PowerPoint Presentations for
Principles of Microeconomics
Sixth Canadian Edition
by Mankiw/Kneebone/McKenzie
Adapted for the
Sixth Canadian Edition by
Marc Prud’homme
University of Ottawa
CONSUMERS,
PRODUCERS,
AND THE
EFFICIENCY OF
MARKETS
Chapter 7
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CONSUMERS, PRODUCERS,
AND THE EFFICIENCY OF MARKETS
 In this chapter, we discuss welfare economics.
 We begin by examining the benefits that buyers
and sellers receive from taking part in a market.
 We then examine how society can make these
benefits as large as possible.
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CONSUMERS, PRODUCERS,
AND THE EFFICIENCY OF MARKETS
 This analysis leads to a profound conclusion:
 The equilibrium of supply and demand in a
market maximizes the total benefits
received by buyers and sellers.
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CONSUMERS, PRODUCERS,
AND THE EFFICIENCY OF MARKETS
 Welfare economics: the study of how the
allocation of resources affects economic wellbeing
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CONSUMER SURPLUS
Our study of welfare economics begins
by looking at the benefits buyers receive
from participating in a market.
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Willingness to Pay
Willingness to pay:
the maximum
amount that a
buyer will pay for a
good
Thinkstock
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TABLE 7.1
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Willingness to Pay
What benefit does John receive from
buying the Elvis Presley album?
Consumer surplus: a buyer’s willingness to
pay minus the amount the buyer actually
pays
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Using the the Demand Curve
to Measure Consumer Surplus
Consumer surplus is closely related to the
demand curve for a product.
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FIGURE 7.1:
The Demand Schedule and the Demand Curve
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Using the the Demand Curve
to Measure Consumer Surplus
 Because the demand curve reflects buyers’
willingness to pay, it can also be used to
measure consumer surplus.
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FIGURE 7.2:
Measuring Consumer Surplus with the emand Curve
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Using the the Demand Curve
to Measure Consumer Surplus
 The area below the demand curve and above the
price measures the consumer surplus in a market.
 The difference between this willingness to pay and the
market price is each buyer’s consumer surplus.
 Thus, the total area below the demand curve and
above the price is the sum of the consumer surplus of
all buyers in the market for a good or service.
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How a Lower Price Raises Consumer Surplus
How much does buyers’ well-being rise in
response to a lower price?
The concept of consumer surplus helps
answer this question.
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FIGURE 7.3:
How the Price Affects Consumer Surplus
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What Does Consumer Surplus Measure?
 Consumer surplus measures the benefit that
buyers receive from a good as the buyers
themselves perceive it.
 Thus, consumer surplus is a good measure of
economic well-being (if policymakers want to
respect the preferences of buyers).
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What Does Consumer Surplus Measure?
 In some circumstances, policymakers might choose
not to care about consumer surplus because they
do not respect the preferences that drive buyer
behaviour.
 Drug addicts
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QuickQuiz
Draw a demand curve for turkey. In your
diagram, show a price of turkey and the
consumer surplus that results from that price.
Explain in words what this consumer surplus
measures.
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Active Learning
Consumer Surplus
A. Find marginal buyer’s WTP at Q =
10.
B. Find CS for P = $30.
Suppose P falls to $20.
How much will CS increase
due to …
C. buyers entering the market
D. existing buyers paying lower price
50
45
40
35
30
25
20
15
10
5
0
0
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10
15
20
25
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Active Learning
demand curve
Answers
P
50
$ 45
A. At Q = 10, marginal
40
buyer’s WTP is $30.
35
B. CS = ½ x 10 x $10 = $50
30
25
P falls to $20.
20
C. CS for the additional buyers
15
= ½ x 10 x $10 = $50
10
D. Increase in CS on initial 10 units
5
= 10 x $10 = $100
0
0
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10
15
20
Q
25
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PRODUCER SURPLUS
 Let’s consider the benefits that
sellers receive from participating in
a market.
Thinkstock
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Cost and the Willingness to Sell
 Cost: the value of everything a seller must give
up to produce a good (i.e., the producers’
opportunity cost)
 Producer surplus: the amount a seller is paid for a
good minus the seller’s cost
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TABLE 7.2:
The Costs of Four Possible Sellers
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Using the Supply Curve
to Measure Producer Surplus
 The producer surplus is closely related to
the supply curve.
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FIGURE 7.4:
The Supply Schedule and the Supply Curve
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FIGURE 7.5:
Measuring Producer Surplus with the Supply Curve
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Using the Supply Curve
to Measure Producer Surplus
 The area above the supply curve and below the
price measures the producer surplus in a market.
 The logic is straightforward: The height of the supply
curve measures sellers’ costs, and the difference
between the price and the cost of production is
each seller’s producer surplus.
 Thus, the total area is the sum of the producer surplus
of all sellers.
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How a Higher Price Raises Producer Surplus
 It is not surprising to hear that sellers always
want to receive a higher price for the goods
they sell.
 But how much does sellers’ well-being rise in
response to a higher price?
 The concept of producer surplus offers a
precise answer to this question.
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FIGURE 7.6:
How the Price Affects Producer Surplus
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QuickQuiz
Draw a supply curve for turkey. In your diagram,
show a price of turkey and the producer surplus
that results from that price.
Explain in words what this producer surplus
measures.
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MARKET EFFICIENCY
 Consumer surplus and producer surplus are the
basic tools that economists use to study the
welfare of buyers and sellers in a market.
 These tools can help us address a fundamental
economic question:
 Is the allocation of resources determined by
free markets in any way desirable?
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The Benevolent Social Planner
 Let’s introduce the benevolent social planner,
who is an all-knowing, all-powerful, wellintentioned dictator.
 This planner wants to maximize the economic
well-being of everyone in society.
 He wants to maximize total surplus.
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The Benevolent Social Planner
 CS = Value to buyers – Amount paid by buyers
 PS = Amount received by sellers – Cost to sellers
 Total surplus = Value to buyers – Amount paid by
buyers + Amount received by sellers – Cost to sellers
 Total surplus = Value to buyers – Cost to sellers
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The Benevolent Social Planner
 If an allocation of resources maximizes total
surplus, we say that the allocation exhibits
efficiency.
 Efficiency: the property of a resource allocation
of maximizing the total surplus received by all
members of society
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The Benevolent Social Planner
 In addition to efficiency, the social planner
might also care about equity.
 Equity: the fairness of the distribution of wellbeing among the members of society
 In this chapter we concentrate on efficiency as
the social planner’s goal.
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Evaluating the Market Equilibrium
 Figure 7.7 shows consumer and producer
surplus when a market reaches the equilibrium
of supply and demand.
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FIGURE 7.7:
Consumer and Producer Surplus in the Market Equilibrium
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Evaluating the Market Equilibrium
 Is this equilibrium allocation of resources
efficient?
 Does it maximize total surplus?
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Evaluating the Market Equilibrium
 These observations lead to two insights about market
outcomes:
1. Free markets allocate the supply of goods to the
buyers who value them most highly, as measured by
their willingness to pay.
2. Free markets allocate the demand for goods to the
sellers who can produce them at the lowest cost.
 The social planner cannot increase economic well-being
by changing the allocation of consumption among
buyers or the allocation of production among sellers.
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Evaluating the Market Equilibrium
 But can the social planner raise total economic wellbeing by increasing or decreasing the quantity of the
good?
 The answer is no, as stated in this third insight about
market outcomes:
3. Free markets produce the quantity of goods that
maximizes the sum of consumer and producer
surplus.
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FIGURE 7.8:
The Efficiency of the Equilibrium Quantity
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QuickQuiz
Draw the supply and demand for turkey. In the
equilibrium, show producer and consumer
surplus.
Explain why producing more turkey would
lower total surplus.
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Classroom Activity
Value of a Time Machine
A new technology has been developed that allows individuals to
travel backward or forward in time. We want to identify the value this
time machine provides to consumers. Let’s assume the four
consumers who most desire this product are in this class.
1. A is the consumer who most values this product. He wants to go
back to the time of the dinosaurs. He is willing to pay $3000.
2. B is the consumer with the next highest willingness to pay. She
would like to see 200 years in the future. She’d pay $2500.
3. C is the next highest bidder. He’d like to relive this entire semester.
He’ll pay up to $800.
4. D is our fourth consumer. She’d pay $200 to move the clock
forward to the end of this class period.
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THE END
Chapter 7
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