1. Copyright © 2004 South-Western 7 Consumers, Producers, and the Efficiency of Markets

2. Copyright © 2004 South-Western Welfare Economics Welfare economics is the study of how the allocation of resources affects economic well- being. Buyers and sellers receive benefits from taking part in the market. The equilibrium in a market maximizes the total welfare of buyers and sellers.

3. Copyright © 2004 South-Western Welfare Economics Equilibrium in the market results in maximum benefits, and therefore maximum total welfare for both the consumers and the producers of the product. Consumer surplus measures economic welfare from the buyer’s side. Producer surplus measures economic welfare from the seller’s side.

4. Copyright © 2004 South-Western CONSUMER SURPLUS Willingness to pay is the maximum amount that a buyer will pay for a good. It measures how much the buyer values the good or service. Consumer surplus is the buyer’s willingness to pay for a good minus the amount the buyer actually pays for it.

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

6. The Demand Schedule and the Demand Curve

7. 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

8. Figure 2 Measuring Consumer Surplus with the Demand Curve Copyright©2003 Southwestern/Thomson Learning (a) Price = $80 Price of Album 50 70 80 0 $100 Demand 1234 Quantity of Albums John’s consumer surplus ($20)

9. Figure 2 Measuring Consumer Surplus with the Demand Curve Copyright©2003 Southwestern/Thomson Learning (b) Price = $70 Price of Album 50 70 80 0 $100 Demand 1234 Total consumer surplus ($40) Quantity of Albums John’s consumer surplus ($30) Paul’s consumer surplus ($10)

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

11. 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. Copyright © 2004 South-Western PRODUCER SURPLUS Producer surplus is the amount a seller is paid for a good minus the seller’s cost. It measures the benefit to sellers participating in a market.

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

14. The Supply Schedule and the Supply Curve

15. Figure 4 The Supply Schedule and the Supply Curve

16. Figure 5 Measuring Producer Surplus with the Supply Curve Copyright©2003 Southwestern/Thomson Learning Quantity of Houses Painted Price of House Painting 500 800 $900 0 600 1234 (a) Price = $600 Supply Grandma’s producer surplus ($100)

17. Figure 5 Measuring Producer Surplus with the Supply Curve Copyright©2003 Southwestern/Thomson Learning Quantity of Houses Painted Price of House Painting 500 800 $900 0 600 1234 (b) Price = $800 Georgia’s producer surplus ($200) Total producer surplus ($500) Grandma’s producer surplus ($300) Supply

18. 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

19. 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. Copyright © 2004 South-Western MARKET EFFICIENCY Consumer surplus and producer surplus may be used to address the following question: Is the allocation of resources determined by free markets in any way desirable?

21. Copyright © 2004 South-Western MARKET EFFICIENCY Total surplus = Consumer surplus + Producer surplus or Total surplus = Value to buyers – Cost to sellers

22. 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

23. Figure 8 The Efficiency of the Equilibrium Quantity Copyright©2003 Southwestern/Thomson Learning Quantity Price 0 Supply Demand Cost to sellers Cost to sellers Value to buyers Value to buyers Value to buyers is greater than cost to sellers. Value to buyers is less than cost to sellers. Equilibrium quantity