Harcourt Brace & Company Chapter 7 Consumers, Producers and the Efficiency of Markets

Harcourt Brace & Company

Chapter 7

Consumers, Producers and the Efficiency of Markets


Market Equilibrium Revisited Does the equilibrium price and quantity result in the maximum total welfare of buyer and seller?

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Market Equilibrium RevisitedDoes the equilibrium price and quantity result in the maximum total welfare of buyer and seller?

Market equilibrium illustrates the way markets allocate scarce resources.

But does it answer whether that market allocation is desirable?

We can turn to Welfare Economics to answer the question.


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 makes the sum of these benefits as large as possible.


Welfare Economics

Equilibrium in the market results in maximum benefits, and therefore total welfare for both the buyer and the seller.

Welfare Economics from the Buyer Side and the Seller Side:– Consumer Surplus– Producer Surplus


Welfare Economics: Consumer Surplus

Market Demand Curve: depicts the various quantities that buyers would want to purchase at different prices.

What determines how much a consumer would be willing to pay (the maximum price) for a good or service?– Answer: The expected benefits received

or Utility.


Utility is...

… the satisfaction (benefit) that a consumer expects to receive from consuming a good or service.

…the power to satisfy a want.


Marginal Utility (MU) is...

…the amount of utility (satisfaction) that one more unit of consumption adds to total utility.– Consumers try to obtain the largest

possible total satisfaction (utility) from the mix of goods and services they buy with their incomes.


Consumer Surplus is...

…the maximum amount a consumer will be willing to pay for a good depends upon the expected utility (benefits) of that good.– Willingness to Pay:

The maximum price that a buyer is willing and able to pay for a good.

Measures how much the buyer values the good or service.


Consumer Surplus: Verbal Definition

The amount a buyer is willing to pay for a good minus the amount the buyer actually pays for it.

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Consumer Surplus: Graphical

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Consumer Surplus: Graphical

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Consumer Surplus


Consumer Surplus and Market Price

The area below the demand curve and above the market price measures the consumer surplus in a market. Hence,– A lower market price will increase

consumer surplus

– A higher market price will reduce consumer surplus


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CONSUMER SURPLUS

ConsumersExpense


Producer Surplus Market Supply Revisited:

– Depicts the various quantities that suppliers would be willing to sell at different prices.

– May be viewed as a measure of supplier costs, i.e.. the opportunity cost to the seller of supplying various quantities of the good.


Producer Surplus: Verbal Definition

The amount a seller is paid minus the cost of production.

Producer surplus measures the benefit to sellers of participating in a market.

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Producer Surplus: Graphical

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Producer Surplus: Graphical

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ProducerSurplus


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Producer Surplus

Producer Costs


Market Efficiency

Under the assumptions of perfect competition and no externalities, the economic well-being of a society is measured as the sum of consumer surplus and producer surplus.

Market Efficiency is attained when total surplus is maximized, a point where resource allocation is efficient.


Market Efficiency

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Market Efficiency

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Market Efficiency: Three observations

Free markets allocate the supply of goods to the buyers who value them most highly.

Free markets allocate the demand for goods to the sellers who can produce them at least cost.

Free markets produce the quantity of goods that maximizes the sum of consumer and producer surplus.


Market Efficiency: Invisible Hand In a free market system the many buyers

and sellers are interested in their own well-being, self-interest.

As market participants are motivated by self-interest a process of coordination and communication takes place so that buyers and sellers are directed to the most efficient outcome.

As if by an Invisible Hand, the free market system reaches efficiency.


Market Failure If a market system affects individuals

other than buyers and sellers of that market, side-effects are created and called Externalities.– Benefits or costs imposed on a third

party who is not the consumer or the producer.

Externalities cause markets to be inefficient, and thus fail.

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Harcourt Brace & Company Chapter 7 Consumers, Producers and the Efficiency of Markets