:,4,John, Chad, Anthony, Flea,0 125,3,Chad, Anthony, Flea,126 175,2,Anthony, Flea,176 250,1,Flea,251 300,0,nobody,$301 & up,Qd,who buys,P (price of iPod),.,6,WTP and the Demand Curve,P,Q,.,7,About the Staircase Shape,This D curve looks like a staircase with 4 steps one per buyer.,P,Q,If there were a huge # of buyers, as in a competitive market,there would be a huge # of very tiny steps,and it would look more like a smooth curve.,.,8,WTP and the Demand Curve,At any Q, the height of the D curve is the WTP of the marginal buyer, the buyer who would leave the market if P were any higher.,P,Q,.,9,Consumer Surplus (CS),Consumer surplus is the amount a buyer is willing to pay minus the amount the buyer actually pays: CS = WTP P,Suppose P = $260. Fleas CS = $300 260 = $40. The others get no CS because they do not buy an iPod at this price. Total CS = $40.,.,10,CS and the Demand Curve,P,Q,P = $260 Fleas CS = $300 260 = $40 Total CS = $40,.,11,CS and the Demand Curve,P,Q,Instead, suppose P = $220 Fleas CS = $300 220 = $80 Anthonys CS =$250 220 = $30 Total CS = $110,.,12,CS and the Demand Curve,P,Q,The lesson: Total CS equals the area under the demand curve above the price, from 0 to Q.,.,13,CS with Lots of Buyers & a Smooth D Curve,The demand for shoes,At Q = 5(thousand), the marginal buyer is willing to pay $50 for pair of shoes. Suppose P = $30. Then his consumer surplus = $20.,.,14,CS with Lots of Buyers & a Smooth D Curve,The demand for shoes,CS is the area b/w P and the D curve, from 0 to Q. Recall: area of a triangle equals x base x height Height =$60 30 = $30. So, CS = x 15 x $30 = $225.,$,.,15,How a Higher Price Reduces CS,If P rises to $40, CS = x 10 x $20 = $100. Two reasons for the fall in CS.,16,P,Q,demand curve,A. Find marginal buyers WTP at Q = 10. B.Find CS for P = $30.,Suppose P falls to $20.How much will CS increase due to,C. buyers entering the market D.existing buyers paying lower price,$,A C T I V E L E A R N I N G 1 Consumer surplus,.,17,Cost and the Supply Curve,A seller will produce and sell the good/service only if the price exceeds his or her cost. Hence, cost is a measure of willingness to sell.,Cost is the value of everything a seller must give up to produce a good (i.e., opportunity cost). Includes cost of all resources used to produce good, including value of the sellers time. Example: Costs of 3 sellers in the lawn-cutting business.,.,18,Cost and the Supply Curve,3,35 & up,2,20 34,1,10 19,0,$0 9,Qs,P,Derive the supply schedule from the cost data:,.,19,Cost and the Supply Curve,.,20,Cost and the Supply Curve,P,Q,At each Q, the height of the S curve is the cost of the marginal seller, the seller who would leave the market if the price were any lower.,.,21,Producer Surplus,P,Q,Producer surplus (PS): the amount a seller is paid for a good minus the sellers cost,PS = P cost,.,22,Producer Surplus and the S Curve,P,Q,PS = P cost,Suppose P = $25. Jacks PS = $15 Janets PS = $5 Chrissys PS = $0 Total PS = $20,Total PS equals the area above the supply curve under the price, from 0 to Q.,.,23,PS with Lots of Sellers & a Smooth S Curve,The supply of shoes,Suppose P = $40. At Q = 15(thousand), the marginal sellers cost is $30, and her producer surplus is $10.,.,24,PS with Lots of Sellers & a Smooth S Curve,The supply of shoes,PS is the area b/w P and the S curve, from 0 to Q. The height of this triangle is $40 15 = $25. So, PS = x b x h = x 25 x $25 = $312.50,.,25,How a Lower Price Reduces PS,If P falls to $30, PS = x 15 x $15 = $112.50 Two reasons for the fall in PS.,P,Q,supply curve,A. Find marginal sellers cost at Q = 10. B.Find total PS for P = $20.,Suppose P rises to $30.Find the increase in PS due to,C. selling 5 additional units D. getting a higher price on the initial