Instructor Sandeep Basnyat 9841892281 Sandeep_basnyat@yahoo

1. Economic Analysis for BusinessSession IX: Consumer Surplus, Producer Surplus and Market Efficiency-1 InstructorSandeep Basnyat 9841892281 Sandeep_basnyat@yahoo.com

2. Welfare Economics • Welfare economics is the study of how the allocation ofresources affects economic well-being. • Buyers and sellers receive benefits from taking part in the market. • Consumer surplus measures economic welfare from the buyer’s side. • Producer surplus measures economic welfare from the seller’sside. • The equilibrium in a market maximizes the total welfare of buyers and sellers.

3. 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. • It’s the benefit that buyers receive from their own perspective.

4. WTP and the Demand Curve P (price of iPod) who buys Qd Derive the demand schedule: $301 & up nobody 0 251 – 300 Flea 1 176 – 250 Anthony, Flea 2 126 – 175 Chad, Anthony, Flea 3 0 – 125 John, Chad, Anthony, Flea 4 CHAPTER 7 CONSUMERS, PRODUCERS, EFFICIENCY OF MARKETS

5. WTP and the Staircase shaped Demand Curve P Q

6. Flea’s WTP Anthony’s WTP Chad’s WTP John’s WTP WTP and the Staircase Demand Curve P At any Q, the height of the D curve is the WTP of the marginal buyer, the buyer who would leave the market if P were any higher. Q

7. Mathematical Calculation of Consumer Surplus (CS) Consumer surplus is the amount a buyer is willing to pay minus the buyer actually 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.

8. Flea’s WTP CS and the Demand Curve P P = $260 Flea’s CS = $300 – 260 = $40 Total CS = $40 Q

9. Flea’s WTP Anthony’s WTP CS and the Demand Curve P Instead, suppose P = $220 Flea’s CS = $300 – 220 = $80 Anthony’s CS =$250 – 220 = $30 Total CS = $110 Q

10. Lessons from CS and the Demand Curve P The lesson: Total CS equals the area under the demand curve above the price, from 0 to Q. Q

11. P h D Q Further Calculations of CS with Smooth D Curve The demand for shoes CS is the area b/w P and the D curve, from 0 to Q. Recall: area of a triangle equals ½ x base x height Height of this triangle is $60 – 30 = $30. So, CS = ½ x 15 x $30 = $225. $

12. P 1. Fall in CS due to buyers leaving market 2. Fall in CS due to remaining buyers paying higher P D Q How a Higher Price Reduces CS If P rises to $40, CS = ½ x 10 x $20 = $100. Two reasons for the fall in CS.

13. ACTIVE LEARNING 1: Consumer surplus demand curve P $ A. Find CS for P = $30. Suppose P falls to $20.How much will CS increase due to… B. buyers entering the market C. existing buyers paying lower price Q

14. ACTIVE LEARNING 1: Answers demand curve P $ A.CS = ½ x 10 x $10 = $50 P falls to $20. B. CS for the additional buyers = ½ x 10 x $10 = $50 C. Increase in CS on initial 10 units= 10 x $10 = $100 Q

15. 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. • Its the benefit that producers receive from their own perspective.

16. Cost and the Supply Curve P Qs Derive the supply schedule from the cost data: $0 – 9 0 10 – 19 1 20 – 34 2 35 & up 3

17. P Q Cost and the Supply Curve CHAPTER 7 CONSUMERS, PRODUCERS, EFFICIENCY OF MARKETS

18. Kitty’s cost Hunter’s cost Angelo’s cost Cost and the Supply Curve P At each Q, the height of the S curve is the cost of the marginal seller, the seller who would leave the market if the price were any lower. Q CHAPTER 7 CONSUMERS, PRODUCERS, EFFICIENCY OF MARKETS

19. Producer Surplus P PS = P – cost Producer surplus (PS): the amount a seller is paid for a good minus the seller’s cost. Q

20. Kitty’s cost Hunter’s cost Angelo’s cost Producer Surplus and the S Curve P PS = P – cost Suppose P = $25. Angelo’s PS = $15 Hunter’s PS = $5 Kitty’s PS = $0 Total PS = $20 Total PS equals the area above the supply curve under the price, from 0 to Q. Q

21. P S h Q PS with Lots of Sellers & a Smooth S Curve The supply of shoes PS is the area b/w P and the S curve, from 0 to Q. The height of this triangle is $40 – 15 = $25. So, PS = ½ x b x h = ½ x 25 x $25 = $312.5

22. P 1. Fall in PS due to sellers leaving market S 2. Fall in PS due to remaining sellersgetting lower P Q How a Lower Price Reduces PS If P falls to $30, PS = ½ x 15 x $15 = $112.5 Two reasons for the fall in PS.

23. Total Surplus Total surplus = Consumer surplus + Producer surplus = Value to buyers – Amount paid by buyers + Amount received by sellers – Cost to sellers Total surplus = Value to buyers – Cost to sellers • Represents the entire area between the maximum price that buyers want to pay and the lowest cost that sellers would incur.

24. P S CS PS D Q Evaluating the Market Equilibrium Market eq’m:P = $30 Q = 15,000 Total surplus = CS + PS

25. Market Efficiency • Market is considered efficient if it maximizes the total surplus • Maximizing total surplus: Maximizing consumer surplus by involving maximum number of consumers in the market for trade + Maximizing producer surplus by involving maximum number of producers in the market for trade

26. P S D Q Does Eq’mQ Maximize Total Surplus? At Q = 20, cost of producing the marginal unit is $35 But consumers wants to pay only $20. Since there is an excess supply, some sellers will not be able to sell, causing total surplus to decrease. So, decreasing production will increase the Total Surplus.

27. Thank you