SECT. 9: CONSUMER CHOICE Consumer and Producer Surplus

Consumer Surplus  Willingness to pay  Maximum price at which you would for a good, based on its utility, is the willingness to pay.  Knowing consumer surplus allows us to know how changes in price affect the welfare of consumers Three types of Consumer Surplus:  Individual Consumer Surplus  The net gain EACH buyer achieves for themselves, from the purchase of a good.  Total Consumer Surplus  The sum of individual consumer surpluses by all buyers of a good  Price Changes and Consumer Surplus

Consumer and Producer Surplus Two types of Consumer Surplus:  Individual Consumer Surplus  The net gain EACH buyer achieves for themselves, from the purchase of a good.  Total Consumer Surplus  The sum of individual consumer surpluses by all buyers of a good

Consumer and Producer Surplus  Why a cost? OPPORTUNITY COST… the person selling a used book, for example, will lose the book from their collection.  Krugman reminder: The true measure of “cost” is opportunity cost, or choice.  Two types of Producer Surplus:  Individual Producer Surplus- The net gain each seller receives from the sale of a good  Total Producer Surplus- Total net gain to all sellers in the market.

Consumer and Producer Surplus c. The term “consumer surplus” usually applies to both, and is often used interchangeably. *The demand curve is stepped, as there are only a FEW potential buyers!!!! The total consumer surplus at a given price is the area BELOW the demand curve, but above the price

Figure 49.7 Producer Surplus in the Used-Textbook Market Ray and Anderson: Krugman’s Economics for AP, First Edition Copyright © 2011 by Worth Publishers

Consumer and Producer Surplus

Price Changes and Consumer Surplus  Each price change (up or down), can lead to an increase, or decrease in consumer surplus.  The quantity demanded of a product changes with price? Correct? This will affect consumer surplus (individual and total)

Consumer and Producer Surplus

Producer Surplus  Cost and Producer Surplus  Cost- the LOWEST price at which a potential seller is willing to sell.

Consumer and Producer Surplus

Why pay taxes?

Consumer and Producer Surplus Efficiency and Deadweight Loss  In a market, there are gains to be made from trade.  Producers AND consumers benefit, and the efficiency of a market, the point where no one can be made better off without making others worse, is the reason why.  Efficiency  Can you improve on a market? Many have tried.

Consumer and Producer Surplus  Reallocate consumption? Reduces consumer surplus, takes items away from someone how values them more, and gives them to consumers who value these items less.  Reallocate sales among sellers? Increases total cost and reduces producer surplus  Changes in Quantity traded? Shortages and Surpluses!

Consumer and Producer Surplus  If market is at equilibrium, there is no way to increase gains from trade!  Any other outcome reduces total surplus  HOWEVER…  Just because a market is efficient does not mean it is fair.  Equity  Also, markets sometimes fail, and fail to deliver efficiency. (no longer maximizing total surplus)

Consumer and Producer Surplus Equity and Efficiency  Society does care about what is fair, and markets can not always fill this need.  MUST sacrifice efficiency for fairness in some cases. Taxes  Progressive  Regressive  Proportional (flat)  Excise (sales)

Consumer and Producer Surplus Excise Tax on Quantities and Prices  Tax imposed on hotel owners

Consumer and Producer Surplus  Tax imposed on consumers.  Tax incidence- WHO really pays the tax? And how much?

Consumer and Producer Surplus Elasticity and effect on tax incidence  When consumers pay most of the tax!

Consumer and Producer Surplus  When producers pay most of the tax!

Consumer and Producer Surplus Benefits of Taxation  Revenue (Tax per unit) X Q d = Tax Revenue

Consumer and Producer Surplus Costs of Taxation  Deadweight Loss  Prevents mutually beneficial transactions…  Like a quota, creates deadweight loss.

Consumer and Producer Surplus Other Specific Costs:  Administrative- not shown in deadweight loss, but how much does it cost to collect the tax, and pay for it?  Alternatives?  Lump-sum tax example- Fair? (same for all) British poll taxes NO… unfair. BUT, incredibly efficient  Value Added Taxes (VAT)?  Some claim fair and efficient

EX: Carbon Taxes