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Copyright © 2004 South-Western
77Consumers, Producers, and the
Efficiency of Markets
Copyright © 2004 South-Western
Welfare Economics
• Welfare economics is the study of how the allocation of resources affects economic well-being.
• Buyers and sellers receive benefits from taking part in the market.
• The equilibrium in a market maximizes the total welfare of buyers and sellers.
Copyright © 2004 South-Western
Welfare Economics
• Equilibrium in the market results in maximum benefits, and therefore maximum total welfare for both the consumers and the producers of the product.
• Consumer surplus measures economic welfare from the buyer’s side.
• Producer surplus measures economic welfare from the seller’s side.
Copyright © 2004 South-Western
CONSUMER SURPLUS
• Willingness to pay is the maximum amount that a buyer will pay for a good.
• It measures how much the buyer values the good or service.
• Consumer surplus is the buyer’s willingness to pay for a good minus the amount the buyer actually pays for it.
Table 1 Four Possible Buyers’ Willingness to Pay
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The Demand Schedule and the Demand Curve
Figure 1 The Demand Schedule and the Demand Curve
Copyright©2003 Southwestern/Thomson Learning
Price ofAlbum
0 Quantity ofAlbums
Demand
1 2 3 4
$100 John’s willingness to pay
80 Paul’s willingness to pay
70 George’s willingness to pay
50 Ringo’s willingness to pay
Figure 2 Measuring Consumer Surplus with the Demand Curve
Copyright©2003 Southwestern/Thomson Learning
(a) Price = $80
Price ofAlbum
50
70
80
0
$100
Demand
1 2 3 4 Quantity ofAlbums
John’s consumer surplus ($20)
Figure 2 Measuring Consumer Surplus with the Demand Curve
Copyright©2003 Southwestern/Thomson Learning
(b) Price = $70Price of
Album
50
70
80
0
$100
Demand
1 2 3 4
Totalconsumersurplus ($40)
Quantity ofAlbums
John’s consumer surplus ($30)
Paul’s consumersurplus ($10)
Figure 3 How the Price Affects Consumer Surplus
Copyright©2003 Southwestern/Thomson Learning
Consumersurplus
Quantity
(a) Consumer Surplus at Price P
Price
0
Demand
P1
Q1
B
A
C
Figure 3 How the Price Affects Consumer Surplus
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Initialconsumer
surplus
Quantity
(b) Consumer Surplus at Price P
Price
0
Demand
A
BC
D EF
P1
Q1
P2
Q2
Consumer surplusto new consumers
Additional consumersurplus to initial consumers
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PRODUCER SURPLUS
• Producer surplus is the amount a seller is paid for a good minus the seller’s cost.
• It measures the benefit to sellers participating in a market.
Table 2 The Costs of Four Possible Sellers
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The Supply Schedule and the Supply Curve
Figure 4 The Supply Schedule and the Supply Curve
Figure 5 Measuring Producer Surplus with the Supply Curve
Copyright©2003 Southwestern/Thomson Learning
Quantity ofHouses Painted
Price ofHouse
Painting
500
800
$900
0
600
1 2 3 4
(a) Price = $600
Supply
Grandma’s producersurplus ($100)
Figure 5 Measuring Producer Surplus with the Supply Curve
Copyright©2003 Southwestern/Thomson Learning
Quantity ofHouses Painted
Price ofHouse
Painting
500
800
$900
0
600
1 2 3 4
(b) Price = $800
Georgia’s producersurplus ($200)
Totalproducersurplus ($500)
Grandma’s producersurplus ($300)
Supply
Figure 6 How the Price Affects Producer Surplus
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Producersurplus
Quantity
(a) Producer Surplus at Price P
Price
0
Supply
B
A
C
Q1
P1
Figure 6 How the Price Affects Producer Surplus
Copyright©2003 Southwestern/Thomson Learning
Quantity
(b) Producer Surplus at Price P
Price
0
P1B
C
Supply
A
Initialproducersurplus
Q1
P2
Q2
Producer surplusto new producers
Additional producersurplus to initialproducers
D EF
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MARKET EFFICIENCY
• Consumer 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?
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MARKET EFFICIENCY
Total surplus
= Consumer surplus + Producer surplus
or
Total surplus
= Value to buyers – Cost to sellers
Figure 7 Consumer and Producer Surplus in the Market Equilibrium
Copyright©2003 Southwestern/Thomson Learning
Producersurplus
Consumersurplus
Price
0 Quantity
Equilibriumprice
Equilibriumquantity
Supply
Demand
A
C
B
D
E
Figure 8 The Efficiency of the Equilibrium Quantity
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Quantity
Price
0
Supply
Demand
Costto
sellers
Costto
sellers
Valueto
buyers
Valueto
buyers
Value to buyers is greaterthan cost to sellers.
Value to buyers is lessthan cost to sellers.
Equilibriumquantity
