Consumers, Producers, and the Efficiency of Markets
C H A P T E R
7 Consumers, Producers, Consumers, Producers,
and the Efficiency of M arkets and the Efficiency of M arkets P R I N C I P L E S O F P R I N C I P L E S O F conomics
E N. Gregory N. Gregory Mankiw Mankiw
Premium PowerPoint Slides © 2009 South-Western, a part of Cengage Learning, all rights reserved by Ron Cronovich In this chapter, In this chapter, look for the answers to these questions: look for the answers to these questions:
§ What is consumer surplus? How is it related to the
demand curve?
§ What is producer surplus? How is it related to the
supply curve?
§ Do markets produce a desirable allocation of
resources? Or could the market outcome be improved upon?
1 W elfare Economics Recall, the allocation of resources refers to:
§
how much of each good is produced
§
which producers produce it
§ § which consumers consume it Welfare economics
§ § First, we look at the well-being of consumers.
2 CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS
W illingness to Pay (W TP) A buyer’s willingness to pay for a good WTP measures
Example:
name WTP
4 buyers’ WTP Anthony $250 for an iPod Chad 175 Flea 300 John 125
CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS
3 W TP and the Demand Curve
Derive the
P (price d
who buys Q demand of iPod) schedule:
$301 & up 251 – 300
name WTP
Anthony $250 176 – 250 Chad 175 126 – 175 Flea 300 0 – 125 John 125
CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS
5 W TP and the Demand Curve P
$350 d
P Q $300 $250 $200 $150 $100 $50
$0 Q
1
2
3
4
6 CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS
About the Staircase Shape… P
This D curve looks like a staircase $350 with 4 steps – one per buyer.
$300 If there were a huge # of buyers,
as in a competitive market,
$250
there would be a huge #
$200
of very tiny steps,
$150
and it would look more like a smooth
$100 curve.
$50 $0 Q
1
2
3
4 CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS
7 W TP and the Demand Curve P
At any Q, Flea’s WTP
$350
the height of Anthony’s WTP the D curve is
$300
the WTP of the
$250
Chad’s WTP
marginal buyer ,
John’s
$200
WTP
$150 $100 $50 $0 Q
1
2
3
4 CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS
8 Consumer Surplus (CS) Consumer surplus Suppose P = $260. name WTP
Flea’s CS = Anthony $250 Chad 175 Flea 300 John 125
9 CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS
CS and the Demand Curve P
P = $260
Flea’s WTP
$350
Flea’s CS =
$300 $250
Total CS =
$200 $150 $100 $50
$0 Q
1
2
3
4 CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS
10 CS and the Demand Curve P
Flea’s WTP Instead, suppose
$350 P = $220
Anthony’s WTP
$300
Flea’s CS =
$250 $200
Anthony’s CS =
$150 $100
Total CS =
$50 $0 Q
1
2
3
4 CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS
11 CS and the Demand Curve P
The lesson: $350 $300 $250 $200 $150 $100
$50 $0 Q
1
2
3
4
12 CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS
CS with Lots of Buyers & a Smooth D Curve
The demand for shoes At Q = 5(thousand),
P
the marginal buyer is $
60 willing to pay $____ 50 for pair of shoes.
40 Suppose P = $30.
30 Then his consumer
20 surplus = $____
10 D
Q
5 10 15 20 25 30
CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS
13 CS with Lots of Buyers & a Smooth D Curve
The demand for shoes
P
$
60
50
40 Recall: area of a triangle equals
30 ½ x base x height
20
10 D
Q
5 10 15 20 25 30
CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS
14 How a Higher Price Reduces CS
If P rises to $40,
P
CS =
60
50
40
30
20 Two reasons for the
10 fall in CS. D
Q
5 10 15 20 25 30
15 CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS A C T I V E L E A R N I N G A C T I V E L E A R N I N G
1
1 demand curve
Consumer surp Consumer surp lus lus
50 P A. Find marginal
$
45 buyer’s WTP at
40 Q = 10.
35 B. Find CS for
30 P = $30.
25 Suppose P falls to $20.
20 How much will CS
15 increase due to…
10 C. buyers entering
5 the market
D. existing buyers
5
10
15
20
25 Q paying lower price
16 A C T I V E L E A R N I N G A C T I V E L E A R N I N G
1 demand curve
1
Answers Answers
50 P $
45
40
35
30
25
20
15
10
5
5
10
15
20 Q
25
17 Cost and the Supply Curve § Cost § Example: Costs of 3 sellers in the lawn-cutting
business.
A seller will produce and sell
name cost
the good/service only if Jack $10 Janet
20 Chrissy
35
18 CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS
Cost and the Supply Curve s
P Q
Derive the supply schedule from the cost data:
name cost
Jack $10 Janet
20 Chrissy
35 CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS
19 Cost and the Supply Curve P s
P Q $40
$0 – 9
$30
10 – 19
$20
20 – 34
$10 35 & up $0 Q
1
2
3 CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS
20 Cost and the Supply Curve P
$40
Chrissy’s cost
$30
Janet’s
$20
cost Jack’s cost
$10 $0 Q
1
2
3
21 CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS
Producer Surplus P
$40 Producer surplus
(PS):
$30 $20 $10 $0 Q
1
2
3 CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS
22 Producer Surplus and the S Curve P
PS = P – cost
$40 Suppose P = $25.
Chrissy’s cost Jack’s PS =
$30
Janet’s PS = Janet’s
$20
cost Chrissy’s PS = Total PS =
Jack’s cost
$10 Total PS equals
$0 Q
1
2
3 CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS
23 PS with Lots of Sellers & a Smooth S Curve
The supply of shoes Suppose P = $40.
P
60 At Q = 15(thousand), the marginal seller’s
50 S cost is $______ 40 and her producer 30 surplus is $______
20
10 Q 5 10 15 20 25 30
24 CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS
PS with Lots of Sellers & a Smooth S Curve
PS is the area b/w The supply of shoes
P
60 S
50 The height of this
40 triangle is
30
20
10 So, PS = ½ x b x h
Q
= 5 10 15 20 25 30
CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS
25 How a Lower Price Reduces PS
If P falls to $30,
P
PS =
60 S
50
40
30 Two reasons for the
20 fall in PS.
10 Q 5 10 15 20 25 30
CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS
26 A C T I V E L E A R N I N G A C T I V E L E A R N I N G
2 supply curve
2
Producer surplus Producer surplus
50 P A. Find marginal
45 seller’s cost 40 at Q = 10.
35 B. Find total PS for
30 P = $20.
25 Suppose P rises to $30.
20 Find the increase
15 in PS due to…
10 C. selling 5
5 additional units
D.
getting a higher price
5
10
15
20
25 Q on the initial 10 units
27 A C T I V E L E A R N I N G A C T I V E L E A R N I N G
2 Answers
2
20
(Policymakers also care about equality, though are focus here is on efficiency.)
§ To answer this,
Is the market’s allocation of resources desirable? Or would a different allocation of resources make society better off?
§
In a market economy, the allocation of resources is decentralized, determined by the interactions of many self-interested buyers and sellers.
§
29 CS, PS, and Total Surplus CS = = buyers’ gains from participating in the market PS = (amount received by sellers) – (cost to sellers) = Total surplus =
28 CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS
Q supply curve
25 P
15
Answers
10
5
50
45
40
35
30
25
20
15
10
5
CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS
30 The Market’s Allocation of Resources
Efficiency
Total = (value to buyers) – (cost to sellers) surplus
An allocation of resources is efficient Efficiency means:
CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS
31 Evaluating the M arket Equilibrium
Market eq’m:
P P = $30
60 Q = 15,000
S
50
40
30
20 Is the market eq’m
10 efficient?
D Q
5 10 15 20 25 30
CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS
32 W hich Buyers Consume the Good?
Every buyer
P
whose WTP is
60
50 S
40 Every buyer whose WTP is
30
20 So,
10 D
Q
5 10 15 20 25 30
33 CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS
W hich Sellers Produce the Good?
Every seller whose
P
60 S
50
40 Every seller whose
30
20
10 D So,
Q
5 10 15 20 25 30
CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS
34 Does Eq’m Q M aximize Total Surplus?
At Q = 20,
P
cost of producing
60 the marginal unit is $____ S
50 value to consumers 40 of the marginal unit 30 is $_____
Hence, can increase
20 total surplus 10 by _______________
D Q This is true at any Q
5 10 15 20 25 30 greater than 15.
CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS
35 Does Eq’m Q M aximize Total Surplus?
At Q = 10,
P
cost of producing
60 the marginal unit is $_____
50 S value to consumers 40 of the marginal unit 30 is $_____
Hence, can increase
20 total surplus 10 by _______________
D Q This is true at any Q
5 10 15 20 25 30 less than 15.
36 CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS
10
20
CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS
37 Does Eq’m Q M aximize Total Surplus?
CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS
38 Adam Smith and the Invisible Hand
an invisible hand
Nor is it always the worse for the society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it.”
an invisible hand to promote an end which was no part of his intention.
He intends only his own gain, and he is in this, as in many other cases, led by
Passages from The Wealth of Nations, 1776
Adam Smith, 1723-1790
“Every individual…neither intends to promote the public interest, nor knows how much he is promoting it….
He will be more likely to prevail if he can interest their self-love in his favor, and show them that it is for their own advantage to do for him what he requires of them… It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest….
Passages from The Wealth of Nations, 1776
Adam Smith, 1723-1790
“Man has almost constant occasion for the help of his brethren, and it is vain for him to expect it from their benevolence only.
P Q S D The market eq’m quantity
60 5 10 15 20 25 30
50
40
30
CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS
39 Adam Smith and the Invisible Hand
The Free M arket vs. Govt Intervention § The market equilibrium is efficient. No other outcome achieves higher total surplus.
§ Govt cannot raise total surplus by changing the market’s allocation of resources. §
(French for “allow them to do”): the notion that
CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS
40 The free market vs. central planning
Suppose resources were allocated not by the § market, but by a central planner who cares about society’s well-being.
§ To allocate resources efficiently and maximize total surplus, the planner would need to know This is impossible, and why centrally-planned
§ economies are never very efficient.
CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS
41 CONCLUSION This chapter used welfare economics to
§ demonstrate one of the Ten Principles:
Markets are usually a good way to organize economic activity.
Important note: §
We derived these lessons assuming perfectly competitive markets. In other conditions we will study in later chapters,
§ the market may fail to allocate resources efficiently…
42 CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS
CONCLUSION § Such market failures occur when:
§ § § We’ll use welfare economics to see how public policy may improve on the market outcome in such cases. § Despite the possibility of market failure, the analysis
in this chapter applies in many markets, and the invisible hand remains extremely important.
CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS
43