Studied by 4 people
Allocation of Resources
-How much of each good is produced
- Which producers produce it
- Which consumers consume it
Welfare Economics
The study of how the allocation of resources affects economic well-being
Willingness to Pay (WTP)
The maximum amount that a buyer will pay for a good; how much the buyer values the good
Marginal Buyer
The buyer who would leave the market first if the price were any higher
Demand Curve
The WTP of the marginal buyer
How does the WTP affect the Demand Curve?
The more buyers there are, the more steps there are, the smoother the curve is
Consumer Surplus (CS)
The amount a buyer is willing to pay for a good minus the amount the buyer actually pays for it
Consumer Surplus Formula
CS = WTP - P
Where is CS in the Demand Curve?
CS is the area under the demand curve above the price (0 to Q)
CS & a Smooth Demand Curve
Area between P and the D curve
Calculating CS from a Demand Curve
Find the area of the triangle from finding P
How Does a Higher Price Reduce CS?
1. Fall in CS due to buyers leaving market
2. Fall in CS due to remaining buyers paying higher P
Cost
Value of everything a seller must give up to produce a good
What Does the Term Cost Include?
Cost of all resources used to produce a good, including the value of a seller's time
Sellers' Production/Sale Rule
A seller will produce and sell the good if the price exceeds their cost (cost is a measure of willingness to sell)
CS & the Supply Curve
The supply curve is the cost of the marginal seller
Marginal Seller
The seller who would leave the market if the price were any lower
Producer Surplus (PS)
The amount a seller is paid for a good minus the seller's cost of providing it
Producer Surplus Formula
PS = P - cost
PS & the S Curve
PS is the area above the supply curve under the price
Calculating PS from a Smooth S Curve
Calculate with the triangle area formula, using P and Q.
How does a Lower Price Reduce PS?
1. Fall in PS due to sellers leaving the market
2. Fall in PS due to remaining sellers getting lower P
CS Equation
Value to Buyers - Amount Paid by Buyers = Buyers' Gains from Participating in the Market
PS Equation
Amount Received by Sellers - Cost of Sellers = Sellers' Gains from Participating in the Market
Total Surplus Formula
CS + PS
Total Surplus
Total gains from trade in a market
Total Surplus Equations
Value to Buyers - Cost to Sellers
CS + PS
Allocation of Resources in a Market Economy
- The allocation is decentralized
- Determined by the interactions of buyers and sellers
Total Surplus & Market Allocation of Resources
- Determine if the allocation of resources is good or not
- Total surplus is a measure of society’s wellbeing
- Consider if the allocation is efficient or not
Efficiency Formula
Total Surplus = Value to Buyers - Cost to Sellers
When is an Allocation of Resources Efficient?
When it maximizes total surplus
Efficiency Definitions
- The goods are consumed by the buyers who value them most
- The goods are produced by the producers with the lowest costs
- Raising or lowering the quantity of a good won’t increase total surplus
Market Equilibrium
The point of intersection of demand and supply curves of a given commodity; at equilibrium, the market is cleared of the commodity
Does Equilibrium Quantity Maximize Total Surplus?
The market equilibrium quantity maximizes total surplus: At any other quantity, can increase total surplus by moving toward the market equilibrium quantity.
Invisible Hand
A phrase coined by Adam Smith to describe the process that turns self-directed gain into social and economic benefits for all
Government Intervention & The Free Market
The government can't raise the total surplus by changing the market's allocation of resources
Laissez-Faire
Policy that government should interfere as little as possible in the nation's economy.
Free Market vs. Central Planning
It is impossible for a central planner to allocate resources. To allocate resources efficiently and maximize total surplus, the planner would need to know every seller's cost and every buyer's WTP for every good in the entire economy.
Market Failures
- A buyer or seller has market power (affect the market price)
- Transactions have side effects that affect bystanders
Market Power
The ability of a single economic actor (or small group of actors) to have a substantial influence on market prices
Externalities
A side effect of an action that affects a third party other than the buyer or seller.
Height of the Demand Curve
Reflects the value of the good to buyers and their WTP
Consumer Surplus
Difference between what a consumer is willing to pay for a good and the amount actually paid
Consumer Surplus on a Graph
The area between the demand curve and the price
Height of the Supply Curve
Sellers' cost of producing the good
When are Sellers Willing to Sell?
If the price they get is at least as high as their cost
Producer Surplus
Difference between what sellers receive for a good and their cost of producing it
Producer Surplus on a Graph
The area above the supply curve and below the price
Efficiency in Regards to Total Surplus
- Total surplus is maximized
- Goods are produced by sellers with the lowest cost
- Goods are consumed by buyers who most value them
- Alterations reduce total surplus
Perfect Competition
Market outcome is efficient
