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Chapter7 - IN THIS CHAPTER YOU WILL Examine the link...

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IN THIS CHAPTER YOU WILL . . . See that the equilibrium of supply and demand maximizes total surplus in a market Examine the link between sellers’ costs of producing a good and the supply curve Examine the link between buyers’ willingness to pay for a good and the demand curve Learn how to define and measure consumer surplus Learn how to define and measure producer surplus When consumers go to grocery stores to buy their turkeys for Thanksgiving din- ner, they may be disappointed that the price of turkey is as high as it is. At the same time, when farmers bring to market the turkeys they have raised, they wish the price of turkey were even higher. These views are not surprising: Buyers al- ways want to pay less, and sellers always want to get paid more. But is there a “right price” for turkey from the standpoint of society as a whole? In previous chapters we saw how, in market economies, the forces of supply and demand determine the prices of goods and services and the quantities sold. So far, however, we have described the way markets allocate scarce resources without directly addressing the question of whether these market allocations are desirable. In other words, our analysis has been positive (what is) rather than normative (what C O N S U M E R S , P R O D U C E R S , A N D T H E E F F I C I E N C Y O F M A R K E T S 141
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142 PART THREE SUPPLY AND DEMAND II: MARKETS AND WELFARE should be). We know that the price of turkey adjusts to ensure that the quantity of turkey supplied equals the quantity of turkey demanded. But, at this equilibrium, is the quantity of turkey produced and consumed too small, too large, or just right? In this chapter we take up the topic of welfare economics, the study of how the allocation of resources affects economic well-being. We begin by examining the benefits that buyers and sellers receive from taking part in a market. We then ex- amine how society can make these benefits as large as possible. This analysis leads to a profound conclusion: The equilibrium of supply and demand in a market maximizes the total benefits received by buyers and sellers. As you may recall from Chapter 1, one of the Ten Principles of Economics is that markets are usually a good way to organize economic activity. The study of wel- fare economics explains this principle more fully. It also answers our question about the right price of turkey: The price that balances the supply and demand for turkey is, in a particular sense, the best one because it maximizes the total welfare of turkey consumers and turkey producers. CONSUMER SURPLUS We begin our study of welfare economics by looking at the benefits buyers receive from participating in a market. WILLINGNESS TO PAY Imagine that you own a mint-condition recording of Elvis Presley’s first album.
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