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What did you study last time?

What did you study last time?. Chapter 6 Supply, Demand, & Government Policies Price controls in markets & effects Taxes on markets & effects. Do you know …. what consumer surplus is and how to measure it? what producer surplus is and how to measure it?

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What did you study last time?

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  1. CRC Microeconomics

  2. What did you study last time? Chapter 6Supply, Demand, & Government Policies • Price controls in markets & effects • Taxes on markets & effects CRC Microeconomics

  3. Do you know … • what consumer surplus is and how to measure it? • what producer surplus is and how to measure it? • what total surplus is and how to measure it? • what market efficiency means? • what causes market failures? CRC Microeconomics

  4. I. What is consumer surplus (CS) and how to measure it? • CS measures the benefits to buyers for participating in a market • CS = a bargain CRC Microeconomics

  5. I. What is consumer surplus (CS) and how to measure it? • For a single buyer: CS = WTP – P = MB - MC, where • WTP = MB = willingness to pay, the maximum price that a marginal buyer is willing and able to pay for a good, based upon his/her perceived value of the good, i.e. marginal benefit, and • P = MC = the price of the good, or marginal cost. CRC Microeconomics

  6. Consumer Surplus (One Buyer) Given the demand curve D and the market price, for the first buyer, willingness to pay (WTP) = marginal benefit (MB). P Because P < WTP , the first buyer enjoys a CS. CS WTP = MB Market price = P = MC D $2 CRC Microeconomics Q 1

  7. Consumer Surplus (One Buyer) For the fourth buyer, WTP = MB. Because P < WTP , the fourth buyer also enjoys a CS. P For the eighth buyer, WTP = MB. Because P = WTP , the eighth buyer enjoys no CS. CS WTP = MB Market price = P = MC D $2 CRC Microeconomics Q 1 4 8

  8. I. What is consumer surplus (CS) and how to measure it? • For the whole market: CS = SCSi = TB - TE, where • SCSi = sum of all CS’s achieved by all buyers, • TB = SMBi = total benefits to all buyers, and • TE = SMCi = P x Q = total expenditures paid by all buyers. CRC Microeconomics

  9. I. What is consumer surplus (CS) and how to measure it? • Graphically, CS is the area below the demand curve and above the price. • A lower price increases CS. CRC Microeconomics

  10. Consumer Surplus (All buyers/Market) Given the demand curve D and the market price, for the first buyer, willingness to pay (WTP) = marginal benefit (MB). P For the fourth buyer, WTP = MB. For the eighth buyer, WTP = MB. WTP = MB Market price D $2 CRC Microeconomics Q 1 4 8

  11. Consumer Surplus (All buyers/Market) For all buyers or the market, the total benefit (TB) is the area... The total expenditure (TE) is the area … P The consumer surplus (CS) is the area …, where market CS = S CSi = TB - TE . CS SWTP = SMB =TB WTP = MB WTP = MB Market price TE D $2 CRC Microeconomics Q 1 4 8

  12. Summary -- CS Given the demand curve D and market price for a single buyer and the market. For the single buyer, CS = WTP – P. For all buyers or the market, CS = SWTP – P*Q = TB – TE. P P CS WTP = MB SWTP = TB CS Market Price TE D D P Q Q Market One Buyer CRC Microeconomics

  13. II. What is producer surplus (PS) and how to measure it? • PS measures the benefits to sellers for participating in a market • PS = gross profit CRC Microeconomics

  14. II. What is producer surplus (PS) and how to measure it? • For a single seller: PS = P - WTR = MB - MC, where • P = MB = the price of the good, or marginal benefit, and • WTR = MC = willingness to receive, the minimum price that a marginal seller is willing and able to receive for selling a good, based upon his/her cost of producing the last unit, i.e. marginal cost of production. CRC Microeconomics

  15. Producer Surplus (one seller) Given the supply curve S and the market price, for the first seller, willingness to receive (WTR) = marginal cost (MC). P Because P > WTP , the first seller enjoys a producer surplus (PS). S PS WTR = MC Market price = P = MB $2 CRC Microeconomics Q 1

  16. Producer Surplus (one seller) For the fourth seller, WTR = MC. Because P > WTR , the fourth seller also enjoys a PS. P For the eighth seller, WTR = MC. Because P = WTR , the eighth seller also enjoys no PS. S PS WTR = MC Market price = P = MB $2 CRC Microeconomics Q 1 4 8

  17. II. What is producer surplus (PS) and how to measure it? • For the whole market: PS = SPSi = TR - VC, where • SPSi = sum of all PS’s achieved by all sellers, • TR = SMBi = P x Q = total revenue received by all sellers, and • VC = SMCi = variable costs incurred by all sellers. CRC Microeconomics

  18. II. What is producer surplus (PS) and how to measure it? • Graphically, PS is the area above the supply curve and below the price. • A higher price increases PS. CRC Microeconomics

  19. Producer Surplus (All sellers/Market) Given the supply curve S and the market price, P for the first seller, WTR= MC For the fourth seller, WTR = MC. For the eighth seller, WTR = MC. S WTR = MC Market price $2 CRC Microeconomics Q 1 4 8

  20. Producer Surplus (All sellers/Market) For all sellers or the market, the variable cost (VC) is the area… P The total revenue (TR) is the area … The producer surplus (PS) is the area …, where market PS = S PSi = TR - TVC . S SWTR = SMC = TVC WTR = MC Market price TR VC PS $2 CRC Microeconomics Q 1 4 8

  21. Summary -- PS Given the supply curve S and market price for a single seller and the market. For the single seller, PS = P - WTR. For all sellers or the market, PS = P*Q - SWTR = TR – VC. P P S S TR PS Market Price VC PS SWTR = VC WTR = MC P Q Q Market One Seller CRC Microeconomics

  22. III. What is total surplus (TS) and how to measure it? • TS measures the benefits to both buyers and sellers for participating in a market. • For the whole market: TS = CS + PS. CRC Microeconomics

  23. Total Surplus = TS = CS + PS Given the demand curve D and the supply curve S in a market. The market equilibrium price is Pe, and the equilibrium quantity Qe. P TE = TR = P * Q S E Pe TE = TR D CRC Microeconomics Q Qe

  24. Total Surplus = TS = CS + PS CS = TB - TE PS = TR - TVC P TS = CS + PS S CS TB = CS + TE E TR = PS + TVC Pe PS TVC TE = TR D CRC Microeconomics Q Qe

  25. IV. What is market efficiency? • A benevolent social planner wants to maximize the well-being of everyone in society. What should the planner do? • The planner wants to achieve efficiency and equity. • Efficiency = best resource allocation, and • Equity = fair distribution of prosperity. CRC Microeconomics

  26. IV. What is market efficiency? • Market efficiency is achieved if maximum TS = maximum (CS + PS)is achieved, or • Best allocation of resources is achieved if TS is maximized. CRC Microeconomics

  27. IV. What is market efficiency? • Free markets would maximize TS, i.e. free markets are efficient. • Why? • Free markets allow buyers who value goods the most highly to buy them. • Free markets allow sellers who can produce goods the most cheaply to sell them. • Free markets result in the quantity of goods that maximize the sum of CS + PS, or TS. CRC Microeconomics

  28. A free market is efficient Given the demand curve D and the supply curve S in a market. P The market equilibrium price is Pe, and the equilibrium quantity Qe. TE = TR = P * Q S CS = TB - TE CS PS = TR - TVC E Pe PS TVC TE = TR D CRC Microeconomics Q Qe

  29. A free market is efficient TS = CS + PS = maximum P A free market is efficient. S CS E Pe PS D CRC Microeconomics Q Qe

  30. A market with a binding price ceiling Now assume that the government imposes a price ceiling, Pc which is binding. Market output falls to Qc. CS rises to CSf and PS falls to PSf. P There exists a DWL, equal to the reduction in TS. S The market becomes inefficient. CS CSf CSf DWL E Pe PS DWL Pc D PSf CRC Microeconomics Q Qc Qe

  31. A market with a binding price floor Now assume that the government imposes a price floor, Pf, which is binding. Market output falls to Qf. CS falls to CSf and PS rises to PSf. P There exists a DWL, equal to the reduction in TS. S The market becomes inefficient. CS CSf Pf PSf DWL E Pe PS DWL D PSf CRC Microeconomics Q Qf Qe

  32. A market with tax Now assume that the government imposes a per-unit tax, T, on the market. P Market output falls to Qt. CS falls to CSt and PS falls to PSt. Government collects tax revenue, GTR. There exists a DWL, equal to the reduction in TS. DWL = ½ * T * (Qe – Qt). CSt CS The market becomes inefficient. T S GTR DWL E Pe PS DWL D PSt CRC Microeconomics Q Qt Qe

  33. IV. What is market efficiency? • The planner should leave the markets alone, i.e. implement a policy known as laissez-faire policy. • Laissez-faire policy: “leave-well-enough-alone” policy, a policy of non-intervention. CRC Microeconomics

  34. IV. What is market efficiency? • The equilibrium outcome in a free market is an efficient allocation of resources. • The invisible hand has already guided buyers and sellers to an allocation of the economy’s resources that maximizes total surplus. CRC Microeconomics

  35. V. What causes market failures? • The forces of supply and demand allocate the economy’s scarce resources efficiently. • Two key assumptions for efficiency: • Markets are perfectly competitive. • There are no externalities (external/side effects) CRC Microeconomics

  36. V. What causes market failures? • If the assumptions do not hold, the conclusion that free market equilibrium is efficient may not be true. • There would be then market failures, which occur when some unregulated, free markets are unable to allocate resources efficiently. CRC Microeconomics

  37. V. What causes market failures? • Markets fail when they are inefficient, i.e. when TS is not maximized. CRC Microeconomics

  38. V. What causes market failures? • Some causes of market failures (inefficiency): • Market power, due to monopolies. • Externalities, due to external effects. • Public goods, due to the free-rider problem. • Common resources, due to undefined property rights. CRC Microeconomics

  39. Summary • Consumer surplus is equivalent to a bargain. • Producer surplus is equivalent to profit. • Total surplus is the sum of CS and PS. CRC Microeconomics

  40. Summary • Markets are efficient when TS is maximized. • Government interventions, in most cases, result in market inefficiency. CRC Microeconomics

  41. Summary • The equilibrium in a free market results in maximum benefits, and therefore maximum well-being for both consumers and producers of the good in that market. CRC Microeconomics

  42. Summary • Government interventions, in most cases, result in market inefficiency. So laissez-faire policy should be implemented. CRC Microeconomics

  43. Final notes • This chapter is about Welfare Economics, the study of how allocation of resources affect economic well-being. CRC Microeconomics

  44. Now you know … • what consumer surplus is and how to measure it. • what producer surplus is and how to measure it. • what total surplus is and how to measure it. • what market efficiency means. • what causes market failures. CRC Microeconomics

  45. What did you study this time? Chapter 6Consumers, Producers, and the Efficiency of Markets • Consumer surplus, producer surplus, and total surplus • Market efficiency CRC Microeconomics

  46. What will you study next time? Chapter 7Applications: The Cost of Taxation • Effects of taxes on markets • Deadweight loss CRC Microeconomics

  47. See You! Take Care! CRC Microeconomics

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