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Ch 4: Consumer Surplus and the Demand Curve: Consumer Surplus = Willingness to pay – Price paid - Willingness to Pay: Maximum price at which a consumer would buy a good. - Total Consumer Surplus: sum of all individual consumer surplus. - PC: - P: - QM: - Total consumer surplus is equal to the area below the demand curve but above the price.o Area of a Triangle = (1/2)bh o Area below demand curve = (1/2)(Pc-PMARKET)QMChanges in Consumer Surplus: Changes in quantity of buyers (shaded triangle on graph) Two sources of increase in CS: In “decrease” same process vice versa - Original buyers – because of price drop - New buyers that now enter the market who will buy because of price drop
Price Discrimination: The sale of a G/S at different prices to different customers. - Consumer becomes profits - Ex: “buy one get one free”, Ladies night Producer Surplus and the Supply Curve:Producer Surplus = Price received – Cost- Cost: Lowest price at which a potential seller is willing to sell - WTS: - Total producer surplus is equal to the area above the supply curve but below the price.Changing Prices Affect on Producer Surplus: - Fall in price reduces PS - Rise in price increases PS - Calculate area of triangle created by rise in price
Gains from Trade: Total Surplus: Net gain to consumers and producers from trading in a market. (TS = PS + CS) 3 Ways to Increase Total Surplus: 1) Reallocate Consumption Among buyers 2) Reallocate Sales Among Producers 3) Change the Quantity that Gets Traded 1) Reallocate Consumption: Lowers Consumer Surplus 2) Reallocate Sales: Lowers Producer Surplus 3) Change Quantity Traded: Lowers Total Surplus
~ Total surplus: Measures gains from trade in a market ~ Markets are: Efficient except under some well-defined conditions ~ When total surplus is maximized: No one can be made better off without making someone else worse off. The Four Important Functions of an Efficient Market: 1) Allocates consumption of the good to the potential buyers who most value it, as indicated by the fact that they have the highest WTP (willingness to pay) 2) Allocates sales to the potential sellers who most value the right to sell the good more than every other seller who makes a sale, so that all transactions are mutually beneficial. 3) 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) Ensures that every potential buyer who doesn’t make a purchase values the good less than every potential seller who makes a sale, so that no mutually beneficial transactions are missed. *** As a result of these four functions, any way of allocating the good other than the market equilibrium outcome lowers total surplus. *** ~ Markets although efficient are NOT necessarily Equitable (fair). ~ Markets sometimes fail to deliver efficiency. Meaning they no longer maximize total surplus.~ Market equilibrium maximizes total surplus. Which does not mean that it results in the best possible outcome for every individual consumer or producer.
Equity and Efficiency: - Efficiency is the best way to achieve a goal - Equity addresses which goal should be achieved - There is often a tradeoff between equity and efficiency - A social choice to pursue equity over efficiency is not necessarily bad. *** Well meaning people can disagree about what is equitable. *** Why Markets Typically Work So Well: 2 powerful features: 1) Property Rights: Valuable items in the economy have specific owners, who can dispose of them as they choose.a. This allows people to resell items without limitations 2) Economic Signals: Any piece of information that helps people and businesses make better economic decisions. a. Ex: If businesses are buying lots of cardboard boxes, you can be sure that will soon increase production.
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