Lecture 7 notes - Applying the Competitive Model: Lecture...

Info iconThis preview shows pages 1–3. Sign up to view the full content.

View Full Document Right Arrow Icon
BE 530 Page 1 of 3 Lecture 7 Applying the Competitive Model: Lecture Review Introduction In this Lecture we address welfare economics —the study of how the allocation of resources affects economic well-being. We measure the benefits that buyers and sellers receive from taking part in a market and we discover that the equilibrium price and quantity in a market maximizes the total benefits received by buyers and sellers. Consumer Surplus Consumer surplus measures the benefits received by buyers from participating in a market. Each potential buyer in a market has some willingness to pay for a good. This willingness to pay is the maximum amount that a buyer will pay for the good. If we plot the value of the greatest willingness to pay for the first unit followed by the next greatest willingness to pay for the second unit and so on (on a price and quantity graph) we have plotted the market demand curve for the good. That is, the height of the demand curve is the marginal buyers’ willingness to pay. Since some buyers value a good more than other buyers, the demand curve is downward sloping. Consumer surplus is a buyer’s willingness to pay minus the amount the buyer actually pays. For example, if you are willing to pay $20 for a new CD by your favorite music artist and you are able to purchase it for $15, you receive consumer surplus on that CD of $5. In general, since the height of the demand curve measures the value buyers place on a good measured by the buyer’s willingness to pay, consumer surplus is the area below the demand curve and above the price . When the price of a good falls, consumer surplus increases for two reasons. First, existing buyers receive greater surplus because they are allowed to pay less for the quantities they were already going to purchase and, second, new buyers are brought into the market because the price is now lower than their willingness to pay. Note that since the height of the demand curve is the value buyers place on a good measured by their willingness to pay, consumer surplus measures the benefits received by buyers as the buyers themselves perceive it . Therefore, consumer surplus is an appropriate measure of buyers’ benefits if policymakers respect the preferences of buyers. Economists generally believe that buyers are rational and that buyer preferences should be respected except possibly in cases of drug addiction, and so on.
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
BE 530 Page 2 of 3 Lecture 7 Producer Surplus Producer surplus measures the benefits received by sellers from participating in a market. Each potential seller in a market has some cost of production. This cost is the value of everything a seller must give up to produce a good and it should be interpreted as the producers’ opportunity cost of production—actual out-of-pocket expenses plus the value of the producers’ time. The cost of production is the minimum amount a seller is willing to accept in order to produce the good. If we plot the cost of the least cost producer of the first unit, then the
Background image of page 2
Image of page 3
This is the end of the preview. Sign up to access the rest of the document.

Page1 / 7

Lecture 7 notes - Applying the Competitive Model: Lecture...

This preview shows document pages 1 - 3. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online