Chapter%206 - Econ 160, Vardanyan Chapter 6 Market...

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Econ 160, Vardanyan 1 Chapter 6 Market Efficiency and Government Intervention In this chapter we discuss the benefit that accrues to the parties that exchange goods in the markets. We will see that when some conditions are met the market equilibrium generates the largest possible total benefit. Consumer Surplus and Producer Surplus The consumer’s willingness to pay is defined as the maximum amount a consumer is willing to pay for a product . The consumer surplus is defined as the difference between the willingness to pay and the price that the consumer actually pays for the product . The example in Figure 6.1 illustrates. The maximum that Juan is willing to pay to have his lawn mowed is $22; that’s his willingness to pay. If the actual price he pays is only $10 then Juan’s consumer surplus is equal to $12. To compute the total consumer surplus we must add the difference between the willingness to pay and actual price for every consumer in the market. In Figure 6.1 it is equal to $30. The total consumer surplus can be interpreted as the consumers’ level of welfare. A concept similar to consumer surplus exists for the producers. A seller’s willingness to accept is defined as the minimum amount the producer is willing to accept as payment for a product; equal to the marginal cost of production . The producer surplus is defined as the difference between the price the producer receives for the product and the willingness to accept . Figure 6.2 illustrates. Abe’s producer surplus is equal to the price he receives for mowing the lawn ($10) and his willingness to accept ($2), i.e. the Abe’s producer surplus is $8. The total producer surplus is the sum of the differences between price and willingness to accept (given by the marginal cost) and is equal to $20; it can be interpreted as the producers’ total level of welfare. Market Equilibrium and Efficiency The total surplus of a market is the sum of consumer surplus and producer surplus . Using the numbers from the example in the book it is equal to $50 (Fig. 6.3). The market equilibrium (i.e. when the price is such that the supply equals demand) generates the highest possible total surplus. Suppose the price is below the equilibrium at a level like $4 in panel A of figure 6.4. This
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This note was uploaded on 05/27/2008 for the course ECON 160B taught by Professor Michaelvardanyan during the Fall '08 term at Binghamton University.

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Chapter%206 - Econ 160, Vardanyan Chapter 6 Market...

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