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1、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 mar
2、kets 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
3、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,
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,
5、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 w
6、ould 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
7、 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 an
8、d 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
9、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
10、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 $20.How much will CS increas
11、e due to,C. buyers entering the market D.existing buyers paying lower price,$,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
12、 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
13、,$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 s
14、urplus (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.,.,
15、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
16、 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
17、 the increase in PS due to,C. selling 5 additional units D. getting a higher price on the initial 10 units,26,A C T I V E L E A R N I N G 2 Producer surplus,.,27,CS, PS, and Total Surplus,CS = (value to buyers) (amount paid by buyers) = buyers gains from participating in the market PS = (amount rece
18、ived by sellers) (cost to sellers) = sellers gains from participating in the market Total surplus = CS + PS = total gains from trade in a market = (value to buyers) (cost to sellers),.,28,The Markets Allocation of Resources,In a market economy, the allocation of resources is decentralized, determine
19、d by the interactions of many self-interested buyers and sellers. Is the markets allocation of resources desirable? Or would a different allocation of resources make society better off? To answer this, we use total surplus as a measure of societys well-being, and we consider whether the markets allo
20、cation is efficient. (Policymakers also care about equality, though are focus here is on efficiency.),.,29,Efficiency,An allocation of resources is efficient if it maximizes total surplus. Efficiency means: The goods are consumed by the buyers who value them most highly. The goods are produced by th
21、e producers with the lowest costs. Raising or lowering the quantity of a good would not increase total surplus.,.,30,Evaluating the Market Equilibrium,Market eqm: P = $30 Q = 15,000 Total surplus = CS + PS Is the market eqm efficient?,.,31,Which Buyers Consume the Good?,Every buyer whose WTP is $30
22、will buy. Every buyer whose WTP is $30 will not. So, the buyers who value the good most highly are the ones who consume it.,.,32,Which Sellers Produce the Good?,Every seller whose cost is $30 will produce the good. Every seller whose cost is $30 will not. So, the sellers with the lowest cost produce
23、 the good.,.,33,Does Eqm Q Maximize Total Surplus?,At Q = 20, cost of producing the marginal unit is $35 value to consumers of the marginal unit is only $20 Hence, can increase total surplus by reducing Q. This is true at any Q greater than 15.,.,34,Does Eqm Q Maximize Total Surplus?,At Q = 10, cost
24、 of producing the marginal unit is $25 value to consumers of the marginal unit is $40 Hence, can increase total surplus by increasing Q. This is true at any Q less than 15.,.,35,Does Eqm Q Maximize Total Surplus?,The market eqm quantity maximizes total surplus:At any other quantity, can increase tot
25、al surplus by moving toward the market eqm quantity.,.,36,Adam Smith and the Invisible Hand,“Man has almost constant occasion for the help of his brethren, and it is vain for him to expect it from their benevolence only.,Adam Smith, 1723-1790,Passages from The Wealth of Nations, 1776,He will be more
26、 likely to prevail if he can interest their self-love in his favor, and show them that it is for their own advantage to do for him what he requires of them,It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.,
27、.,37,Adam Smith and the Invisible Hand,“Every individualneither intends to promote the public interest, nor knows how much he is promoting it.,Adam Smith, 1723-1790,Passages from The Wealth of Nations, 1776,He intends only his own gain, and he is in this, as in many other cases, led by an invisible
28、hand to promote an end which was no part of his intention.,Nor is it always the worse for the society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it.”,an invisible hand,.,38,The Free Market
29、 vs. Govt Intervention,The market equilibrium is efficient. No other outcome achieves higher total surplus. Govt cannot raise total surplus by changing the markets allocation of resources. Laissez faire (French for “allow them to do”): the notion that govt should not interfere with the market.,.,39,
30、The free market vs. central planning,Suppose resources were allocated not by the market, but by a central planner who cares about societys well-being. To allocate resources efficiently and maximize total surplus, the planner would need to know every sellers cost and every buyers WTP for every good i
31、n the entire economy. This is impossible, and why centrally-planned economies are never very efficient.,.,40,CONCLUSION,This chapter used welfare economics to demonstrate one of the Ten Principles: Markets are usually a good way to organize economic activity. Important note: We derived these lessons
32、 assuming perfectly competitive markets. In other conditions we will study in later chapters, the market may fail to allocate resources efficiently,.,41,CONCLUSION,Such market failures occur when: a buyer or seller has market power the ability to affect the market price. transactions have side effec
33、ts, called externalities, that affect bystanders. (example: pollution) Well use welfare economics to see how public policy may improve on the market outcome in such cases. Despite the possibility of market failure, the analysis in this chapter applies in many markets, and the invisible hand remains
34、extremely important.,CHAPTER SUMMARY,The height of the D curve reflects the value of the good to buyerstheir willingness to pay for it. Consumer surplus is the difference between what buyers are willing to pay for a good and what they actually pay. On the graph, consumer surplus is the area between
35、P and the D curve.,42,CHAPTER SUMMARY,The height of the S curve is sellers cost of producing the good. Sellers are willing to sell if the price they get is at least as high as their cost. Producer surplus is the difference between what sellers receive for a good and their cost of producing it. On th
36、e graph, producer surplus is the area between P and the S curve.,43,CHAPTER SUMMARY,To measure of societys well-being, we use total surplus, the sum of consumer and producer surplus. Efficiency means that total surplus is maximized, that the goods are produced by sellers with lowest cost, and that they are consumed by buyers who most value them. Under perfect competition, the market outcome is efficient. Altering it would reduce total surplus.,44,