ch7 Consumers, Producers and the Efficiency of Markets
producer surplus (equation)
= amount received by sellers - cost to sellers
consumer surplus (equation)
= value to buyers - amount paid by buyers
total surplus (equation)
= value to buyers - amount paid by buyers + amount received by sellers - cost to sellers = value to buyers - cost to sellers
Adam Smith's "invisible hand" concept suggests that a competitive market outcome a. maximizes total surplus. b. generates equality among the members of society. c. minimizes total surplus. d. both maximizes total surplus and generates equality among the members of society.
A
An increase in the price of a good along a stationary supply curve a. increases producer surplus. b. does all of the things described in these answers. c. decreases producer surplus. d. improves market equity.
A
Consumer surplus is the area a. below the demand curve and above the price. b. above the supply curve and below the price. c. above the demand curve and below the price. d. below the supply curve and above the price. e. below the demand curve and above the supply curve.
A
Cost and the Supply Curve
At each Q, the height of the S curve is the cost of the marginal seller, the seller who would leave the market if the price were any lower.
An increase in the price of a good along a stationary demand curve a. improves the material welfare of the buyers. b. decreases consumer surplus. c. improves market efficiency. d. increases consumer surplus.
B
If a benevolent social planner chooses to produce less than the equilibrium quantity of a good, then a. total surplus is maximized. b. the value placed on the last unit of production by buyers exceeds the cost of production. c. producer surplus is maximized. d. the cost of production on the last unit produced exceeds the value placed on it by buyers. e. consumer surplus is maximized.
B
If a benevolent social planner chooses to produce more than the equilibrium quantity of a good, then a. the value placed on the last unit of production by buyers exceeds the cost of production. b. the cost of production on the last unit produced exceeds the value placed on it by buyers. c. consumer surplus is maximized. d. total surplus is maximized. e. producer surplus is maximized.
B
If a market is efficient, then a. the market allocates buyers to the sellers who can produce the good at least cost. b. all of these answers. c. none of these answers. d. the quantity produced in the market maximizes the sum of consumer and producer surplus. e. the market allocates output to the buyers that value it the most.
B
In general, if a benevolent social planner wanted to maximize the total benefits received by buyers and sellers in a market, the planner should a. choose a price below the market equilibrium price. b. allow the market to seek equilibrium on its own. c. choose any price the planner wants because the losses to the sellers (buyers) from any change in price are exactly offset by the gains to the buyers (sellers). d. choose a price above the market equilibrium price.
B
Joe has ten pairs of football boots and Sue has none. A pair of football boots costs €50 to produce. If Joe values an additional pair of boots at €100 and Sue values a pair of boots at €40, then to maximize a. efficiency Sue should receive the glove. b. efficiency Joe should receive the glove. c. equity, Joe should receive the glove. d. consumer surplus both should receive a glove.
B
Medical care clearly enhances people's lives. Therefore, we should consume medical care until a. everyone has as much as they would like. b. the benefit buyers place on medical care is equal to the cost of producing it. c. buyers receive no benefit from another unit of medical care. d. we must cut back on the consumption of other goods.
B
The seller's cost of production is a. none of these answers. b. the minimum amount the seller is willing to accept for a good. c. the seller's producer surplus. d. the maximum amount the seller is willing to accept for a good. e. the seller's consumer surplus.
B
If a buyer's willingness to pay for a new Honda is €20,000 and she is able to actually buy it for €18,000, her consumer surplus is a. €18,000. b. €20,000. c. €2,000. d. €0. e. €38,000.
C
If a market generates a side effect or externality, then free market solutions a. maximize producer surplus. b. are efficient. c. are inefficient. d. are equitable.
C
Suppose that the price of a new bicycle is €300. Natalie values a new bicycle at €400. It costs €200 for the seller to produce the new bicycle. What is the value of total surplus if Natalie buys a new bike? a. €500 b. €300 c. €200 d. €400 e. €100
C
Total surplus is the area a. above the supply curve and below the price. b. below the demand curve and above the price. c. below the demand curve and above the supply curve. d. below the supply curve and above the price. e. above the demand curve and below the price.
C
Consumer Surplus (CS)
CS = WTP - P
A buyer's willingness to pay is that buyer's a. minimum amount they are willing to pay for a good. b. producer surplus. c. consumer surplus. d. maximum amount they are willing to pay for a good. e. none of these answers.
D
If a producer has market power (can influence the price of the product in the market) then free market solutions a. are equitable. b. are efficient. c. maximize consumer surplus. d. are inefficient.
D
If buyers are rational and there is no market failure, a. free market solutions are efficient. b. free market solutions maximize total surplus. c. all of these answers. d. free market solutions are equitable. e. free market solutions are efficient and free market solutions maximize total surplus.
E
Producer surplus is the area a. below the supply curve and above the price. b. below the demand curve and above the supply curve. c. below the demand curve and above the price. d. above the demand curve and below the price. e. above the supply curve and below the price.
E
Suppose there are three identical vases available to be purchased. Buyer 1 is willing to pay €30 for one, buyer 2 is willing to pay €25 for one, and buyer 3 is willing to pay €20 for one. If the price is €25, how many vases will be sold and what is the value of consumer surplus in this market? a. Three vases will be sold and consumer surplus is €80. b. One vase will be sold and consumer surplus is €5. c. One vase will be sold and consumer surplus is €30. d. Three vases will be sold and consumer surplus is €0. e. Two vases will be sold and consumer surplus is €5.
E
Consumer surplus is the buyer's willingness to pay minus the seller's cost. (T or F?)
F
Free markets are efficient because they allocate output to buyers who have a willingness to pay that is below the price. (T or F?)
F
If your willingness to pay for a hamburger is €3.00 and the price is €2.00, your consumer surplus is €5.00. (T or F?)
F
Producer surplus is a measure of the unsold inventories of suppliers in a market. (T or F?)
F
Producing more of a product always adds to total surplus. (T or F?)
F
Total surplus is the seller's cost minus the buyer's willingness to pay. (T or F?)
F
Consumer surplus is a good measure of buyers' benefits if buyers are rational. (T or F?)
T
Cost to the seller includes the opportunity cost of the seller's time. (T or F?)
T
Equilibrium in a competitive market maximizes total surplus. (T or F?)
T
Externalities are side effects, such as pollution, that are not taken into account by the buyers and sellers in a market. (T or F?)
T
If the demand curve in a market is stationary, consumer surplus decreases when the price in that market increases. (T or F?)
T
Producer surplus is the area above the supply curve and below the price. (T or F?)
T
The height of the supply curve is the marginal seller's cost. (T or F?)
T
The major advantage of allowing free markets to allocate resources is that the outcome of the allocation is efficient. (T or F?)
T
The two main types of market failure are market power and externalities. (T or F?)
T
The Free Market versus Government Intervention
The market equilibrium is efficient. No other outcome achieves higher total surplus. ● Government cannot raise total surplus by changing the market's allocation of resources. ● Laissez faire (French for "allow them to do"): the notion that government should not interfere with the market.
The lesson:
Total CS equals the area under the demand curve above the price, from 0 to Q.
consumer surplus
a buyer's willingness to pay minus the amount the buyer actually pays
the efficiency of the equilibrium qty
at qty's less than the equilibrium qty, the value to buyers exceeds the cost to sellers. At qty's greater than the equilibrium qty, the cost to sellers exceeds the value to buyers. Therefore, the market equilibrium maximizes the sum of producer and consumer surplus
On the graph, consumer surplus is the area
between P and the D curve.
On the graph, producer surplus is the area
between P and the S curve.
Under perfect competition, the market outcome is
efficient. Altering it would reduce total surplus.
WTP measures
how much the buyer values the good
Efficiency means that total surplus is
maximized, that the goods are produced by sellers with lowest cost, and that they are consumed by buyers who most value them.
The height of the S curve is
sellers' cost of producing the good.
producer surplus
the amount a seller is paid for a good minus the seller's cost PS = P - cost
Consumer surplus is
the difference between what buyers are willing to pay for a good and what they actually pay.
At any Q
the height of the D curve is the WTP of the marginal buyer, the buyer who would leave the market if P were any higher.
willingness to pay
the maximum amount that a buyer will pay for that good
Consumer surplus at price P2
the price falls from P1 to P2, the qty demanded rises form Q1 to Q2, and the consumer surplus rises to the area of the triangle ADF. The increase in consumer surplus (area BCFD) occurs in part because existing consumers now pay less (area BCED) and in part because new customers enter the market at the lower price (area CEF)
Sellers are willing to sell if
the price they get is at least as high as their cost.
efficiency
the property of a resource allocation of maximizing the total surplus received by all members of society Total surplus = (value to buyers) - (cost to sellers)
equity
the property of distributing economic prosperity (Wohlstand) fairly among the members of society
Consumer surplus at price P1
the qty demanded is Q1 and consumer surplus equals the area of the triangle ABC
Producer surplus at price P1
the qty demanded is Q1 and producer surplus equals the area of the triangle ABC
welfare economics
the study how the allocation of resources affects economic well-being
Producer surplus at price P2
the supplied rises from Q1 to Q2 and the producer surplus rises to the area of the triangle ADF. The increase in producer surplus (area BCFD) occurs in part because existing producers now receive more (area BCED) and in part because new producers enter the market at the higher price (area CEF)
cost
the value of everything a seller must give up to produce a good (i.e., opportunity cost). ● Includes cost of all resources used to produce good, including value of the seller's time. ● Example: Costs of 3 sellers in the lawn-cutting business. A seller will produce and sell the good/service only if the price exceeds his or her cost. Hence, cost is a measure of willingness to sell
The height of the D curve reflects
the value of the good to buyers—their willingness to pay for it.
To measure society's well-being, we use
total surplus, the sum of consumer and producer surplus.
Producer surplus is the difference between
what sellers receive for a good and their cost of producing it.
The Free Market versus Central Planning
● Suppose resources were allocated not by the market, but by a central planner who cares about society's well-being. ● 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. ● This is impossible, and why centrally-planned economies are never very efficient.
An allocation of resources is efficient if it maximizes total surplus. Efficiency means:
● The goods are consumed by the buyers who value them most highly. ● The goods are produced by the producers with the lowest costs. = (value to buyers) - (cost to sellers) ● Raising or lowering the quantity of a good would not increase total surplus.
Such market failures occur when:
● a buyer or seller has market power—the ability to affect the market price. ● transactions have side effects, called externalities, that affect bystanders. (example: pollution)
allocation of resources refers to:
● how much of each good is produced ● which producers produce it ● which consumers consume it
