1 Consumers, Producers, and the Efficiency of Markets Chapter 7

2 EfficiencyEquity

3 Economic Welfare  Welfare of buyers: consumer surplus.  Welfare of suppliers: producer surplus.  What price and quantity in a market maximizes the sum of the two?  That’s the efficient allocation.

4 Consumer Surplus

Table 1 Four Possible Buyers’ Willingness to Pay Copyright©2004 South-Western

6 The Demand Schedule and the Demand Curve

Figure 1 The Demand Schedule and the Demand Curve Copyright©2003 Southwestern/Thomson Learning Price of Album 0Quantity of Albums Demand 1234 $100 John’s willingness to pay 80 Paul’s willingness to pay 70 George’s willingness to pay 50 Ringo’s willingness to pay

Figure 2 Measuring Consumer Surplus with the Demand Curve Copyright©2003 Southwestern/Thomson Learning (a) Price = $80 Price of Album $100 Demand 1234 Quantity of Albums John’s consumer surplus ($20)

Figure 2 Measuring Consumer Surplus with the Demand Curve Copyright©2003 Southwestern/Thomson Learning (b) Price = $70 Price of Album $100 Demand 1234 Total consumer surplus ($40) Quantity of Albums John’s consumer surplus ($30) Paul’s consumer surplus ($10)

Figure 3 How the Price Affects Consumer Surplus Copyright©2003 Southwestern/Thomson Learning Consumer surplus Quantity (a) Consumer Surplus at Price P Price 0 Demand P1P1 Q1Q1 B A C

Figure 3 How the Price Affects Consumer Surplus Copyright©2003 Southwestern/Thomson Learning Initial consumer surplus Quantity (b) Consumer Surplus at Price P Price 0 Demand A B C DE F P1P1 Q1Q1 P2P2 Q2Q2 Consumer surplus to new consumers Additional consumer surplus to initial consumers

12 Producer Surplus

Table 2 The Costs of Four Possible Sellers Copyright©2004 South-Western

14 The Supply Schedule and the Supply Curve

Figure 4 The Supply Schedule and the Supply Curve

Figure 5 Measuring Producer Surplus with the Supply Curve Copyright©2003 Southwestern/Thomson Learning Quantity of Houses Painted Price of House Painting $ (a) Price = $600 Supply Grandma’s producer surplus ($100)

Figure 5 Measuring Producer Surplus with the Supply Curve Copyright©2003 Southwestern/Thomson Learning Quantity of Houses Painted Price of House Painting $ (b) Price = $800 Georgia’s producer surplus ($200) Total producer surplus ($500) Grandma’s producer surplus ($300) Supply

Figure 6 How the Price Affects Producer Surplus Copyright©2003 Southwestern/Thomson Learning Producer surplus Quantity (a) Producer Surplus at Price P Price 0 Supply B A C Q1Q1 P1P1

Figure 6 How the Price Affects Producer Surplus Copyright©2003 Southwestern/Thomson Learning Quantity (b) Producer Surplus at Price P Price 0 P1P1 B C Supply A Initial producer surplus Q1Q1 P2P2 Q2Q2 Producer surplus to new producers Additional producer surplus to initial producers D E F

20 Market Efficiency

Figure 7 Consumer and Producer Surplus in the Market Equilibrium Copyright©2003 Southwestern/Thomson Learning Producer surplus Consumer surplus Price 0 Quantity Equilibrium price Equilibrium quantity Supply Demand A C B D E

22 Efficiency The property of resource allocation of maximizing the total surplus received by all members of society. Total surplus = CS + PS = (value to buyers – amount paid by buyers) + (amount received by sellers – cost to sellers) = value to buyers – cost to sellers

23 Market for Organs “The average wait for a kidney transplant is 3.5 years and about 6,000 Americans die every year because a kidney cannot be found.”

24 End of Chapter Questions

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26 9. Consider how health insurance affects the quantity of health care services performed. Suppose that the typical medical procedure has a cost of $100, yet a person with health insurance only pays $20 out-of-pocket when she chooses to have an additional procedure performed. a)Draw a demand curve showing the quantity at $100 and $20. What are the welfare implications if the cost to society of an additional procedure is $100. b)Given your analysis, why might the use of care be excessive.

Many parts of CA experienced a severe drought in the late 1980’s and early 1990’s. a)Use S&D to show the effect of a drought on the equilibrium price and quantity of water. b)Many communities did not allow the price of water to change. Show the effect. c)LA required all residents to cut consumption by 10%. Is this policy efficient? d)What are the efficiency implications of allowing the price to adjust? What are the equity implications.

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