ECON 202, Maclachlan, Spring 20051 Consumers, Producers, and the Efficiency of Markets Chapter 7

ECON 202, Maclachlan, Spring 2005 1

Consumers, Producers, and the Efficiency of Markets

Chapter 7


Efficiency Equity


Economic Welfare

Welfare of buyers: consumer surplus.Welfare of suppliers: producer surplus.What price and quantity in a market

maximizes the sum of the two?That’s the efficient allocation.


Consumer Surplus

Table 1 Four Possible Buyers’ Willingness to Pay

Copyright©2004 South-Western


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


(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


(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


Consumersurplus

Quantity

(a) Consumer Surplus at Price P

Price

0

Demand

P1

Q1

B

A

C

Figure 3 How the Price Affects Consumer Surplus


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


Producer Surplus

Table 2 The Costs of Four Possible Sellers

Copyright©2004 South-Western


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


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


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


Producersurplus

Quantity

(a) Producer Surplus at Price P

Price

0

Supply

B

A

C

Q1

P1

Figure 6 How the Price Affects Producer Surplus


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


Market Efficiency

Figure 7 Consumer and Producer Surplus in the Market Equilibrium


Producersurplus

Consumersurplus

Price

0 Quantity

Equilibriumprice

Equilibriumquantity

Supply

Demand

A

C

B

D

E

Figure 8 The Efficiency of the Equilibrium Quantity


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


Efficiency

The property of resource allocation of maximizing the total surplus received by all members of society.

Total surplus = CS + PS

= (value to buyers – amount paid by buyers)

+ (amount received by sellers – cost to sellers)

= value to buyers – cost to sellers


Market for Organs

“The average wait for a kidney transplant is 3.5 years and about 6,000 Americans die every year because a kidney cannot be found.”


End of Chapter Questions



9. Consider how health insurance affects the quantity of health care services performed. Suppose that the typical medical procedure has a cost of $100, yet a person with health insurance only pays $20 out-of-pocket when she chooses to have an additional procedure performed.

a) Draw demand curve, show quantity at $100 and $20. What are the welfare implications if the cost to society of an additional procedure is $100.

b) Given your analysis, why might the use of care be excessive.


10. Many parts of CA experienced a severe drought in the late 1980’s and early 1990’s.

a) Use S&D to show effect of a drought on the equilibrium price and quantity.

b) Many communities did not allow the price of water to change. Show the effect.

c) LA required all residents to cut consumption by 10%. Is this policy efficient?

d) What are the efficiency implications of allowing the price to adjust? What are the equity implications.


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ECON 202, Maclachlan, Spring 20051 Consumers, Producers, and the Efficiency of Markets Chapter 7