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Lecture 10

ECO101H1 Lecture 10: Consumer Demand Theory Review

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ECO100 : Lecture 10 Consumer Demand Theory + Review Review Consumer surplus = price buyer would be willing to pay less market price Measures benefit to consumer participating in market Producer surplus = market price less cost to seller Measures benefit to producer participating in market Allocatively efficient level of output: level of output where total surplus is maximized Consumer + producer surplus Key result: equilibrium output in a competitive market is allocatively efficient Allocative Efficiency: In usual linear demandsupply graph: Consumer surplus = area below demand curve, above MCP Producer surplus = area above supply curve, below MCP Question: how much would consumers and producers pay to prevent a market from shutting down? Consumer surplus + producer surplus = total surplus If output of a good is less than output in a competitive market, output is too low and is allocatively inefficient Value of good to buyers exceeds cost to sellers of producing good Gains from trade not fully realized The benefits of participating in the market Implication: Government policies that prevent output from reaching competitive level result in allocative inefficiency Welfare analysis (not required on Test 1): Welfare analysis of perfect competition vs imperfectly competitive markets (required for test 2, not yet studied) Suppose imposed price ceiling below market price: In more sophisticated framework (welfare) Results in loss of total surplus Market not in equilibrium Consumer surplus increases, producer surplus falls Total surplus currently is less than equilibrium surplus Allocatively inefficient Review: Your brother gives you a frequent flier coupon, giving you a 200 discount on regular airfare. The cost of TorontoVancouver airfare is 500 for a regular ticket. You value the flight at 400. Should you use the coupon, pay 300, and fly to vancouver? No: MB: 400 MC: 500, MC>MB MC is 500 because the 200 coupon has a OC of 200
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