PEco Module 5

• Despite the possibility of market failure, the analysis in this chapter applies in many markets, and the invisible hand remains extremely important.
• Consumer surplus is the amount a buyer is willing to pay minus the amount the buyer actually pays: CS = WTP - P.
• Producer surplus is the amount a producer is willing to accept minus the amount the producer actually receives: PS = WTR - TR.
• Markets produce a desirable allocation of resources if the market outcome can be improved upon.
• The allocation of resources refers to how much of each good is produced, which producers produce it, and which consumers consume it.
• Welfare economics studies how the allocation of resources affects economic well-being.
• Total PS for P = $20 can be found.
• In a market economy, the allocation of resources is decentralized, determined by the interactions of many self-interested buyers and sellers.
• Every buyer whose WTP is ≥ $30 will buy.
• Marginal seller’s cost can be found at Q = 10.
• Every buyer whose WTP is < $30 will not.
• CS = (value to buyers) – (amount paid by buyers) is the buyers’ gains from participating in the market.
• The market equilibrium is efficient if it maximizes total surplus.
• Total surplus = CS + PS.
• PS = (amount received by sellers) – (cost to sellers) is the sellers’ gains from participating in the market.
• If P rises to $30, the increase in PS due to selling 5 additional units is $25.
• The buyers who value the good most highly are the ones who consume it.
• Total surplus = CS + PS is the total gains from trade in a market.
• The increase in PS on initial 10 units is $100.
• The fall in PS is due to sellers leaving the market and remaining sellers getting lower prices.
• Market equilibrium: P = $30, Q = 15,000.
• Every seller whose cost is > $30 will not.
• Producer surplus is represented by the supply curve.
• At Q = 20, the cost of producing the marginal unit is $35 and the value to consumers of the marginal unit is only $20, hence, total surplus can be increased by reducing Q.
• The goods are produced by the producers with the lowest costs.
• If P falls to $30, PS = ½ x 15 x $15 = $112.50.
• Raising or lowering the quantity of a good would not increase total surplus.
• The sellers with the lowest cost produce the good.
• Efficiency = (value to buyers) – (cost to sellers) is the total surplus.
• Efficiency means: The goods are consumed by the buyers who value them most highly.
• Every seller whose cost is ≤ $30 will produce the good.
• The free market vs central planning: This chapter used welfare economics to demonstrate one of the ten principles: markets are usually a good way to organize economic activity.
• In other conditions we will study in later chapters, the market may fail to allocate resources efficiently.
• Laissez faire (french for “allow them to do”): the notion that govt should not interfere with the market.
• To allocate resources efficiently and maximize total surplus, the planner would need to know every seller’s cost and every buyer’s wtp for every good in the entire economy.
• Important note: we derived these lessons assuming perfectly competitive markets.
• Adam Smith, 1723-1790, Passages from The Wealth of Nations, 1776:It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.
• We’ll use welfare economics to see how public policy may improve on the market outcome in such cases.
• The market equilibrium is efficient: no other outcome achieves higher total surplus.
• Adam Smith, 1723-1790, Passages from The Wealth of Nations, 1776:By pursuing his own interest he frequently promotes that of the society more effectively than when he really intends to promote it.