Economic Efficiency

Topics: Supply and demand, Economics, Microeconomics Pages: 21 (1522 words) Published: March 28, 2014
Sessions 6, 7 & 8
Economic Efficiency
y

Consumer Surplus
A buyer’s willingness
to pay (WTP) for a good
p y(
)
g
is the maximum amount
the buyer will pay for
that good
good.


WTP measures how
much the buyer values
the good.


Example:
4 buyers’ WTP for an iPod

name
Anthony

WTP
$250

Chad

175

Flea

300

John

125

Consumer Surplus
Q: If price of iPod is $200, who will buy an iPod,
and what is quantity demanded?
q
y
A: Anthony & Flea will buy an iPod,
Chad & John will not.
Hence, Qd = 2
when P = $200.

Consumer Surplus
Derive the
demand
schedule:

P (price
of iPod)
)
$301 & up
251 – 300

who buys
nobody
Flea

Qd
0
1

176 – 250

Anthony, Flea

2

126 – 175

Chad, Anthony,
Flea

3

,
,
John, Chad,
Anthony, Flea

4

0 – 125

Consumer Surplus
This D curve looks like a staircase
with 4 steps – one per buyer.
If there were a huge no. of buyers,
as in a competitive market, there
would be a huge no. of very tiny steps
and it would look more like
a smooth curve.

$
$350
$300
$250
$200
$150
$100
$50
$0
0

1

2

3

4

Consumer Surplus
Consumer surplus is the amount a buyer is
willing to pay minus the amount the buyer actually
g
p y
y
y
pays:


CS = WTP – P
Suppose P = $260.
Flea’s CS = $300 – 260 = $40.
The others get no CS because they do not buy an iPod at this price. Total CS = $40.

Consumer Surplus
Flea’s WTP

$
$350
$300

P = $260
Flea’s CS =
$300 – 260 = $40

$250
$200

Total CS = $40

$150
$100
$50
$0
0

1

2

3

4

Consumer Surplus
The lesson:
Total CS
equals the
area under
the demand
curve above
the price, from
0 to Q.

Flea’s WTP

$
$350
$300

Anthony’s WTP

$250
$200

Suppose P = $220
Flea’s CS =
$300 – 220 = $80

$150

Anthony’s CS =

$100
$50

$250-220 = $30
Total CS = $110

$0
0

1

2

3

4

Consumer Surplus
P
CS

is the area
b/w P and the D
curve, f
from 0 to Q.
Recall:

area of
a triangle equals
½ x base x height
Height

=
60 – 30 = 30.
So,

CS = ½ x 15 x 30
225.
= 225

60

The demand for shoes

50
h
40
30

Pairs of shoes

20
10

D

0

Q
0

5 10 15 20 25 30

Consumer Surplus
P
If P rises to 40,
CS = ½ x 10 x 20
= 100.



Two

reasons for the
fall in CS.
f ll i CS

2. Fall in
2 F ll i CS d t
due to
remaining buyers
paying higher P

60

The demand for shoes

50

1. Fall in CS due to
buyers leaving
market

40
30
20
10

D

0

Q
0

5 10 15 20 25 30

Producer Surplus
1)

Producer surplus is the analogous measure for producers.
Some producers are producing units at a cost just equal to
the
th market price.
k t i

2)

Other units, however, could be produced for less than the
market price, and would still be produced and sold even if
price
the market price was lower. Producers therefore enjoy a
benefit – a surplus – from selling these units.

3)

For each unit, the producer’s surplus is the difference
between the market price the producer receives and the
marginal
ma ginal cost of producing this unit.
p od cing
nit

Producer Surplus P


Suppose P =40.

60

The supply of shoes

50

S

At Q = 15 the
15, th
marginal seller’s
40
cost is 30 and his
30,
producer surplus is 30
10.
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