© 2007 Worth Publishers Essentials of Economics Krugman Wells Olney Prepared by: Fernando & Yvonn Quijano

chapter © 2007 Worth Publishers Essentials of Economics Krugman Wells Olney 2 of 28 How much am I willing to pay for that used textbook? What you will learn in this chapter: ➤ The meaning of consumer surplus and its relationship to the demand curve ➤ The meaning of producer surplus and its relationship to the supply curve ➤ The meaning and importance of total surplus and how it can be used both to measure the gains from trade and to evaluate the efficiency of a market ➤ How to use changes in total surplus to measure the deadweight loss of taxes ➤ Why the deadweight loss of a tax means that its true cost is more than the amount of tax revenue collected

chapter © 2007 Worth Publishers Essentials of Economics Krugman Wells Olney 3 of 28 Consumer Surplus and the Demand Curve Willingness to Pay and the Demand Curve A consumer’s willingness to pay for a good is the maximum price at which he or she would buy that good.

chapter © 2007 Worth Publishers Essentials of Economics Krugman Wells Olney 4 of 28 Consumer Surplus and the Demand Curve Willingness to Pay and the Demand Curve

chapter © 2007 Worth Publishers Essentials of Economics Krugman Wells Olney 5 of 28 Consumer Surplus and the Demand Curve Willingness to Pay and Consumer Surplus TABLE 6-1 Consumer Surplus When the Price of a Used Textbook Is $30 Potential buyerWillingness to payPrice paid Individual consumer surplus = willingness to pay − price paid Aleisha$59$30 Brad Claudia35305 Darren25−− Edwina10−− Total consumer surplus: $49

chapter © 2007 Worth Publishers Essentials of Economics Krugman Wells Olney 6 of 28 Consumer Surplus and the Demand Curve Willingness to Pay and Consumer Surplus Individual consumer surplus is the net gain to an individual buyer from the purchase of a good. It is equal to the difference between the buyer’s willingness to pay and the price paid. Total consumer surplus is the sum of the individual consumer surpluses of all the buyers of a good. The term consumer surplus is often used to refer to both individual and to total consumer surplus.

chapter © 2007 Worth Publishers Essentials of Economics Krugman Wells Olney 7 of 28 Consumer Surplus and the Demand Curve Willingness to Pay and Consumer Surplus

chapter © 2007 Worth Publishers Essentials of Economics Krugman Wells Olney 8 of 28 Consumer Surplus and the Demand Curve Willingness to Pay and Consumer Surplus

chapter © 2007 Worth Publishers Essentials of Economics Krugman Wells Olney 9 of 28 Consumer Surplus and the Demand Curve How Changing Prices Affect Consumer Surplus

chapter © 2007 Worth Publishers Essentials of Economics Krugman Wells Olney 10 of 28 Consumer Surplus and the Demand Curve How Changing Prices Affect Consumer Surplus

chapter © 2007 Worth Publishers Essentials of Economics Krugman Wells Olney 11 of 28 Producer Surplus and the Supply Curve Cost and Producer Surplus

chapter © 2007 Worth Publishers Essentials of Economics Krugman Wells Olney 12 of 28 Producer Surplus and the Supply Curve Cost and Producer Surplus A potential seller’s cost is the lowest price at which he or she is willing to sell a good. Individual producer surplus is the net gain to a seller from selling a good. It is equal to the difference between the price received and the seller’s cost. Total producer surplus in a market is the sum of the individual producer surpluses of all the sellers of a good. Economists use the term producer surplus to refer both to individual and to total producer surplus.

chapter © 2007 Worth Publishers Essentials of Economics Krugman Wells Olney 13 of 28 Producer Surplus and the Supply Curve Cost and Producer Surplus TABLE 6-2 Producer Surplus When the Price of a Used Textbook Is $30 Potential sellerCostPrice received Individual producer surplus = price received − cost Andrew$5$30$25 Betty Carlos25305 Donna35−− Engelbert45−− Total consumer surplus: $45

chapter © 2007 Worth Publishers Essentials of Economics Krugman Wells Olney 14 of 28 Producer Surplus and the Supply Curve Cost and Producer Surplus

chapter © 2007 Worth Publishers Essentials of Economics Krugman Wells Olney 15 of 28 Producer Surplus and the Supply Curve Cost and Producer Surplus

chapter © 2007 Worth Publishers Essentials of Economics Krugman Wells Olney 16 of 28 Producer Surplus and the Supply Curve Changes in Producer Surplus

chapter © 2007 Worth Publishers Essentials of Economics Krugman Wells Olney 17 of 28 Consumer Surplus, Producer Surplus, and the Gains from Trade The Gains from Trade

chapter © 2007 Worth Publishers Essentials of Economics Krugman Wells Olney 18 of 28 Consumer Surplus, Producer Surplus, and the Gains from Trade The Gains from Trade The total surplus generated in a market is the total net gain to consumers and producers from trading in the market. It is the sum of the producer and the consumer surplus.

chapter © 2007 Worth Publishers Essentials of Economics Krugman Wells Olney 19 of 28 Consumer Surplus, Producer Surplus, and the Gains from Trade The Efficiency of Markets: A Preliminary View

chapter © 2007 Worth Publishers Essentials of Economics Krugman Wells Olney 20 of 28 Consumer Surplus, Producer Surplus, and the Gains from Trade The Efficiency of Markets: A Preliminary View

chapter © 2007 Worth Publishers Essentials of Economics Krugman Wells Olney 21 of 28 Consumer Surplus, Producer Surplus, and the Gains from Trade The Efficiency of Markets: A Preliminary View

chapter © 2007 Worth Publishers Essentials of Economics Krugman Wells Olney 22 of 28 Consumer Surplus, Producer Surplus, and the Gains from Trade The Efficiency of Markets: A Preliminary View The market equilibrium maximizes total surplus—the sum of producer and consumer surplus. It does this because the market performs four important functions: 1. It allocates consumption of the good to the potential buyers who value it the most, as indicated by the fact that they have the highest willingness to pay. 2. It allocates sales to the potential sellers who most value the right to sell the good, as indicated by the fact that they have the lowest cost. 3. It ensures that every consumer who makes a purchase values the good more than every seller who makes a sale, so that all transactions are mutually beneficial. 4. It ensures that every potential buyer who doesn’t make a purchase values the good less than every potential seller who doesn’t make a sale, so that no mutually beneficial transactions are missed. Maximizing total surplus at your local hardware store.

chapter © 2007 Worth Publishers Essentials of Economics Krugman Wells Olney 23 of 28 Applying Consumer and Producer Surplus: The Efficiency Costs of a Tax The excess burden, or deadweight loss, from a tax is the extra cost in the form of inefficiency that results because the tax discourages mutually beneficial transactions.

chapter © 2007 Worth Publishers Essentials of Economics Krugman Wells Olney 24 of 28 Applying Consumer and Producer Surplus: The Efficiency Costs of a Tax

chapter © 2007 Worth Publishers Essentials of Economics Krugman Wells Olney 25 of 28 Applying Consumer and Producer Surplus: The Efficiency Costs of a Tax

chapter © 2007 Worth Publishers Essentials of Economics Krugman Wells Olney 26 of 28 Applying Consumer and Producer Surplus: The Efficiency Costs of a Tax Deadweight Loss and Elasticities

chapter © 2007 Worth Publishers Essentials of Economics Krugman Wells Olney 27 of 28 Applying Consumer and Producer Surplus: The Efficiency Costs of a Tax Deadweight Loss and Elasticities

chapter © 2007 Worth Publishers Essentials of Economics Krugman Wells Olney 28 of 28 Willingness to pay Individual consumer surplus Total consumer surplus Consumer surplus Cost Individual producer surplus Total producer surplus Producer surplus Total surplus Excess burden Deadweight loss K E Y T E R M S