Chapter+Seven

Consumers, Producers and the Efficiency of Markets


 The key to this chapter is **//Willingness to Pay//**. Willingness to pay, is just that. **The willingness of a consumer to pay for a certain product or service**. When the willingness to pay for a certain product or service is high, the producer can charge a higher price without sacrificing the number of items sold.

//**Surplus**// is profit, **it's the revenue minus all costs.** But it's not that simple, there's two different types of surplus. **//Producer Surplus//**, which is **revenue minus the costs of production** and **//Consumer Surplus//** which is the **Willingness to Pay (mentioned above) minus the amount they pay.**

These concepts may seem a little confusing, but when shown on a Supply/Demand graph it becomes clearer.

Consumer surplus is the area above the equilibrium price on a supply and demand curve between the two curves. Producer Surplus is the area below.

So the blue area is the consumer surplus. Everyone who's willingness to pay is above the current price is represented. Producer surplus is represented by the salmon colored area. For every unit of whatever it is they're selling or providing that they sell or provide, they gain revenue. Revenue minus the cost of production (represented by the diagonal upward sloping line that the salmon colored area is touching).

Consumer surplus is the area above the equilibrium price on a supply and demand curve between the two curves. Producer Surplus is the area below.

Why is this important?

For three reasons.

Well firstly, it helps us understand how economics in principle work. Economics is the science of allocating limited resources to those who need it or want it the most. In most cases this can be quantified by how much each person __is willing to pay__. That's right, the Willingness to Pay discussed above. Second, it allows us to see which side (Consumer or Producer) is gaining the most benefit in a given market. This is important in calculating //**Equity**//, which is **how fairly the surplus is distributed in a given market**. Finally and most importantly, it lets us calculate the **//Total Surplus//** of a given market which in turn allows us to evaluate the health of the market. This is called market //**Efficiency**//. If a market is efficient, **it is said to have maximized the Total Surplus possible.**

Wait, let's take a step back here. What's Total Surplus? The //**Total Surplus**// is **the Consumer Surplus added to the Producer Surplus**. So in this case, Total Surplus would be the blue area added to the salmon colored area. Total Surplus represents how much wealth there is total in the market. Efficiency is directly related to Total Surplus as described above: Efficiency is the measure of how much the Total Surplus is maximized.

How can it be maximized? It's actually quite simple. Equilibrium price (smth you should've learned in earlier chapters) will maximize the surplus in the market. However Equity(mentioned above) also needs to be taken into account. While the graph shown represents a nice balance between producer and consumer surplus, it isn't always so. Sometimes the graph might looks more like this:



As you can see here, the consumer surplus is way larger than the producer surplus. This is a clear example of a market that isn't equitable, or doesn't have high equity. To correct this, government policymakers might try to impose government policies such as a price floor to give producers more surplus.



As you can see, the price floor raised the producer surplus significantly. The market has high equity, the surplus is now more evenly distributed than before. However there is also a third label on the graph for something else, **//Deadweight Loss(DWL)//**. What is Deadweight Loss? **DWL is an amount of surplus lost in a market that does not go to either party. Instead it is "lost".** Almost all government policies (such as the one just shown) create deadweight loss, which is inefficient.

So policymakers face a tradeoff: Market Efficiency or Equity. The more efficient a market is (how maximized the total surplus is) the less equitable it is (how evenly the surplus is distributed). And when policymakers impose a government policy in order to try and raise equity, they often create deadweight loss and decrease efficiency.

__Summary __
- consumer surplus is buyer's willingness to pay minus price.This is area below the demand curve and above the price Producer surplus is price minus seller's cost. This is area below the price and above the supply curve. - consumer surplus measures benefit buyers get from market. Producer surplus measures benefit sellers get. - total surplus is consumer surplus + producer surplus. When total surplus is maximized, it is said to be efficient. - it is important to consider both efficiency as well as equity - the equilibrium maximizes total surplus because visible hand of the market place leads buyers and sellers to allocate resources. - market failure is due to externality.


welfare economics: study of how the allocation of resources affects economic well-being willingness to pay: the maximum amount that a buyer will pay for a good consumer surplus: the amount a buyer is willing to pay for a good minus the amount the buyer actually pays for it cost: the value of everything a seller must give up to produce a good producer surplus: the amount a seller is paid for a good minus the seller's cost. efficiency: maximize total surplus. equity: how fairly resources are distributed.


1. What does invisible hand allow market to achieve?

2. How do you calculate consumer surplus?

3. How do you calculate producer surplus

4. What is market failure

answers 1. Invisible hand guides buyers and sellers to allocate resources efficiently

2. it is area below the demand curve and above the price. (Willingness to pay - Price)

3. Area below the price and above the supply curve. (Price - cost)

4. market failure is when single buyer or seller is able to manipulate the market prices

__Media __
media type="file" key="Factors of Production.mp3"

media type="youtube" key="WforwhGw5dI" height="344" width="425" http://kr.youtube.com/watch?v=WforwhGw5dI