12/4/19

Learning Objectives
§ Examine the link between buyers’ willingness to pay for
CONSUMERS, a good and the demand curve.
PRODUCERS, AND § Learn how to define and measure Consumer Surplus.
THE EFFICIENCY § Examine the link between sellers’ cost of producing a
OF MARKETS good and the supply curve.
§ Learn how to define and measure Producer Surplus.
Chapter 7 § See that the equilibrium of supply and demand
maximizes total surplus in a market.

Copyright © 2017 by Nelson Education Ltd. 7-1 Copyright © 2014 by Nelson Education Ltd. 7-2

1 2

Consumers, Producers,
FIGURE 7.1
and the Efficiency of Markets The Demand Schedule and the Demand Curve

What benefit does John

§ Welfare economics: the study of receive from buying the Elvis
how the allocation of resources Presley album?
affects economic well-being.
§ Consumer surplus: a buyer’s
willingness to pay minus the amount
the buyer actually pays
§ Willingness to pay: the maximum
amount that a buyer will pay for a
good.

Copyright © 2017 by Nelson Education Ltd. 7-3 Copyright © 2017 by Nelson Education Ltd. 7-4

3 4

1
 12/4/19

FIGURE 7.2 Consumer Surplus

Measuring Consumer Surplus with the Demand Curve

USING THE THE DEMAND CURVE

TO MEASURE CONSUMER SURPLUS

§ The area below the demand curve and above the

price measures the consumer surplus in a market.
§ The difference between this willingness to pay and
the market price is each buyer’s consumer surplus.
§ Thus, the total area below the demand curve and
above the price is the sum of the consumer surplus of
all buyers in the market for a good or service.
Copyright © 2017 by Nelson Education Ltd. 7-5 Copyright © 2017 by Nelson Education Ltd. 7-6

5 6

FIGURE 7.3
How the Price Affects Consumer Surplus Consumer Surplus
WHAT DOES CONSUMER SURPLUS MEASURE?
§ Consumer surplus measures the benefit that buyers
receive from a good as the buyers themselves perceive it.
§ Thus, consumer surplus is a good measure of economic
well-being (if policymakers want to
respect the preferences of buyers).
§ In some circumstances, policymakers might choose not to
care about consumer surplus because they do not
respect the preferences that drive buyer behaviour.
§ Drug addicts
Copyright © 2017 by Nelson Education Ltd. 7-7 Copyright © 2017 by Nelson Education Ltd. 7-8

7 8

2
 12/4/19

Producer Surplus FIGURE 7.4

The Supply Schedule and the Supply Curve

§ Let’s consider the benefits that sellers The producer surplus is closely
receive from participating in a market. related to the supply curve.

§ Cost: the value of everything a seller

must give up to produce a good (i.e.,
the producers’ opportunity cost)
§ Producer surplus: the amount a seller is
paid for a good minus the seller’s cost

Thinkstock
Copyright © 2014 by Nelson Education Ltd. 7-9 Copyright © 2017 by Nelson Education Ltd. 7-10

9 10

FIGURE 7.5
Measuring Producer Surplus with the Supply Curve Producer Surplus
US IN G TH E SU P P LY CU R V E TO
ME A S U R E PR O D U C E R SU R P LU S
§ The area above the supply curve and below the
price measures the producer surplus in a market.
§ The logic is straightforward: The height of the supply
curve measures sellers’ costs, and the difference
between the price and the cost of production is
each seller’s producer surplus.
§ Thus, the total area is the sum of the producer surplus
Copyright © 2017 by Nelson Education Ltd. 7-11
of all sellers. Copyright © 2017 by Nelson Education Ltd. 7-12

11 12

3
 12/4/19

FIGURE 7.6
How the Price Affects Producer Surplus
Market Efficiency
§ Consumer surplus and producer surplus are the basic
tools that economists use to study the welfare of
buyers and sellers in a market.
§ These tools can help us address a fundamental
economic question:
§ Is the allocation of resources determined by free
markets in any way desirable?

Copyright © 2017 by Nelson Education Ltd. 7-13 Copyright © 2017 by Nelson Education Ltd. 7-14

13 14

Market Efficiency Market Efficiency

THE BENEVOLENT SOCIAL PLANNER THE BENEVOLENT SOCIAL PLANNER (CONTINUED)
§ Let’s introduce the benevolent social planner, who is an
all-knowing, all-powerful, well-intentioned dictator. CS = Value to buyers – Amount paid by buyers
§ This planner wants to maximize the economic well-being PS = Amount received by sellers – Cost to sellers
of everyone in society. He wants to maximize total surplus.
Total surplus = Value to buyers – Amount paid by buyers +
§ If an allocation of resources maximizes total surplus, we Amount received by sellers – Cost to sellers
say that the allocation exhibits efficiency.
Total surplus = Value to buyers – Cost to sellers

Copyright © 2017 by Nelson Education Ltd. 7-15 Copyright © 2017 by Nelson Education Ltd. 7-16

15 16

4
 12/4/19

FIGURE 7.7
Consumer and Producer Surplus in the Market Equilibrium Evaluating the Market Equilibrium
1. Free markets allocate the supply of goods to the
buyers who value them most highly, as measured by
Is this equilibrium their willingness to pay.
allocation of
2. Free markets allocate the demand for goods to the
resources efficient? sellers who can produce them at the lowest cost.
3. Free markets produce the quantity of goods that
Does it maximize maximizes the sum of consumer and producer
total surplus? surplus.
Due to all these reasons, social planner cannot lead to a
better outcome that the free market.

Copyright © 2017 by Nelson Education Ltd. 7-17 Copyright © 2017 by Nelson Education Ltd. 7-18

17 18

FIGURE 7.8
The Efficiency of the Equilibrium Quantity Quick
Quiz

ü Draw the supply and demand for turkey. In the

equilibrium, show producer and consumer
surplus.
ü Explain why producing more turkey would lower
total surplus.

Copyright © 2017 by Nelson Education Ltd. 7-19 Copyright © 2017 by Nelson Education Ltd. 7-20

19 20

5
 12/4/19

Appendix Appendix
The Mathematics of Consumer and Producer Surplus The Mathematics of Consumer and Producer Surplus

§ you how to calculate consumer and producer surplus

for linear supply and demand curves.

§ The demand and supply curves from the appendix to

Chapter 4:

Copyright © 2017 by Nelson Education Ltd. 7-21 Copyright © 2017 by Nelson Education Ltd. 7-22

21 22

Appendix Appendix
The Mathematics of Consumer and Producer Surplus The Mathematics of Consumer and Producer Surplus

Consumer surplus = Area ABC = (1/2) ⇥ Base ⇥ Height § For this example, total surplus—which is the total value
to buyers measured by their willingness to pay less the
= (1/2) ⇥ 16 ⇥ $4 = $32 total cost to sellers of providing the good—is $96.

Producer surplus = Area CBD = (1/2) ⇥ Base ⇥ Height

= (1/2) ⇥ 16 ⇥ $8 = $64

Total Surplus = CS + PS = Area ABD = $32 + $64 = $96

Copyright © 2017 by Nelson Education Ltd. 7-23 Copyright © 2017 by Nelson Education Ltd. 7-24

23 24