Consumer Surplus, Producer Surplus, and Market Efficiency

1
Consumer Surplus, Producer Surplus, and Market
Efficiency
2
Consumer Surplus and the Demand Curve

• Example is the market for used textbooks,
  concentrating on the buyers.
• The example is going to show that the demand
  curve is derived from peoples tastes or
  preferences and these tastes and preferences also
  determine how much they gain from the opportunity
  to buy used books.

3
Willingness to Pay

• Maximum price at which he or she would buy a good
• Individuals wont buy the good if it costs more
  than this among but eager to do so if it cost
  less
• If the price is just equal to an individuals
  willingness to pay, he or she is indifferent
  between buying and not buying

4
The Demand Curve for Used Textbooks
Price of book
Aleisha
59
Potential buyers
Willingness to pay
59
Aleisha
Brad
45
Brad
45
35
Claudia
Claudia
25
35
Darren
10
Edwina
Darren
25
A consumers willingness to pay for a good is the
maximum price at which he or she would buy that
good.
10
Edwina
D
5
4
3
2
1
0
Quantity of books
5
Willingness to Pay

• Not a smooth curve because it is only dealing
  with a small number of consumers
• Each horizontal segment how much one is willing
  to pay
• What is the quantity demanded at 59?
• What is the quantity demanded at 45?

6
Willingness to Pay Consumer Surplus

• Campus Bookstore makes used textbooks available
  at a price of 30. Who will buy books?
• Do they gain from their purchase?

7
Consumer Surplus in the Used Textbook Market
Aleishas consumer surplus 59-3929
The total consumer surplus is given by the entire
shaded area - the sum of the individual consumer
surpluses of Aleisha, Brad, and Claudia - equal
to 29 15 5 49.

8
Willingness to Pay Consumer Surplus

• Individual Consumer Surplus net gain that a
  buyer achieves from the purchase of a good
• Whenever a buyer pays a price less than his or
  her willingness to pay, the buy achieves an
  individual consumer surplus
• Total Consumer Surplus sum of the individual
  consumer surpluses achieved by all the buyers of
  a good
• Aleisha, Brad and Claudia 29 15 5 49

9
Consumer Surplus

• Refers to both individual and total consumer
  surplus
• Total consumer surplus is equal to the area below
  the demand curve but above the price

The total consumer surplus generated by
purchases of a good at a given price is equal
to the area below the demand curve but above
that price
10
Changing Prices Affects Consumer Surplus

• Textbook Example again..
• BUTthe bookstore has now decided to sell used
  textbooks for 20 instead of 30. How much would
  this fall in price increase consumer surplus?

11
Consumer Surplus and a Fall in the Price of Used
Textbooks
12
Changing Prices Affects Consumer Surplus

• The graph showed that when the price of a good
  falls, the area under the demand curve but not
  above the price (which is equal to total consumer
  surplus) increases

13
Producer Surplus and the Supply Curve

• We have buyers of goods that would be willing to
  pay more for their purchase than the price they
  actually pay
• Some sellers of a good would have been willing to
  sell it for less than the price they actually
  receive

14
Producer Surplus and the Supply Curve

• Sellers cost lowest price at which a potential
  seller is willing to sell
• What is Andrews cost? What is Bettys cost?

15
Producer Surplus and the Supply Curve

• Since the students dont have to manufacture the
  books, does it cost the student who sells a book
  anything to make that book available for sale?
• YES!
• You wont have it later in your personal
  collection opportunity cost!
• When saying cost of a good as a seller,
  referring to selling that good even if you dont
  spend any money to sell the good

16
Producer Surplus and the Supply Curve

• Individual Producer Surplus the net gain, the
  difference between the price he actually gets and
  his cost, the minimum price at which he would
  have been willing to sell
• Total Producer Surplus the total net gain to
  all sellers in the market
• Producer Surplus refers to either the total or
  individual producer surplus

17
Producer Surplus in the Used Textbook Market
Total Producer Surplus is given by the entire
shaded area, the sum of the individual producer
surpluses of Andrew, Betty, and Carlos. 25
15 5 45
The total producer surplus from sales of a good
at a given price is the area above the supply
curve but below that price.
18
How Changing Price Affects Producer Surplus

• When the price of a good rises, producer surplus
  increases through two ways
• The gains of those who would have supplied the
  good even at the original, lower price and
• The gains of those who are induced to supply the
  good by the higher price

19
A Rise in the Price Increases Producer Surplus
20
Consumer Surplus, Producer Surplus, and the Gains
from Trade

• Total Surplus generated in a market is the total
  net gain to consumers and producers from trading
  in the market. It is the sum of the producer and
  the consumer surplus
• This also shows there are gains from trade

21
Total Surplus
22
The Efficiency of Markets

• Markets are usually efficient
• Are they?
• It is claimed that once the market has produced
  its gains from trade, there is no way to make
  some people better off without making ofther
  people worse off, except..under well-defined
  conditions

23
The Efficiency of Markets

• A committee wants to improve on the market
  equilibrium by deciding who gets and who gives up
  a used textbook. The goal of the committee
  bypass the market outcome and come up with
  another arrangement that would produce higher
  total surplus

24
The Efficiency of Markets

• Three ways to increase the total surplus
• Reallocate consumption among consumers
• Reallocate sales among sellers
• Change the quantity traded

25
1. Reallocate consumption among consumers

• Committee tries to increase total surplus by
  selling books to different consumers

26
2. Reallocate sales among sellers

• Committee tried to increase total surplus by
  altering who sells their books, taking sales away
  from sellers who would have sold their books in
  the market equilibrium and instead compelling
  those who would not have sold their books in the
  market equilibrium to sell them

27
3. Change the quantity traded

• Committee tries to increase total surplus by
  compelling students to trade either more books or
  fewer books than the market equilibrium quantity.

28
The Efficiency of Markets

• Key Idea once this market is in equilibrium,
  there is no way to increase the gains from trade
• An efficient market performs four important
  functions

29
The Efficiency of Markets

• An efficient market performs four important
  functions
• It allocates consumption of the good to the
  potential buyers who most value it, as indicated
  by the fact that they have the highest
  willingness to pay
• It allocates sales to the potential sellers who
  most value the right to sell the good, as
  indicated by the fact that they have the lowest
  cost

30
The Efficiency of Markets

1. It ensures that every consumer who makes a
   purchase values the good more than every seller
   who makes a sale, so that all transactions are
   mutually beneficial
2. It ensures that every potential buyer who doesnt
   make a purchase values the good less than every
   potential seller who doesnt make a sale, so that
   no mutually beneficial transaction are missed

31
The Efficiency of Markets

• Three caveats
• Market can be efficient, it isnt necessarily
  fair
• Markets sometimes fail
• Even when market equilibrium maximizes total
  surplus, this does not mean that it results in
  the best outcome for every individual consumer
  and producer

32
The Efficiency of Markets

• Efficiency is about how to achieve goals, not
  what those goals should be

33
Consumer Surplus, Producer Surplus, and Market
Efficiency Notes
34
Willingness to Pay

• Individuals wont buy the good if it costs more
  than this among but eager to do so if it cost
  less
• If the price is just equal to an individuals
  willingness to pay, he or she is indifferent
  between buying and not buying

35
The Demand Curve for Used Textbooks
Price of book
Aleisha
59
Potential buyers
Willingness to pay
59
Aleisha
Brad
45
Brad
45
35
Claudia
Claudia
25
35
Darren
10
Edwina
Darren
25
10
Edwina
D
5
4
3
2
1
0
Quantity of books
36
Willingness to Pay

• What is the quantity demanded at 59?
• What is the quantity demanded at 45?

37
Willingness to Pay Consumer Surplus

• Campus Bookstore makes used textbooks available
  at a price of 30. Who will buy books?
• Do they gain from their purchase?

38
Consumer Surplus in the Used Textbook Market
Aleishas consumer surplus 59-3929

39
Willingness to Pay Consumer Surplus

• Individual Consumer Surplus net gain that a
  buyer achieves from the purchase of a good
• Total Consumer Surplus sum of the individual
  consumer surpluses achieved by all the buyers of
  a good

40
Consumer Surplus

• Refers to both individual and total consumer
  surplus

41
Consumer Surplus and a Fall in the Price of Used
Textbooks
42
Changing Prices Affects Consumer Surplus

• The graph showed that when the price of a good
  falls, the area under the demand curve but not
  above the price (which is equal to total consumer
  surplus) increases

43
Producer Surplus and the Supply Curve

• We have buyers of goods that would be willing to
  pay more for their purchase than the price they
  actually pay

44
Producer Surplus and the Supply Curve

• Sellers cost lowest price at which a potential
  seller is willing to sell
• What is Andrews cost? What is Bettys cost?

45
Producer Surplus and the Supply Curve

• Since the students dont have to manufacture the
  books, does it cost the student who sells a book
  anything to make that book available for sale?
• YES!

46
Producer Surplus and the Supply Curve

• Individual Producer Surplus
• Total Producer Surplus
• Producer Surplus

47
Producer Surplus in the Used Textbook Market
48
How Changing Price Affects Producer Surplus

• When the price of a good rises, producer surplus
  increases through two ways

49
A Rise in the Price Increases Producer Surplus
50
Consumer Surplus, Producer Surplus, and the Gains
from Trade

• This also shows there are gains from trade

51
Total Surplus
52
The Efficiency of Markets

• Markets are usually efficient
• Are they?
• It is claimed that once the market has produced
  its gains from trade, there is no way to make
  some people better off without making ofther
  people worse off, except..under well-defined
  conditions

53
The Efficiency of Markets

• A committee wants to improve on the market
  equilibrium by deciding who gets and who gives up
  a used textbook. The goal of the committee
  bypass the market outcome and come up with
  another arrangement that would produce higher
  total surplus

54
The Efficiency of Markets

• Three ways to increase the total surplus
• Reallocate consumption among consumers
• Reallocate sales among sellers
• Change the quantity traded

55
1. Reallocate consumption among consumers

• Committee tries to increase total surplus by
  selling books to different consumers

56
2. Reallocate sales among sellers

• Committee tried to increase total surplus by
  altering who sells their books, taking sales away
  from sellers who would have sold their books in
  the market equilibrium and instead compelling
  those who would not have sold their books in the
  market equilibrium to sell them

57
3. Change the quantity traded

• Committee tries to increase total surplus by
  compelling students to trade either more books or
  fewer books than the market equilibrium quantity.

58
The Efficiency of Markets

• Key Idea once this market is in equilibrium,
  there is no way to increase the gains from trade
• An efficient market performs four important
  functions

59
The Efficiency of Markets

• An efficient market performs four important
  functions
• It allocates consumption of the good to the
  potential buyers who most value it, as indicated
  by the fact that they have the highest
  willingness to pay
• It allocates sales to the potential sellers who
  most value the right to sell the good, as
  indicated by the fact that they have the lowest
  cost

60
The Efficiency of Markets

1. It ensures that every consumer who makes a
   purchase values the good more than every seller
   who makes a sale, so that all transactions are
   mutually beneficial
2. It ensures that every potential buyer who doesnt
   make a purchase values the good less than every
   potential seller who doesnt make a sale, so that
   no mutually beneficial transaction are missed

61
The Efficiency of Markets

• Three caveats
• Market can be efficient, it isnt necessarily
  fair
• Markets sometimes fail
• Even when market equilibrium maximizes total
  surplus, this does not mean that it results in
  the best outcome for every individual consumer
  and producer

62
The Efficiency of Markets

• Efficiency is about how to achieve goals, not
  what those goals should be