Unit 4: Consumer and Producer Surplus
What is individual producer surplus?
Individual producer surplus is the price that the seller gets minus the cost.
What happens when there is a rise in price in terms of producer surplus?
A rise in the price results in producers experiencing an increase in producer surplus. A rise in price means that there is a greater difference between the price the the seller receives and the cost, meaning that producer surplus increases.
Define cost.
Cost is the lowest price at which a potential seller is willing to sell. Even if the seller is not the manufacturer the seller is losing the object because it will no longer be in their possession.
Describe the importance of property rights.
Property rights are important to a well functioning economy because people would not buy things if they could not have ownership properties over them. The existence of property rights provides incentives for mutually beneficial transactions to occur. Property rights give incentives for people to create and protect their inventions/ideas.
What are the two factors that ensure that the market functions properly?
The factors that ensure the proper function of the market are property rights and economic signals.
What happens when the price of a good falls in terms of consumer surplus?
When the price of a good falls the area under the demand curve but above the price increases. This change in the graph indicates that there was in increase in total consumer surplus because when the price of a good falls, that means that the price consumers pay is lower which makes the difference between the consumer's willingness to buy and price paid even greater, therefore increasing consumer surplus.
What happens when there is a fall in price in terms of producer surplus?
A fall in price results in a reduction of producer surplus. When the price falls, that means more people are willing the to buy the good because it is available at a cheaper price. So when the price that the seller (producer) gets decreases, that automatically decreases the producer surplus.
What does it mean for a market to be efficient?
A market is efficient when the market has produced gains from trade in a way that there is no way to make some people better off without making other people worse off.
How are markets' benefits measured?
An efficient market's benefit to society is measured through consumer and produced surplus. Because the market is made up entirely of consumers and producers, showing the surpluses for these two groups shows how much a market is benefitting from the efficiency of the market. The market creates benefit for society by helping the good be sold and bought at a price that benefits both the buyer and seller. It becomes inefficient when the buyer and seller do not value things in the same way.
Characterize an inefficient market.
An inefficient market is characterized by missed opportunities for mutually beneficial transactions, when gains from trade go unrealized, when total surplus could have been increased, and lack of property rights and inaccuracy of economic signals lead to market failure.
What is consumer surplus?
Consumer surplus is a consumer's net gain, calculated by willingness to pay minus the amount that was paid. Consumer surplus exists when the willingness to buy exceeds the amount that the consumer paid. Another way to say it is that consumer surplus exists when consumers buy a good at a lower price than they would have been willing to buy it (your value - market value).
Describe the importance of economic signals.
Economic signals are important to a functioning market because they are pieces of information that helps firms and individuals make better economic decisions. An example includes prices, which provide important information about other peoples costs and willingness to pay.
How is communism characterized in terms of efficiency?
In its structure, communism is defined as the opposite of efficient. In communism, the supply is set by the government rather than the market. This causes shortages and the government to have goods that people do not value.
What are the ways to increase to the total surplus without using the market?
One could try to increase the total surplus without using the market by: reallocating consumption among consumers (intentionally selling objects to different consumers, which results in a lower consumer surplus as compared to market equilibrium), reallocating sales among sellers (actively changing the sellers of the products, lowers the total producer surplus as compared to market equilibrium), and changing the quantity traded (actively trading more or less than equilibrium. All of these artificial increases of the surplus results in losses for various groups. The lesson learned is that once a market reaches equilibrium, there is no way to increase the gains from trade and actually, any other outcome reduces the total surplus. Any way of allocating goods other than the market equilibrium outcome lowers total surplus.
Describe the ways in which producers interpret economic signals.
Producers generally interpret economic signals that take the form of price change and profit change. When the profits rise within an industry, that tells producers that consumers want more of that product. When profits decline in an industry, that lets producers know that consumers want less of that product.
What are the characteristics of an efficient market?
The main characteristics of an efficient market are: 1) allocation consumption of the good to the potential buyers who value it the most, buyers who have the highest willingness to pay 2) allocation of sales to the potential sellers who values the right to sell the good most, indicated by the fact that they provide the good at the lowest cost 3) every consumer who makes a purchase values the good more than every seller who makes a sale so all transactions are mutually beneficially 4) every potential buyer who doesn't purchase a good, values at the good less than every potential seller who does not make a sale so that no mutually beneficial transactions are missed.
What are the caveats of market efficiency?
There are two caveats of market efficiency: equity is often in conflict with efficiency, and some markets fail to deliver efficiency. It occurs that even when market equilibrium maximizes total surplus, it does not mean it is the best outcome for every individual producer and consumer. Efficiency only provides us with the best way to achieve a goal, not what that goal should be. Efficiency only helps achieve the goal after that goal has been defined but does not play a significant role in defining that goal. Society often has strong feelings about equity and fairness which comes at the expense of efficiency.
What is total consumer surplus?
Total consumer surplus on the graph is the total area that is below the demand curve but above the price. The total consumer surplus is all of the individual surpluses in a given situation added up.
What is total producer surplus?
Total producer surplus is the combination of individual producer surpluses. In the graphical representation, total producer surplus is the area above the supply curve but below the price line.
What are specific indicators of market inefficiency?
We can determine that a market is inefficient by examining three facets of the market: market power, externalities, and public goods. A market is inefficient when one firm has too much market power, meaning that the one firm has the ability to change the prices throughout the entire industry. A market is inefficient when it produces externalities, which are negative side effects that impact the welfare of others. A market is inefficient when the nature of a good makes it unsuitable to be efficiency allocated by the market and it becomes a public good, such as national defense.
What happens when the price of a good rises in terms of consumer surplus?
When the price of a good rises, the area under the demand curve but above the price decreases. This change under the graph indicates that there was a decrease in total consumer surplus because when the price of a good rises, that means that the difference between the consumer's willingness to buy and the price paid is shrinking, therefore a reduction in the consumer surplus.
What is willingness to pay?
Willingness to pay is the maximum price at when a person would buy a good. A horizontal segment on the step-like graph corresponds to a potential buyer's willingness to pay.
