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Chapter 7

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University of Ottawa
David Gray

Chapter 7-Consumers, producers and efficiency From individual D to market D: Slight diversion back to chapter 4, pages 68-69 - In order to examine the underpinnings of the D curve, we have to examine the behaviour of consumers - Market Demand is aggregation of the demands of all consumers - The market D curve is the horizontal summation of all of the individuals’ demand curves o Figure 4.2 o set all individual D curves adjacent to each other so that they share the same P axis  under those conditions, one can sum across them Individual and Market Demand Curves (check page 1 in the middle for both curves) General idea behind this chapter: - To demonstrate that the free market equilibrium generated in the S & D model is efficient o The quantity is said to be efficient if the welfare of producers on the S side plus the welfare of consumers on the D side is higher at that level of output than at any other output level - To this end, we define a measure of consumer welfare called consumer surplus, a measure of producer welfare called producer surplus, and a global measure of welfare called total surplus Consumer surplus: - Definition: welfare economics o Not about social assistance or income assistance programs o How the allocation of resources (input and hence outputs) affects economic well-being o Consider well-being of demanders (consumers) and of suppliers (firms) .. - Think of price as a measure of the consumer’s willingness to pay given a quantity o i.e. how much is the consumption of that last unit worth to the consumer or to all consumers? - This willingness to pay differs across individuals o Table 7-1 indicates the willingness of 4 individuals to pay for a unit of the good in question. Arranged in order:  John $100 (first unit)  Paul $80 (second unit)  George $ 70 (third unit)  Ringo $ 50 (fourth unit)  I have no idea who these guys are - Thus generally, the willingness of all consumers to pay diminishes as quantity consumed rises Check the demand schedule for buyers in table 7-1 (middle of page 2), as well as the demand curve and graph at the end of page 2……… Check willingness pay to graph at the start of page 3…… Willingness to pay: - This willingness to pay also varies within an individual as his/her consumption level rises o Example: the amount of clothing in your wardrobe o My example involving the consumption of gin and tonics - Consumer surplus is a measure of consumer well-being that reflects the payment rendered - CS = willingness to pay – TR (requirement to pay) - Graphically (figure 7.2), for each unit consumed, it is the height of the D curve minus the height corresponding to the transactions price. (figure 7-2 is in middle of page 3) o For all of the units consumed, it is the area under the D curve yet above the transactions price. - for all but the marginal unit, the consumer gets a ‘bonus’, and this quantity is counted in consumer welfare o my own example: espresso coffee A consumer’s demand and consumer surplus - As the level of consumption rises, the level of consumer surplus diminishes o consumer surplus at the margin (the very last unit produced) is 0 - Practical applications - Often in the context of public works projects. In order to justify the expenditure for light-rail transit, should have some estimate of the implicit value of consumers in addition to merely the number of riders or the amount collected in fares - A decrease in price will raise consumer surplus and thus make consumers better off o Figure 7-3 (check middle of page 4) - An increase in price will have the opposite effect Producer
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