7 - Consumers, Producers, and the Efficiency of Markets

This chapter covers welfare economics, which is the study of how the allocation of resources affects economic well-being.

7.1 - Consumer Surplus

Willingness to Pay

A buyer’s maximum value that they are willing to pay for a good or service is called their willingness to pay.

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

\[ \text{Consumer surplus} = \text{Value to buyers } - \text{ Amount paid by buyers} \]

Using the Demand Curve to Measure Consumer Surplus

The marginal buyer is the buyer who would leave a market first if the price of a good were any higher.

The area below the demand curve and above the price measures the consumer surplus in a market.

What Does Consumer Surplus Mean?

Consumer surplus measures the benefit that buyers derive from the market as the buyers themselves perceive it. In most markets, this reflects consumer well-being.

7.2 - Producer Surplus

Cost and Willingness to Sell

In this situation, cost is interpreted as the opportunity cost (i.e. the cost of choosing not to do anything else).

Producer surplus is the amount a seller is paid minus his cost of production.

\[ \text{Producer surplus} = \text{Amount received by sellers } - \text{ Cost to sellers} \]

Using the Supply Curve to Measure Producer Surplus

The marginal seller is the seller who would leave a market first if the price of a good were any lower.

The area below the price and above the supply curve measures the producer surplus in a market.

7.3 - Market Efficiency

Benevolent Social Planners

Total surplus, calculated as the sum of consumer and producer surplus, is a measure of societal well-being.

\[\begin{split} \begin{align*} \text{Total surplus} &= \text{Consumer surplus } + \text{ Producer surplus} \\ &= (\text{Value to buyers } - \text{ Amount paid by buyers}) + (\text{Amount received by sellers } - \text{ Cost to sellers}) \\ &= \text{Value to buyers } - \text{ Cost to sellers} \end{align*} \end{split}\]

If the allocation of resources maximizes total surplus, economists say that the allocation exhibits efficiency.

Equality is the property of distributing economic prosperity uniformly among members of society.

Evaluating the Market Equilibrium

The area between the supply and demand curves up to the point of equilibrium represents the total surplus of a market.