3.5 Demand, Supply, and Efficiency

inefficiency of price floors and price ceilings

As a result, two changes occur. First, an inefficient outcome occurs and the total surplus of society is reduced. The loss in social surplus that occurs when the economy produces at an inefficient quantity is called deadweight loss. A second change from the price ceiling is that some of the producer surplus is transferred to consumers.

Key Concepts

Consumer surplus is the gap between the price that consumers are willing to pay, based on their preferences, and the market equilibrium price. Producer surplus is the gap between the price for which producers are willing to sell a product, based on their costs, and the market equilibrium price. Social surplus is the sum of consumer surplus and producer surplus. Total surplus is larger at the equilibrium quantity and price than it will be at any other quantity and price. Deadweight loss is loss in total surplus that occurs when the economy produces at an inefficient quantity.

Alfred Marshall

famous economist In 1890, wrote that asking whether supply or demand determined a price was like arguing "whether it is the upper or the under blade of a pair of scissors that cuts a piece of paper." the answer is both demand and supply are always involved.

demand and supply diagram

holds within it the concept of economic efficiency

deadweight loss

loss in social surplus that occurs when the economy produces at an inefficient quantity In a very real sense, it is like money thrown away that benefits no one.

social surplus/economic surplus/ total surplus

sum of consumer surplus and producer surplus

producer surplus

the amount that a seller is paid for - the sellers actual cost=

efficiency

when it is impossible to improve the situation of one party without imposing a cost on another. if a situation is inefficient it becomes possible benefit at least one party without imposing costs on others Efficiency in the demand and supply model has the same basic meaning: The economy is getting as much benefit as possible from its scarce resources and all the possible gains from trade have been achieved. In other words, the optimal amount of each good and service is being produced and consumed.