Equilibrium (cont’d)

So What Do Buyers Get Out of This? Consumer surplus Difference between what you are willing-to-pay and what you have to pay Willingness-to-pay Everything under the demand curve up to the last unit that you bought What you had to pay Average price paid x number of units purchased

Consumer Surplus Demand Curve is Also Marginal Value and Avg Revenue CS Amount Paid Total WTP = CS + Amt Paid

What Do Sellers Get Out of This? Producer Surplus The difference between what they get paid (total revenues) and what it costs them Total Revenues > = Average Price x Quantity Purchased Total Costs > = Sum of Marginal Costs up to the amount supplied (QS) Or = the area under the supply curve up to Qs

What is the Value of the Market To Consumers = Consumer Surplus To Producers = Producer Surplus Value equals the sum of both CS and PS

Market Efficiency Evaluating the market equilibrium Market outcomes Free markets allocate the supply of goods to the buyers who value them most highly Measured by their willingness to pay Free markets allocate the demand for goods to the sellers who can produce them at the least cost Only produce if you are paid as much (or more) than product costs to make (MC)

Consumer and producer surplus in the market equilibrium 7 Consumer and producer surplus in the market equilibrium Price A Supply Demand D Consumer surplus Equilibrium price E Equilibrium quantity Producer surplus B C Quantity Total surplus—the sum of consumer and producer surplus—is the area between the supply and demand curves up to the equilibrium quantity

Market Efficiency Evaluating the market equilibrium Social planner Cannot increase economic well-being by Changing the allocation of consumption among buyers Changing the allocation of production among sellers Cannot rise total economic well-being by Increasing or decreasing the quantity of the good Free markets produce the quantity of goods that maximizes the sum of consumer and producer surplus

The efficiency of the equilibrium quantity 8 The efficiency of the equilibrium quantity Price Supply Demand Cost to sellers Value to buyers Equilibrium quantity Value to buyers Cost to sellers Q1 Q2 Quantity Value to buyers is greater than cost to sellers Value to buyers is less than cost to sellers At quantities less than the equilibrium quantity, such as Q1, the value to buyers exceeds the cost to sellers. At quantities greater than the equilibrium quantity, such as Q2, the cost to sellers exceeds the value to buyers. Therefore, the market equilibrium maximizes the sum of producer and consumer surplus.

Market Efficiency Evaluating the market equilibrium Equilibrium outcome Efficient allocation of resources Consumers: Goods to those who value it most (MV >= P) Suppliers Goods produced by those with least costs/most efficient production (P>MC) Efficient use of resources Produce only goods whose value is >= cost of using the resources

Market Efficiency & Market Failure In the world Competition - far from perfect Market power A single buyer or seller (small group) Control market prices Markets are inefficient Keeps the price and quantity away from the equilibrium of supply and demand

Market Efficiency & Market Failure In the world Decisions of buyers and sellers Affect people who are not participants in the market at all Externalities Cause welfare in a market to depend on more than just the value to the buyers and the cost to the sellers Inefficient equilibrium From the standpoint of society as a whole

Market Efficiency & Market Failure E.g.: market power and externalities The inability of some unregulated markets to allocate resources efficiently Occurs only in specific market types: Monopoly Possibly oligopoly (small number of producers) Externalities (pollution, fish, natural resources) Asymmetric information (financial markets) Public policy Can potentially remedy the problem Increase economic efficiency