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Lecture - 9

(1) The price that balances supply and demand maximizes total welfare for consumers and producers as it results in the quantity where willingness to pay equals willingness to accept. (2) Consumer surplus measures the benefit consumers receive and producer surplus measures the benefit producers receive; total surplus is the sum of consumer and producer surplus. (3) When prices are set above or below the equilibrium, it results in a deadweight loss which is a cost to society through reduced total surplus.

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Abdullah Al Rahad Hossain
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79 views

Lecture - 9

(1) The price that balances supply and demand maximizes total welfare for consumers and producers as it results in the quantity where willingness to pay equals willingness to accept. (2) Consumer surplus measures the benefit consumers receive and producer surplus measures the benefit producers receive; total surplus is the sum of consumer and producer surplus. (3) When prices are set above or below the equilibrium, it results in a deadweight loss which is a cost to society through reduced total surplus.

Uploaded by

Abdullah Al Rahad Hossain
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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ECONOMICS

HSS 301
Lecture - 9
Economic Welfare &
Market Efficiency
Buyers always want to pay less, and
sellers always want to be paid more. But
is there a “right price” from the
standpoint of society as a whole?
The price that balances the supply and demand is, in a
particular sense, the best one because it maximizes the total
welfare of a product’s consumers and producers.
No consumer or producer aims to achieve this goal, but
their joint action directed by market prices moves them
toward a welfare-maximizing outcome, as if led by an
invisible hand.
• The maximum amount that a
buyer will pay for a good

Willingness • It measures how much that


buyer values the good
to pay
• Represented by his/her
demand curve
Every point on the demand curve shows some
consumer’s willingness to pay for a certain quantity.

Point ‘A’ shows that some consumers are willing to pay


‘𝑷𝟎 ’ price for 𝑸𝟎 amount of this product.
P
Point ‘B’ shows that, more consumers are willing to buy
this good paying the lower price ‘𝑷𝟏 ’
A
𝑷𝟎
Adding all these points ( such as A,B,C) of willingness to
B
𝑷𝟏 pay, we get the market demand curve for this product.
C
𝑷𝟐 Demand
Curve
𝑸𝟎 𝑸𝟏 𝑸𝟐 Q
Consumer Surplus

• The amount a buyer is willing to pay for a good


minus the amount the buyer actually pays for it

• Measures the benefit that buyers receive from a good.


Thus, consumer surplus is a good measure of
economic well-being if policymakers want to satisfy
the preferences of buyers.
If market price is 𝑷𝟎 , we can see from the demand curve
that some buyers are willing to pay this price & buy a total
of 𝑸𝟎 quantity of this product.
P
Since demand curve shows all the willingness to pay & 𝑷𝟎
is the actual amount that every consumer pays to buy this
product, area between the demand curve & the price line
Consumer gives us the total welfare/benefit to the consumers from
Surplus buying 𝑸𝟎 amount of this product.
𝑷𝟎

Demand
Curve
0
𝑸𝟎 Q
Fall in price increases Rise in price decreases
consumer surplus consumer surplus

P P

CS
𝑷𝟐
CS

𝑷𝟏 Demand Demand
Curve Curve
0 Q 0
𝑸𝟏 𝑸𝟐 Q
• The minimum amount that a
seller will receive for a good

Willingness • It measures seller’s cost of


to Sell producing the good

• Represented by his/her
supply curve
Every point on the supply curve shows some
producer’s production cost which is the minimum
price he is willing to receive for a certain quantity.

P Supply Point ‘A’ shows that some producers are willing to


Curve sell 𝑸𝟎 amount of this product for ‘𝑷𝟎 ’ price.

Point ‘B’ shows that, more producers are willing to


𝑷𝟐 C sell this good receiving the higher price ‘𝑷𝟏 ’.

𝑷𝟏 B Adding all these points (such as A,B,C) of willingness


to sell, we get the market supply for this product.
𝑷𝟎 A

𝑸𝟎 𝑸𝟏 𝑸𝟐 Q
Producer Surplus

• The amount a seller is paid for a good minus the


seller’s cost of providing it

• Measures the benefit that sellers receive from a good.


Thus, producer surplus is a good measure of
economic well-being if policymakers want to satisfy
the preferences of sellers.
If market price is 𝑷𝟎 , we can see from the
supply curve that some sellers are willing to
P sell 𝑸𝟎 quantity of this product at this price.
Supply
Curve Since supply curve shows all the willingness to
sell & 𝑷𝟎 is the actual amount that every seller
receive by selling this product,
𝑷𝟎 area between the price line & the supply curve
Producer
gives us the total welfare/benefit to the sellers
Surplus
from selling 𝑸𝟎 amount of this product.

0
𝑸𝟎 Q
Fall in price decreases Rise in price increases
producer surplus producer surplus

P P
Supply
Supply
Curve
𝑷𝟐 Curve

PS

𝑷𝟏
PS

0 Q 0 𝑸𝟐
𝑸𝟏 Q
Welfare to the society: Total Surplus, TS = CS+PS

• Total welfare to the society


P from any market is the sum
Supply of consumer surplus &
producer surplus.
CS

𝑷𝟎
• Free markets produce the
PS
quantity of goods that
maximizes the total surplus.
Demand Thus, allocation from a free
market is efficient.
0 𝑸𝟎 Q
What happens if How does consumer welfare
& producer welfare change?
price is set
above or below How does the total welfare
the equilibrium? to the society change?
When a price flooring is imposed

• A legal minimum price at


P 𝑷𝟏 causes a surplus in the
Supply market. 𝑸𝟏 amount of the
CS product is sold.
𝑷𝟏
• New CS has a smaller
PS
DWL
value while new PS has a
larger value.
• TS is less than equilibrium.
Demand • Lost TS is called the
Deadweight loss
0 𝑸𝟏 𝑸 𝟎 Q
When a price ceiling is imposed

• A legal maximum price at


P 𝑷𝟏 causes a shortage in the
Supply
market. 𝑸𝟏 amount of the
product is sold.
CS DWL
• New CS has a greater value
while new PS has a smaller
𝑷𝟏 value.
PS
• TS is less than equilibrium.
Demand • Deadweight loss is created
0 due to the price ceiling
𝑸𝟏 𝑸𝟎 Q
• A deadweight loss is a cost to
society created by market
inefficiency, which occurs when
supply and demand are out of
Deadweight equilibrium.
Loss/ • In the following cases market gets
Change in out of equilibrium & deadweight
Total Surplus loss emerges:
• Price Controls
• Taxes
• Monopolies
• Externalities
Exercise

Consider the following demand & supply functions for a market


of chocolate.
𝑄 = 300 + 1400𝑃
𝑄 = 2400 − 700𝑃
1. Find out the market clearing price & quantity for chocolate.
2. Calculate the maximum possible CS, PS, TS in this market.
3. Calculate the shortage/surplus, change in CS, PS, TS when:
a) Govt imposes a price ceiling at $0.6
b) Govt imposes a price flooring at $1.5
c) Legal maximum price is $2
Exercise

Supply & Demand functions for a market of T-shirt are given by:
𝑄 = 2(𝑃 − 30)
𝑄 = 300 − 𝑃
1. Find out the market clearing price & quantity of T-shirt.
2. Calculate the CS, PS, TS from this market.
3. Calculate the shortage/surplus & new CS, PS, TS when:
a) Legal maximum price is fixed at $80
b) Legal minimum price is fixed at $150
c) Price flooring is imposed at $100
Thank You

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