Consumers, Producers, and the Efficiency of MarketsChapter 7Revisiting the Market EquilibriumDo the equilibrium price and quantity maximize the total welfare of buyers and sellers?uMarket equilibrium reflects the way markets allocate scarce resources. u Whether the market allocation is desirable is determined by welfare economics.Welfare EconomicsWelfare economics is the study of how the allocation of resources affects economic well-being.uBuyers and sellers receive benefits from taking part in the market. uThe equilibrium in a market maximizes the total welfare of buyers and sellers. Welfare EconomicsEquilibrium in the market results in maximum benefits, and therefore maximum total welfare for both the consumers and the producers of the product.Welfare EconomicsuConsumer surplus measures economic welfare from the buyers side.uProducer surplus measures economic welfare from the sellers side.Consumer SurplusuWillingness to pay is the maximum price that a buyer is willing and able to pay for a good.uIt measures how much the buyer values the good or service.Consumer SurplusConsumer surplus is the amount a buyer is willing to pay for a good minus the amount the buyer actually pays for it.Four Possible Buyers Willingness to Pay.Consumer SurplusThe market demand curve depicts the various quantities that buyers would be willing and able to purchase at different prices.Four Possible Buyers Willingness to Pay.Measuring Consumer Surplus with the Demand Curve.Price of Album5070800$1001234Quantity of AlbumsJohns willingness to payPauls willingness to payGeorges willingness to payRingos willingness to payDemandMeasuring Consumer Surplus with the Demand Curve.Price of Album5070800$1001234Quantity of AlbumsDemandJohns consumer surplus ($20)Price = $80Measuring Consumer Surplus with the Demand Curve.Price of Album5070800$1001234Quantity of AlbumsDemandJohns consumer surplus ($30)Total consumer surplus ($40)Price = $70Pauls consumer surplus ($10)Measuring Consumer Surplus with the Demand CurveThe area below the demand curve and above the price measures the consumer surplus in the market.Q2P2How the Price Affects Consumer Surplus.QuantityPrice0DemandCopyright 2001 by Harcourt, Inc. All rights reservedInitial consumer surplusAdditional consumer surplus to initial consumersConsumer surplus to new consumersQ1P1DEFBCAConsumer Surplus and Economic Well-BeingConsumer surplus, the amount that buyers are willing to pay for a good minus the amount they actually pay for it, measures the benefit that buyers receive from a good as the buyers themselves perceive it.Producer SurplusuProducer surplus is the amount a seller is paid minus the cost of production. uIt measures the benefit to sellers participating in a market.The Costs of Four Possible Sellers.Producer Surplus and the Supply CurveuJust as consumer surplus is related to the demand curve, producer surplus is closely related to the supply curve.uAt any quantity, the price given by the supply curve shows the cost of the marginal seller, the seller who would leave the market first if the price were any lower.Supply Schedule for the Four Possible Sellers.Producer Surplus and the Supply Curve.Quantity of Houses PaintedPrice of House Painting500800$90006001234Grandmas costGeorgias costFridas costMarys costSupplyThe area below the price and above the supply curve measures the producer surplus in a market.Producer Surplus and the Supply CurveMeasuring Producer Surplus with the Supply Curve.Quantity of Houses PaintedPrice of House Painting500800$90006001234SupplyGrandmas producer surplus ($100)Price = $600Measuring Producer Surplus with the Supply Curve.Quantity of Houses PaintedPrice of House Painting500800$90006001234SupplyGrandmas producer surplus ($300)Price = $800Georgias producer surplus ($200)Total producer surplus ($500)P2Q2How Price Affects Producer Surplus.QuantityPrice0SupplyQ1P1AB CInitial Producer surplusAdditional producer surplus to initial producersDE FProducer surplus to new producersMarket EfficiencyConsumer surplus and producer surplus may be used to address the following question:Is the allocation of resources determined by free markets in any way desirable?Economic Well-Being and Total SurplusandConsumer Surplus=Value to buyers_Amount paid by buyersProducer Surplus=Amount received by sellers_Cost to sellersEconomic Well-Being and Total SurplusorTotal Surplus=Value to buyers_Cost to sellersTotal Surplus=Consumer SurplusProducer Surplus+Market EfficiencyMarket efficiency is achieved when the allocation of resources maximizes total surplus.Market EfficiencyIn addition to market efficiency, a social planner might also care about equity the fairness of the distribution of well-being among the various buyers and sellers.Evaluating the Market Equilibrium.PriceEquilibrium price0QuantityEquilibrium quantityASupplyCBDemandDEConsumer and Pr