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1、7CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETSrketsWHATS NEW IN THE SIXTH EDITION:There are no major changes to this chapter.LEARNING OBJECTIVES:By the end of this chapter, students should understand:the link between buyers willingness to pay for a good and the demand curve.how to define and m
2、easure consumer surplus.the link between sellers costs of producing a good and the supply curve.how to define and measure producer surplus.that the equilibrium of supply and demand maximizes total surplus in a market.CONTEXT AND PURPOSE:Chapter 7 is the first chapter in a three-chapter sequence on w
3、elfare economics and market efficiency. Chapter 7 employs the supply and demand model to develop consumer surplus and producer surplus as a measure of welfare and market efficiency. These concepts are then utilized in Chapters 8 and 9 to determine the winners and losers from taxation and restriction
4、s on international trade.The purpose of Chapter 7 is to develop welfare economicsthe study of how the allocation of resources affects economic well-being. Chapters 4 through 6 employed supply and demand in a positive framework, which focused on the question, “What is the equilibrium price and quanti
5、ty in a market?” This chapter now addresses the normative question, “Is the equilibrium price and quantity in a market the best possible solution to the resource allocation problem, or is it simply the price and quantity that balance supply and demand?” Students will discover that under most circums
6、tances the equilibrium price and quantity is also the one that maximizes welfare.KEY POINTS:Consumer surplus equals buyers willingness to pay for a good minus the amount they actually pay for it, and it measures the benefit buyers get from participating in a market. Consumer surplus can be computed
7、by finding the area below the demand curve and above the price.Producer surplus equals the amount sellers receive for their goods minus their costs of production, and it measures the benefit sellers get from participating in a market. Producer surplus can be computed by finding the area below the pr
8、ice and above the supply curve.An allocation of resources that maximizes the sum of consumer and producer surplus is said to be efficient. Policymakers are often concerned with the efficiency, as well as the equality, of economic outcomes.The equilibrium of supply and demand maximizes the sum of con
9、sumer and producer surplus. That is, the invisible hand of the marketplace leads buyers and sellers to allocate resources efficiently.Markets do not allocate resources efficiently in the presence of market failures such as market power or externalities.CHAPTER OUTLINE:I.Definition of welfare economi
10、cs: the study of how the allocation of resources affects economic well-being.Students often are confused by the use of the word “welfare.” Remind them that we are talking about social well-being and not public assistance.II.Consumer SurplusA.Willingness to Pay1.Definition of willingness to pay: the
11、maximum amount that a buyer will pay for a good.2.Example: You are auctioning a mint-condition recording of Elvis Presleys first album. Four buyers show up. Their willingness to pay is as follows:Students will understand consumer surplus if you take the time to work through the Elvis Presley example
12、. If you start with this simple example, students will have no trouble understanding how to find consumer surplus on a graph.Table 1BuyerWillingness to PayJohn$100Paul$80George$70Ringo$50If the bidding goes to slightly higher than $80, all buyers drop out except for John. Because John is willing to
13、pay more than he has to for the album, he derives some benefit from participating in the market.Activity 1Value of a Time MachineType:In-class demonstrationTopics: Consumer surplusMaterials needed: NoneTime: 10 minutesClass limitations: Works in any size classPurposeConsumer surplus can be a hard co
14、ncept for students because it is based on avoided expense rather than on money that is actually exchanged. This example puts a specific dollar value on consumer surplus.InstructionsTell the class, “A new technology has been developed that allows individuals to travel backward or forward in time. We
15、want to identify the value this time machine provides to consumers. Lets assume the four consumers who most desire this product are in this class.”Choose four student names and use them in the following example:“Scott is the consumer who most values this product. He wants to go back to the time of t
16、he dinosaurs. He is willing to pay $3,000.”“Carol is the consumer with the next highest willingness to pay. She would like to see 200 years in the future. Shed pay $2,500.”“Steve is the next highest bidder. Hed like to relive this entire semester. Hell pay up to $800.”“Jeanne is our fourth consumer.
17、 Shed pay $200 to move the clock forward to the end of this class period.”On the board write:Scott $3,000Carol $2,500Steve $800Jeanne$2003.Definition of consumer surplus: the amount a buyer is willing to pay for a good minus the amount the buyer actually pays for it.4.Note that if you had more than
18、one copy of the album, the price in the auction would end up being lower (a little over $70 in the case of two albums) and both John and Paul would gain consumer surplus.“This represents the demand curve for the time machine. Consumer surplus is the difference between what consumers are willing to p
19、ay and the amount they actually have to pay. The market price will determine who uses the time machine and how much surplus they keep.”“If the price of a time machine ride was $500, three rides would be soldone to Scott, one to Carol, and one to Steve. Jeanne is not willing to pay $500, so she would
20、nt time travel.” “We can calculate the consumer surplus of three time trips. Scott would pay $3,000 but only pays $500, leaving $2,500 of net benefits.” (Put these numbers on the board.) “Carol has net benefits of $2,000. Steve has $300 in net benefits. Adding up these net savings gives $4,800 in co
21、nsumer surplus.”Points for DiscussionThe consumer surplus depends on a goods selling price and the number of consumers who are willing to purchase the good at that price. The lower the price, the greater the consumer surplus.B.Using the Demand Curve to Measure Consumer Surplus1.We can use the inform
22、ation on willingness to pay to derive a demand curve for the rare Elvis Presley album.PriceBuyersQuantity DemandedMore than $100None0$80 to $100John1$70 to $80John, Paul2$50 to $70John, Paul, George3$50 or lessJohn, Paul, George, Ringo4Figure 12.At any given quantity, the price given by the demand c
23、urve reflects the willingness to pay of the marginal buyer. Because the demand curve shows the buyers willingness to pay, we can use the demand curve to measure consumer surplus.Figure 23.Consumer surplus can be measured as the area below the demand curve and above the price.C.How a Lower Price Rais
24、es Consumer SurplusFigure 31.As price falls, consumer surplus increases for two reasons.a.Those already buying the product will receive additional consumer surplus because they are paying less for the product than before (area A on the graph).b.Because the price is now lower, some new buyers will en
25、ter the market and receive consumer surplus on these additional units of output purchased (area B on the graph).D.What Does Consumer Surplus Measure?It is important to stress that consumer surplus is measured in monetary terms. Consumer surplus gives us a way to place a monetary cost on inefficient
26、market outcomes (due to government involvement or market failure).1.Remember that consumer surplus is the difference between the amount that buyers are willing to pay for a good and the price that they actually pay. 2.Thus, it measures the benefit that consumers receive from the good as the buyers t
27、hemselves perceive it.ALTERNATIVE CLASSROOM EXAMPLE:Review the material on price ceilings from Chapter 6. Redraw the market for two-bedroom apartments in your town. Draw in a price ceiling below the equilibrium price. Then go through:consumer surplus before the price ceiling is put into place.consum
28、er surplus after the price ceiling is put into place.III.Producer SurplusA.Cost and the Willingness to Sell1.Definition of cost: the value of everything a seller must give up to produce a good.You will need to take some time to explain the relationship between the producers willingness to sell and t
29、he cost of producing the good. The relationship between cost and the supply curve is not as apparent as the relationship between the demand curve and willingness to pay.2.Example: You want to hire someone to paint your house. You accept bids for the work from four sellers. Each painter is willing to
30、 work if the price you will pay exceeds her opportunity cost. (Note that this opportunity cost thus represents willingness to sell.) The costs are:SellerCostMary$900Frida$800Georgia$600Grandma$500Table 23.Bidding will stop when the price gets to be slightly below $600. All sellers will drop out exce
31、pt for Grandma. Because Grandma receives more than she would require to paint the house, she derives some benefit from producing in the market.4.Definition of producer surplus: the amount a seller is paid for a good minus the sellers cost of providing it.5.Note that if you had more than one house to
32、 paint, the price in the auction would end up being higher (a little under $800 in the case of two houses) and both Grandma and Georgia would gain producer surplus.B.Using the Supply Curve to Measure Producer Surplus1.We can use the information on cost (willingness to sell) to derive a supply curve
33、for house painting services.PriceSellersQuantity Supplied$900 or moreMary, Frida, Georgia, Grandma4$800 to $900Frida, Georgia, Grandma3$600 to $800Georgia, Grandma2$500 to $600Grandma1less than $500None02.At any given quantity, the price given by the supply curve represents the cost of the marginal
34、seller. Because the supply curve shows the sellers cost (willingness to sell), we can use the supply curve to measure producer surplus.Figure 4Figure 53.Producer surplus can be measured as the area above the supply curve and below the price.C.How a Higher Price Raises Producer SurplusFigure 61.As pr
35、ice rises, producer surplus increases for two reasons.a.Those already selling the product will receive additional producer surplus because they are receiving more for the product than before (area C on the graph).b.Because the price is now higher, some new sellers will enter the market and receive p
36、roducer surplus on these additional units of output sold (area D on the graph).ALTERNATIVE CLASSROOM EXAMPLE:Review the material on price floors from Chapter 6. Redraw the market for an agricultural product such as corn. Draw in a price support above the equilibrium price. Then go through:producer s
37、urplus before the price support is put in place.producer surplus after the price support is put in place. Make sure that you discuss the cost of the price support to taxpayers.D.Producer surplus is used to measure the economic well-being of producers, much like consumer surplus is used to measure th
38、e economic well-being of consumers.Pretty Woman, Chapter 6. Vivien (Julia Roberts) and Edward (Richard Gere) negotiate a price. Afterward, Vivien reveals she would have accepted a lower price, while Edward admits he would have paid more. If you have done a good job of introducing consumer and produc
39、er surplus, you will see the light bulbs go off above your students heads as they watch this clip.IV.Market EfficiencyA.The Benevolent Social Planner1.The economic well-being of everyone in society can be measured by total surplus, which is the sum of consumer surplus and producer surplus:Total Surp
40、lus = Consumer Surplus + Producer SurplusTotal Surplus = (Value to Buyers Amount Paid by Buyers) + (Amount Received by Sellers Cost to Sellers)Because the Amount Paid by Buyers = Amount Received by Sellers:2.Definition of efficiency: the property of a resource allocation of maximizing the total surp
41、lus received by all members of society.3.Definition of equality: the property of distributing economic prosperity uniformly the members of society.Now might be a good time to point out that many government policies involve a trade-off between efficiency and equity. When you evaluate government polic
42、ies, like price ceilings or floors, you can explain them in terms of equity and efficiency.B.Evaluating the Market EquilibriumFigure 71.At the market equilibrium price:a.Buyers who value the product more than the equilibrium price will purchase the product; those who do not, will not purchase the pr
43、oduct. In other words, the free market allocates the supply of a good to the buyers who value it most highly, as measured by their willingness to pay.b.Sellers whose costs are lower than the equilibrium price will produce the product; those whose costs are higher, will not produce the product. In ot
44、her words, the free market allocates the demand for goods to the sellers who can produce it at the lowest cost.2.Total surplus is maximized at the market equilibrium.Figure 8a.At any quantity of output smaller than the equilibrium quantity, the value of the product to the marginal buyer is greater t
45、han the cost to the marginal seller so total surplus would rise if output increases.b.At any quantity of output greater than the equilibrium quantity, the value of the product to the marginal buyer is less than the cost to the marginal seller so total surplus would rise if output decreases.3.Note th
46、at this is one of the reasons that economists believe Principle #6: Markets are usually a good way to organize economic activity.It would be a good idea to remind students that there are circumstances when the market process does not lead to the most efficient outcome. Examples include situations su
47、ch as when a firm (or buyer) has market power over price or when there are externalities present. These situations will be discussed in later chapters.C.In the News: Ticket Scalping1.Ticket scalping is an example of how markets work to achieve an efficient outcome.2.This article from The Boston Globe describes economist Chip Cases experience with