Examine link b/w buyer's willingness to pay for a good and the demand curve, how to define and measure
consumer surplus, examine link b/w sellers' cost of producing a good and the supply curve, how to define
Chapter 7 Consumers, Producers, And the Efficiency of Markets
Welfare Economics: Study of how the allocation of resources affects economic wellbeing.
first being by examining benefits that buyers and sellers receive for
taking part in a market.
Then how society can make these benefits as large as possible
therefore: The equilibrium of supply and demand in a market maximizes
the total benefits received by buyers and sellers.
Principles: Markets are usually a good way of organizing economic activity: welfare economics explains
Turkey is not to high not to low in price: buyers: always want less price, whereas sellers want more money
in the price
the price that balances the supply and demand for turkey is the best one because it maximizes the
total welfare of turkey consumers and buyers.
Benefits buyers receive from participating in a market.
Willingness to Pay
Selling a CD: 4 people want it for auction.
Willingness to pay: maximum amount that a buyer will pay for a good, measures how much buyer values
Each buyer would love to buy the CD less than his willingness to pay, and refuse above his w.t., and
indifferent to the price w.t.p.
John gets CD for $80 instead of $100 he out for= John receives CONSUMER SURPLUS of $20.
Consumer Surplus: A buyer's willingness to pay minus the amount the buyer actually pays.
measures benefit to buyers of participating in a market.
Using Demand Curve To Measure Consumer Surplus
demand is derived from willingness to pay
Height in demand curve and willingness to pay is related on the graph.
At any quantity, the price given by the demand curve shows the willingness to pay of the marginal buyer,
the buyer who would leave the market first if the price was any higher. ex:
Buyer Willingness To Pay
Price above 100 dollars= the quantity demanded in the market is 0 b/c no buyer is willing to pay that
much. If the price is b/w $80 and $100=quantity demand is 1 and so on.
At quantity of 4 albums, the demand curve has a height o $50, the price that Ringo (the marginal buyer) is
willing to pay for an album. At a quantity of 3 albums, the demand curve has a height of $70, the price
that George (now the marginal buyer) is willing to pay.
On the graph: The area below the demand curve and above the prices measures the consumer surplus in a
market=the height of the demand curve measures the value buyers place on good.
Difference b/w willingness to pay and market price is each buyer's consumer surplus, Thus the total area
below the demand curve and above the price is the sum of the consumer surplus of all buyers in the
market for a good and service.
HOW A LOWER PRICE RAISES CONSUMER SURPLUS
buyers want to pay less for goods, lower prices make buyers of a good better off.
How much does buyer's wellbeing rise in response to a lower price?
fig 7.3: Downwardslope graph.
Idea: Consumer surplus is the area above the price and below the demand curve.
increase in consumer surplus attributable to the lower price is the area BCFD.
increase of surplus has 2 parts:
1 those buyers who were already buying Q1 of the good at the higher price P1 are better off because they
now pay less. Increase in Consumer Surplus of existing buyers is the reduction in the amount they pay; it
equals area BCED.
2. Some new buyers enter the market because they are now willing to buy the good at the lower price.
=Quantity demand in the market increases from Q1 to Q2. Consumer surplus these newcomers receive is
the area of the triangle CEF. WHAT DOES CONSUMER SURPLUS MEASURE?
Developing concept of consumer surplus is to make normative judgements about the
desirability of market outcomes.
Let's see if Consumer surplus is a good measure of economic wellbeing:
Consumer Surplus measures the benefit that buyers receive from a good as the buyers
themselves perceive it.
Thus, consumer surplus is a good measure of economic wellbeing if policymakers
want to respect the preferences of buyers.
Policymakers might choose not to care about consumers surplus b/c they do no respect
preferences that drive buyers behaviour.
ex: Druggies willing to pay high price for heroin (they do not get a large benefit
from heroin at a low price b/c it is not a good measure of the buyer's benefit thrfr
consumer surplus here is not good for economic wellbeing.
Economists assume People are rational in their decisions in buying and their preferences should be
respected. =thrfor consumers are best judges of how much benefit they will receive from goods they buy.
other side of market, analysis of seller's welfare
COST AND THE WILLINGNESS TO SELL
painting house. 4 people auction: who will do the work at the lowest price.
painter willing: if price she would receive exceeds her cost of doing the work.
Cost: the value of everything a seller must give up to produce a good.
Cost: painter's opportunity cost: includes painter's outofpocket expenses (paint. brushes
etc) + value that the painters place on their own time.
Grandma 500 each person is showing their willingness to sell their services.
Grandma: sole remaining bidder: 600: job goes to painter who can do work at lowest