Consumer Surplus

Willingness to Pay: the value of a good to a person
Consumer Surplus: the benefit that a buyer gets calculated by the willingness to pay for a good mius the amount the buyer actually pays for it.
Consumer Surplus
Consumer Surplus

http://www.ecosystemvaluation.org/demand_curve1.gif
How do you calculate Consumer Surplus?
Consumer Surplus = Value to buyers - Amount paid by buyers
The area below the demand curve and above the price measures the consumer surplus in a market.
Because buyers always want to pay less for the goods they buy, a lower price makes buyers of a good better off.

At any quantity, the price given by the demand curve shows the willingness to pay of the marginal buyer, the buyer who would leave the market first if the price were any higher.

Consumer Surplus
Consumer Surplus

http://www.chass.utoronto.ca/~reak/eco100/surplus1.gif
The Consumer Surplus at Price P is the area A. When the price falls from P to P' and the quantity rises from q to q', consumer surplus increases. Area A is the initial consumer surplus, B is the additional consumer surplus to initial consumers, and C is the Consumer Surplus to new consumers.

http://www.youtube.com/watch?v=qTxniCLYgok



Market Efficiency

*economists use consumer surplus and producer surplus to study the welfare of buyers and sellers in the market.
-This can help us answer a fundamental question
→ IS THE ALLOCATION OF RESOURCES DETERMINED BY FREE-MARKETS DESIRABLE?


*QUICK REMINDER*

Consumer surplus: benefit that buyers receive from participating in a market
→ Consumer surplus= Value to buyers – Amount paid by buyers
Producer surplus: the benefit that sellers receive.
→ Producer surplus= Amount received by sellers – Cost to sellers
Therefore,
→Total surplus= Consumer surplus+ Producer Surplus
→Total surplus= Value to buyers – Amount paid by buyers+ Amount received by sellers – Cost to sellers
-Amount paid by buyers = Amount received by sellers

So, Total surplus= Value to buyers – Cost to sellers


external image 500px-Consumer_Surplus.jpg
Red: Consumer Surplus
Blue: Producer Surplus

Red AND Blue: Total Surplus



Efficiency: The property of a resource allocation of maximizing the total surplus received by all members of society.
→If an allocation of resources maximizes total surplus, we say that the allocation exhibits efficiency.
→If an allocation is NOT efficient, gains from trade among buyers and sellers are not being realized.


Equity: Fairness of the distribution of well-being among the members of society.
*Evaluating Equity is harder than evaluating Efficiency.




EVALUATING THE MARKET EQUILIBRIUM

1. Free markets allocate the supply of goods to the buyers WHO VALUE THEM MOST HIGHLY, as measured by their WILLINGNESS TO PAY.
2. Free markets allocate the demand for good s to the sellers WHO CAN PRODUCE THEM AT LEAST COST.
3. Free market produce the quantity of goods that MAXIMIZES the sum of consumer and producer surplus.


Refer to the graph in your text book page 150.


Q1 : Value>Cost (Good)
Q1--> Q* : Surplus maximizes : Consumption and production is greater


Q2 : Value<Cost (Bad)
Q2-->Q* : Surplus maximizes : Consumption and production is less


http://www.youtube.com/watch?v=seKH552xd5c

http://www.youtube.com/watch?v=7RnIXc1ub1k&feature=related



QUESTION:
1. Why do economists think that free market is the best way to organize economic activity? (page 150-152)
2. Give me the equation for Consumer Surplus, Producer Surplus, and Total Surplus.
3. Who does the market allocate the supply of goods to?
4. Who does the market allocate the demand for goods to?
5. Where is consumer surplus, producer surplus and total surplus maximized?

Chapter 7 Answer KELJ


Summary

Consumer surplus equals buyer's willingness to pay for a good minus the amount they actually pay for ti, and it emasures the benfit buyers get from participating in a market. Producer surplus equals the amount sellers receive for their goods minus their costs of production and it emasures the benefit sellers get from participating in a market. An allocation of resources that maximizes the sum of consumer and producer surplus is said to be efficient. The equilibirum of supply and demand maximizes the sume of consumer and producer surplus.