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Econ 1B03 Chapter 7.docx

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McMaster University
Hannah Holmes

Richard Damra Thursday, January 31st, 2013 Econ 1B03 – Chapter 7 Revisiting the Market Eqilibirium  Do the equilibrium price and quantity maximize the total welfare of buyers and sellers?  Market equilibrium reflects the way markets allocate scarce resources.  Whether the market allocation is desirable can be addressed by welfare economics Welfare Economics  The study of how the allocation of resources affects economic well being  Buyers and sellers receive benefits from participating in the market.  Equilibrium in the market maximizes these benefits Consumer Surplus  Every buyer in an economy is only willing to pay up to a certain amount for a good or service. We define:  Willingness-to-pay: the maximum amount a buyer will pay for a good. Also called the reservation price. Measures the value the buyer places on the good.  When a buyer actually plays less than he/she is willing to pay, they enjoy a benefit. We define:  Consumer surplus: The buyer’s willingness-to-pay for a good minus the amount they actually pay.  Market demand curve depicts consumers’ willingness-to-pay o Depicts how consumers value the good.  Suppose the market price of a good is $50 o  We can illustrate total benefits: Consumer surplus, CS. It is the area under the demand curve above the selling price. In other words the area of a triangle.  In the above graph the CS(Consumer Surplus) is $11 250. Richard Damra Thursday, January 31st, 2013 How a Price Change Affects Consumer Surplus  Producer Surplus  Producer Surplus: Amount that a seller is paid for a good minus the seller’s cost  measures the benefit to sellers participating in the market.  Willingness-to-sell: Lowest price a supplier will take to produce a good and offer it for sale. o Cost is a measure of the sellers willingness-to-sell.  Just as consumer surplus is related to the demand curve, producer surplus is closely related to the supply curve. o The supply curve reflects a producer’s costs (more on costs in Chapter 13)  The area below the selling price and above the supply curve measures the producer surplus in a market.  Again suppose the selling price is $50 o Richard Damra
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