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Lecture 10

# Lecture 10-Consumer Surplus

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School
University of Toronto St. George
Department
Economics
Course
ECO101H1
Professor
Jack Carr
Semester
Fall

Description
Tuesday, October 20th, 2009. Consumer Demand Theory Measures benefit to buyers of participating in a market 1. 5HVHUYDWLRQSULFH³ZLOOLQJQHVVWRSD\´: Highest price you are willing to pay 2. Consumer surplus: Difference between actual price and reservation price 3. Rational consumer: Seeks to maximize consumer surplus Example: price of shirt, a baseball bat, or a sports ticket: \$50 You have \$50 to spend Consumer buys 1 unit, 2 units, etc. (not, say, 1.5 units) 2. DD is not linear If P > 7, DD = 0 If P > 6, but not more than 7, DD = 1 If P > 5, but not more than 6, DD = 2 (Note: Text, Figures 7.1 and 7.2, the horizontal portion of DD is shown as a solid line) ³6WHSSHG´'HPDQG&XUYH Shaded rectangle: consumer surplus (\$4) on first unit purchased 3 1 6 Q P DD 2 7 5 www.notesolution.com DD Curves: Standard Practice 1. In general, we will assume DD curves are downward-sloping except in numerical examples designed to illustrate consumer surplus. 2. 6ROHSXUSRVHRIWKH³VWHSOLNH´ DD curves is to facilitate calculation of consumer surplus Consumer Surplus equals area under demand curve and above the price Producer Surplus Amount seller is paid ± (less the) VHOOHU¶VFRVW Example: House Painters Individual A will work for \$10 per hour (opportunity cost) B will work for \$15 per hour (opportunity cost) C will work for \$20 per hour (opportunity cost) D will work for \$25 per hour (opportunity cost) If market price (wage) is \$20, then: A, B, C will work (D will not work) Producer surplus in market: A \$20 - \$10 = \$10 B \$20 - \$15 = \$ 5 C \$20 - \$20 = 0 \$15 P DD 5 Q SS Market Price P = 3 Consumer Surplus www.notesolution.com P DD 10 Q QE Q1 5 17 SS * Producer Surplus = Area below price and above supply curve Total Surplus = Consumer Surplus + Producer Surplus Key Result: Equilibrium in a competitive market maximizes total surplus Ù competitive market is (allocatively) efficient To left of QE, value of buyer > cost to sellers => efficient to increase output To right of QE, value to buyer < cost to sellers => efficient to reduce output P SS _ P Q Producer Surplus P DD QE Q SS www.notesolution.com At Q1, Consumer Surplus = 17 ± 10 = 7 At Q1, Producer Surplus = 10 ± 5 = 5 ,IZH³DGGXS´DOOWKHVXUSOXVHVWROHIWRI4(ZLOOHTXDOTotal Surplus Allocative Efficiency Question: How much, in total, would consumers and producers pay to prevent this market from shutting down? Answer: Consumer Surplus + Producer Surplus = Total Surplus Example: Market for Blue Fox Fur Coat ³:LOOLQJQHVVWRSD\´ \$ 2000 Market (world) price: \$ 500 Illegal to import into Canada How much would you be willing to pay for this market to exist (assuming price would be \$500)? Answer: (up to) \$1,500 P DD QE Q SS PE Producer Surplus Consumer Surplus www.notesolution.comth Tuesday, October 20 , 2009. Consumer Demand Theory Measures benefit to buyers of participating in a market 1. #0807;,9L4357L.0 ZLOOL3J3088945, : Highest price you are willing to pay 2. Consumer surplus: Differencebetween actual price and reservation price 3. Rational consumer: Seeks to maximize consumer surplus Example: price of shirt, a baseball bat, or a sports ticket: \$50 You have \$50 to spend <4:770807;,9L4357L.0 ZLOOL3J3088945, Shirt: \$200 Baseball bat: \$100 Sports ticket: \$25 What will you buy? Answer: shirt (consumer surplus: \$200 - \$50 = \$150) Consumer Surplus Definition: Difference between the maximum a buyer would pay for a good and the price a buyer actually pays Example: Market Price \$3 P Q Consumer Surplus 7 1 4 (7 3) 6 2 3 (6 3) 5 3 2 (5 3) 4 4 1 (4 3) 3 5 0 (3 3) 2 6 Not Relevant * Consumer Surplus equals area under demand curve and above the price www.notesolution.com
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