Principles of Economics- Mankiw (5th) 148

Principles of Economics- Mankiw (5th) 148 - this region...

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154 PART THREE SUPPLY AND DEMAND II: MARKETS AND WELFARE 1. Free markets allocate the supply of goods to the buyers who value them most highly, as measured by their willingness to pay. 2. Free markets allocate the demand for goods to the sellers who can produce them at least cost. Thus, given the quantity produced and sold in a market equilibrium, the social planner cannot increase economic well-being by changing the allocation of con- sumption among buyers or the allocation of production among sellers. But can the social planner raise total economic well-being by increasing or de- creasing the quantity of the good? The answer is no, as stated in this third insight about market outcomes: 3. Free markets produce the quantity of goods that maximizes the sum of consumer and producer surplus. To see why this is true, consider Figure 7-8. Recall that the demand curve reflects the value to buyers and that the supply curve reflects the cost to sellers. At quanti- ties below the equilibrium level, the value to buyers exceeds the cost to sellers. In
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Unformatted text preview: this region, increasing the quantity raises total surplus, and it continues to do so until the quantity reaches the equilibrium level. Beyond the equilibrium quantity, however, the value to buyers is less than the cost to sellers. Producing more than the equilibrium quantity would, therefore, lower total surplus. These three insights about market outcomes tell us that the equilibrium of sup-ply and demand maximizes the sum of consumer and producer surplus. In other words, the equilibrium outcome is an efficient allocation of resources. The job of the benevolent social planner is, therefore, very easy: He can leave the market Price Equilibrium price Quantity Equilibrium quantity A Supply C B Demand D Producer surplus Consumer surplus E Figure 7-7 C ONSUMER AND P RODUCER S URPLUS IN THE M ARKET E QUILIBRIUM . Total surplus— the sum of consumer and producer surplus—is the area between the supply and demand curves up to the equilibrium quantity....
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