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Chapter 7 Notes

by: Devon Black

Chapter 7 Notes Econ 10A

Devon Black
Harvard University

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Market efficiency
Principles of Economics
N. Gregory Mankiw
Class Notes
Economics, Microeconomics, efficiency, failure
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This 3 page Class Notes was uploaded by Devon Black on Friday September 23, 2016. The Class Notes belongs to Econ 10A at Harvard University taught by N. Gregory Mankiw in Fall 2016. Since its upload, it has received 4 views. For similar materials see Principles of Economics in Economics at Harvard University.


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Date Created: 09/23/16
th Principles of Economics, 7 ed. Chapter 7: Consumers, Producers, and the Efficiency of Markets I) Introduction A) Positive: what is B) Normative: what should be C) Welfare economics explains the principles that markets are usually a good way to organize economic activity 1) P* is the best price because it maximizes the total welfare of turkey consumers and suppliers II) Consumer Surplus A) Willingness to Pay 1) Measures how an individual values a good 2) If the price is equal to a consumer’s willingness to pay, then they are indifferent about buying that good 3) Consumer surplus measures the benefit that buyers receive from participating in a market – the price may be lower than their willingness to pay B) Using the Demand Curve to Measure Consumer Surplus 1) Consumer surplus is closely related to the demand curve for a product (a) Demand curve for any Q iD at the willingness to pay for the marginal buyer 2) Area below the demand curve and above the price measures the consumer surplus in a market (a) Height of the demand curve measures the value buyers place on the good C) How a Lower Price Raises Consumer Surplus 1) Lower prices benefit buyers 2) In a large market (i.e. one that has many buyers), the effect of each buyer’s willingness to pay being exceeded and therefore their stepping out from the market is so small, that the demand curve is smooth, rather than steps (a) Consumer surplus is still the area above the price and below the demand curve (i.e. the buyer’s willingness to pay) 3) As prices lower, consumer surplus rises (a) Those who were already going to buy the item at the higher price now receive a larger surplus because they’re paying less (b) Some new buyers have entered the market because the price is below their willingness to pay (1) Quantity demanded increased as price decreased because the demand curve slopes downward D) What Does Consumer Surplus Measure? 1) Consumer surplus measures the benefit a consumer receives from participating in the market as they see it (a) Good economic measure if policymakers want to respect the preferences of buyers 2) Consumer surplus generally reflects economic well-being III) Producer Surplus A) Cost and the Willingness to Sell 1) Cost should be interpreted as the seller’s opportunity cost 2) At a price equal to the cost, sellers are indifferent about providing services B) Using the Supply Curve to Measure Producer Surplus 1) Height of the supply curve reflects the seller’s costs 2) Area below the price and above the supply curve measures the producer surplus in a market C) How a Higher Price Raises Producer Surplus IV) Market Efficiency A) The Benevolent Social Planner 1) Different measures of economic well-being (a) Total Surplus = value to buyers – cost to sellers (1) Maximization of total surplus is efficiency (2) If it’s inefficient, then not all of the gains possible for buyers and sellers are being realized B) Evaluating the Market Equilibrium 1) Free markets allocate the supply of goods to the buyers who value them most highly, as measured by their willingness to pay 2) Free markets allocate the demand for goods to the sellers who can produce them at the lowest cost 3) Free markets produce the quantity of goods that maximizes the sum of consumer and producer surplus 4) To the left of Q*, the value to buyers of a good is greater than the cost to sellers 5) To the right of Q*, the value to buyers of a good is less than the cost to sellers C) Case Study: Should There Be a Market in Organs? V) Conclusion: Market Efficiency and Market Failure A) If the assumptions made above aren’t true, then market equilibrium may not be efficient B) If a person has a monopoly version of market power, then they can make the market inefficient because they are keeping price and Q awDy from the natural equilibria C) When externalities occur, the welfare implications of the market depend on more than just buyers and sellers D) Market failure can occur when there’s too many externalities and a few people have market power Vocabulary Welfare Economics: the study of how the allocation of resources affects economic well-being Willingness to Pay: the maximum amount that an individual buyer will pay for a good Consumer Surplus: the amount a buyer is willing to pay for a good minus the amount the buyer actually pays for it Marginal Buyer: the buyer who would leave the market first if the price were any higher; the buyer with the lowest willingness to pay Cost: the value of everything a seller must give up to produce a good Producer Surplus: the amount a seller is paid for a good minus the seller’s cost of providing it Marginal Seller: the seller who would leave the market first if the price were any lower; the seller with the highest cost Efficiency: the property of a resource allocation of maximizing the total surplus received by all members of society Equality: the property of distributing economic prosperity uniformly among the members of society Market Power: ability to influence prices Externality: the cost or benefit that affects a part who did not choose to incur that cost or benefit Market Failure: the inability of some unregulated markets to allocate resources efficiently


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