0 Do First!  How much would you be willing to pay for a pair of Nike Jordans?  How would you feel if you got the Jordans for less than you were willing to pay? For the exact amount you were willing to pay? For more than you were willing to pay?

1 Welfare Economics  Welfare = well being, happiness Welfare Economics: the study of how the allocation of resources affects economic well being  You benefit when you can buy the Jordans for less than you were willing to pay, and you are economically better off! (that’s why you’re so happy)

2 Your turn!  What is welfare economics in your own words? CHAPTER 7 CONSUMERS, PRODUCERS, EFFICIENCY OF MARKETS

3 Willingness to Pay (WTP) A buyer’s willingness to pay for a good is the maximum amount the buyer will pay for that good. WTP measures how much the buyer values the good. nameWTP Anthony$250 Chad175 Flea300 John125 Example: 4 buyers’ WTP for an iPod

4 CHAPTER 7 CONSUMERS, PRODUCERS, EFFICIENCY OF MARKETS WTP and the Demand Curve Q:If price of iPod is $200, who will buy an iPod, and what is quantity demanded? nameWTP Anthony$250 Chad175 Flea300 John125

5 CHAPTER 7 CONSUMERS, PRODUCERS, EFFICIENCY OF MARKETS WTP and the Demand Curve Derive the demand schedule: 0 – – – – 300 $301 & up QdQd who buys P (price of iPod) nameWTP Anthony$250 Chad175 Flea300 John125

6 CHAPTER 7 CONSUMERS, PRODUCERS, EFFICIENCY OF MARKETS WTP and the Demand Curve PQdQd $301 & up0 251 – – – – 1254 P Q

7 CHAPTER 7 CONSUMERS, PRODUCERS, EFFICIENCY OF MARKETS About the Staircase Shape… This D curve looks like a staircase with 4 steps – one per buyer. P Q If there were a huge # of buyers, as in a competitive market, there would be a huge # of very tiny steps, and it would look more like a smooth curve.

8 CHAPTER 7 CONSUMERS, PRODUCERS, EFFICIENCY OF MARKETS WTP and the Demand Curve 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. P Q Flea’s WTPAnthony’s WTPChad’s WTPJohn’s WTP

9 Your Turn!  What is the marginal buyer?  At $250 Who is the Marginal Buyer? What is the Qd?  At $125 Who is the Marginal Buyer? What is the Qd? CHAPTER 7 CONSUMERS, PRODUCERS, EFFICIENCY OF MARKETS

10 CHAPTER 7 CONSUMERS, PRODUCERS, EFFICIENCY OF MARKETS Consumer Surplus (CS) Consumer surplus is the amount a buyer is willing to pay minus what the buyer actually pays: CS = WTP – P nameWTP Anthony$250 Chad175 Flea300 John125 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.

11 CHAPTER 7 CONSUMERS, PRODUCERS, EFFICIENCY OF MARKETS CS and the Demand Curve P Q Flea’s WTP P = $260 Flea’s CS = $300 – 260 = Total CS =

12 CHAPTER 7 CONSUMERS, PRODUCERS, EFFICIENCY OF MARKETS CS and the Demand Curve P Q Flea’s WTPAnthony’s WTP Instead, suppose P = $220 Flea’s CS = $300 – 220 = $ Anthony’s CS = $250 – 220 = $ Total CS = $

13 CHAPTER 7 CONSUMERS, PRODUCERS, EFFICIENCY OF MARKETS CS and the Demand Curve P Q The lesson: Total CS equals the area under the demand curve above the price, from 0 to Q.

14 Your Turn!  What is consumer surplus?  Using the previous example, what is the consumer surplus if the price is $125? Hint – compute each consumer’s surplus & add them together! CHAPTER 7 CONSUMERS, PRODUCERS, EFFICIENCY OF MARKETS

15 CHAPTER 7 CONSUMERS, PRODUCERS, EFFICIENCY OF MARKETS P Q $ CS with Lots of Buyers & a Smooth D Curve The demand for shoes D 1000s of pairs of shoes Price per pair At Q = 5(thousand), the marginal buyer is willing to pay $50 for pair of shoes. Suppose P = $30. Then his consumer surplus = $20.

16 CHAPTER 7 CONSUMERS, PRODUCERS, EFFICIENCY OF MARKETS P Q CS with Lots of Buyers & a Smooth D Curve The demand for shoes D 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 = $. So, CS = ½ x 15 x $30 = $ h $

17 CHAPTER 7 CONSUMERS, PRODUCERS, EFFICIENCY OF MARKETS P Q How a Higher Price Reduces CS D If P rises to $40, CS = ½ x 10 x $20 = $100. Two reasons for the fall in CS. 1. Fall in CS due to buyers leaving market 2. Fall in CS due to remaining buyers paying higher P

A C T I V E L E A R N I N G 1 : Consumer surplus 18 P $ Q demand curve 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