5.2: Benefit, Cost and Surplus
Supply and Marginal Cost
• Supply and cost parallels the ideas between demand and benefit
Question: Marginal Cost is
a) The same as marginal benefit because producers benefit from the money
they receive when they sell the good
b) The opportunity cost of producing one more unit
c) The total opportunity cost of producing all the units of the good
d) Zero at the efficient level of production
Supply, Cost, and Minimum Supply Price (page 110)
• Producers point of view: they distinguish between cost and price
• Cost is what the firm give up and price is what the firm receives when they sell
the good or service.
• Marginal cost (cost of producing one more unit of it) determines whether a
firm would want to produce another unit of it, but the minimum Supply price
determines supply. Marginal cost is the minimum price that a firm is willing to
• If a unit of coffee costs the firm 5 bucks to produce, how much would the firm
charge at least? They will charge at least 5 dollars.
• The minimum price determines supply. A supply curve is a marginal cost
curve. If you pay enough, the firm is willing to sell. (Marginal Cost)
• Supply price is a marginal cost curve
• Market supply curve give answers to the quantity that this market is willing
to produce at a certain price.
• Market supply: quantity in the graph is the addition of the individuals supply
quantity at the given prices.
• How do you know marginal cost is increasing? It increases because increases
opportunity cost. They have to sacrifice some resources. Marginal cost is
increasing because of increasing opportunity cost. You must give up more of
one resource to get another.
Individual Supply and Market Supply (page 110)
• The relationship between the price of good and the quantity supplied is
called the individual supply
• The relationship between the price of good and the quantity supplied by all
producers is called the market supply
• MARKET SUPPLY CURVE: horizontal sum of all the individual supply curve
and is formed by adding the quantities supplied by all the producers at each
• Society marginal cost is referred to as marginal social cost (MSC) Producer Surplus (page 111)
• Producer surplus is the excess amount received from a sale of good or
service over the cost of producing it
• Producer surplus is the price received for the good – marginal cost
• It is measured by the area below the market price and above the supply
curve, summed over the quantity sold
• More they sell, the higher the producer surplus
• Producer surplus = price received – marginal cost (minimum supply price)
• For example: The market price for pizza is 15 dollars. If she is willing to
produce the 50 pizza for 10, then she will receive a producer surplus of 5 on
the 50 pizza.
• Assume that Mario and Max are the only ones making pizza in the market:
The area between the cost and the MC of both max and Mario’s producer
surplus is the economy producer surplus
• Area under the MC is the total cost.
• The marginal benefit is determine by demand
• Marginal social benefit curve related to marginal benefit related to demand
Question: The producer surplus on a unit of a good is
a) Difference between the marginal social benefit and the marginal cost
b) Number of dollars worth of other goods and services forgone to produce this
unit of the good
c) Difference between the price of the good and the marginal cost of producing
d) Difference between the total cost of the good and the marginal cost
Consumer surplus and producer surplus can be used to measure the efficiency of a
What is the relationship between marginal benefit, value and demand?
Marginal benefit is the amount that someone is willing to pay for one more unit of it.
Value is what we get. Willingness to pay determines demand. The market demand
curve tells us the quantity the market is willing to pay for a certain price.
Consumer surplus is the excess of the benefit received from a good over the amount
paid for it.
What is the relationship between marginal cost, minimum supply price, and supply?
1. The cost of producing one more unit of a good or service is its marginal cost
2. Marginal cost is the minimum supply price that producer must receive to
induce them to offer to sell another unit of the good or service
3. But the Minimum supply price determines supply
4. So a supply curve is a marginal cost curve
5. It is not true that minimum supply price is the value of one more unit of a
good or service.
6. Marginal benefit is the value of one more unit of a good or service. What is the relationship between individual supply and market supply?
1. The market supply curve is the horizontal sum of the individual supply curve.
2. It is formed by adding the quantities supplied by all producers at each price
What is producer surplus? How is it measured?
1. Producer surplus is the excess of the amount received from the sale of a good
or service over the cost of producing it.
2. It is calculated by the price received for the good and the amount spent
producing it (marginal cost / minimum supply price)
What is consumer surplus? How is it measured?
1. Consumer surplus is the excess marginal benefit from the sale of a good or
service over the price paid for it.
2. It is measured by the marginal benefit minus the price summed over the
• Marginal social benefit from 30 kilometres is the benefit that the entire
society receives, which is the sum of the marginal benefits that the people in
the society receive.
• The marginal benefit from 30 kilometers that one person receives is the
maximum price that the person is willing to paid to travel 30 kilometres
• A demand curve is a marginal benefit curve, so the demand schedule tells us
the willingness (maximum) price willingly paid at each quantity demanded.
• Consumer surplus is the area below the demand curve and above the
• The producer surplus is the area above the supply curve and below the
5.3: Is the Competitive Market Efficient?
Efficiency of Competitive Equilibrium
• Marginal demand curve – Marginal social benefit
• Market supply curve – marginal social cost
• Equilibrium in a market occurs when quantity supplied equals quantity
• At this point, the intersection, marginal social benefit equals marginal
social cost on the supply curve (Condition for allocative efficiency)
• A competitive market achieves allocative efficiency • At the equilibrium quantity marginal benefit equals marginal cost, so
the quantity is efficient quantity
• When efficient quantity is produced, total surplus (the sum of
consumer surplus and producer surplus) is maximized.
• Total Surplus: The sum of consumer surplus and producer surplus is
the total surplus.
• TS = CS + PS
• This number does not indicate welfare exactly but the higher the
number the better.
• BIG TS = Good
• TS (see graph on textbook)
The competitive market is efficient because
A) People can buy the good at a price that matches their marginal benefit
B) Marginal social benefit from the good equals the marginal social cost of
producing the good
C) Sellers of the good get a price that exceeds their marginal cost
D) Total surplus is reduced to zero
• Market delivers inefficient outcome and it occurs when a market delivers too
little of an item or is over produced.
▪ Tal surplus is smaller than its maximum possible level
▪ When too little of an item is produced
▪ Deadweight loss: the decrease in total surplus from an inefficient
level of production. Equals the decrease in total surplus
▪ Too much of an item is produced
▪ When quantity produced is greater than quantity that
▪ Consumers is willing to pay at a certain price
▪ The price consumers are willing to pay is less than what it
costs to produce
▪ The grey triangle shows deadweight loss
Question: At the efficient level of production, ______
a) Producer surplus must be greater than consumer surplus
b) There is no deadweight loss
c) Total surplus is maximized
d) Both C) and D) are correct Question: A deadweight loss:
a) Is possible only if the good is under produced but not possible if the good is
b) Subtracts only form producer surplus
c) A loss to consumer and a gain to producer
d) Is a loss inflicted
Sources of Market Failure and obstacles to Efficiency
▪ Sources that creates deadweight losses are
o Price and quantity regulation (underproduction) For example
o Taxes and subsidies (underproduction) (paying taxes, HST
o Externalities (overproduction)
o Public goods and common resources (underproduction)
▪ Private goods are coffee, hamburger, etc. (when you consume
the foods it is gone only for yourself)
▪ Public goods where everyone can have
o Monopoly (underproduction)
o High transaction costs (high costs (underproduction)
Price and Quantity Regulation
• Price regulation can lead to underproduction because a quantity regulation
limits the amount that a firm is permitted to produce. For example: CAP on
housing for University staffs
• 25% lower
• Price regulations make market inefficient
Taxes and Subsidies
• Taxes increase the prices paid by buyers and lower the prices received by
• Subsidies lower the prices paid by buyers and increase the prices received by
• So subsidies increase the quantity produced and lead to overproduction
• Externality is a cost or benefit that affects someone other than the seller or
the buyer of a good
• Example if you smoke and it effects other people
• Positive externality (flu vaccine) government subsidize education and it is a
• Negative externalities (air pollution)
• External cost example: electricity creates an external cost by burning coal
that creates acid rain. The utility doesn’t consider this cost when it chooses
the quantity of power to produce. Overproduction results
• Underproduction external cost example: an apartment owner would provide
an external benefit if she installed an smoke detector. She doesn’t consider her neighbor’s marginal benefit and decides not to install the smoke detector.
The result is underproduction
Public Goods and Common Resources
• Public good benefits everyone and no one can be excluded from its benefits
• Example: when everyone does not want to pay for public good (free rider
problem), this leads to underproduction
• Common resource is owned by no one but can be used by everyone
• For example everyone ignores the cost of their own use of a common
resource (tragedy of the commons). The tragedy of the commons leads to
• Example: turn on the lights: it is a public good
• Cost of turning on the lights would be 100. To finance public goods,
government taxes individuals
• Common resources: Fishing. Leads to overfishing.
• Monopoly is a firm that has sole provider of a good or service
• Inefficient outcome
• One firm selling the product will always lead to inefficiency
• Self interest of monopoly is to maximize its profit
• Monopoly charges a price that too high and produces too little. As a result,
Alternatives to the Market
▪ When market is inefficient, can one of the alternative nonmarket methods
that we describe at the beginning of this chapter do a better job?
Do competitive markets use resources efficiently?
Competitive markets use resources efficiently when quantity demanded equals the
quantity supplied. This happens at the point when the demand curve and supply
What is deadweight loss and under what conditions does it occur?
Deadweight loss is the scale of inefficiency, which is the decrease in total surplus
from an inefficient level of production. Deadweight loss can occur when there is an
overproduction or underproduction. The grey triangle shows the deadweight loss,
which reduces the surplus, to less than its maximum.
What are the obstacles to achieving an efficient allocation of resources in the market
1) price and quantity regulation
2) Taxes and subsidies 3) Externalities
4) Public goods and common resources
6) High transaction costs
Equilibrium in a competitive market occurs when the quantity demanded equals the
quantity supplied at the intersection of the demand curve and the supply curve.
At this point of intersection marginal social benefit equals marginal social cost,
which is the condition for allocative efficiency.
So in equilibrium, a competitive market achieves allocative efficiency
• Market demand curve tells of the marginal social benefit
• Market supply curve tells of the marginal social cost
• Where the demand curve and the supply curve intersect, the marginal social
benefit equals the marginal cost
• This is the condition for allocative efficiency and at this point, it delivers an
efficient use of resources for the entire society.
• At allocative efficiency, the sum of the consumer surplus (green area) and the
producer surplus (blue area) is maximized
• Deadweight loss: when inefficient quantity is produced, consumer surplus
decreases and producer surplus decreases. The loss of the total surplus is the
• Demand curve is a marginal benefit curve, and we measure marginal benefit
by the maximum price that is willingly paid for another unit of a good