Chapter 7

• Welfare economics – The study of how the allocation of resources affects economic well-being
• Willingness to pay – Maximum amount that a buyer will pay for a good
• Consumer surplus – Amount a buyer is willing to pay for a good minus amount the buyer actually pays

  – Willingness to pay minus price paid
• Demand schedule

  – Derived from the willingness to pay of the possible buyers
• Marginal buyer - The buyer who would leave the market first if the price were any higher
• Consumer surplus in a market

  – Area below the demand curve and above the price
• Producer surplus – Amount a seller receives for a good minus the minimum amount the seller was willing to accept
• Marginal supplier – The seller who would enter the market last if the price were any lower
• Cost – Value of everything a seller must give up to produce a good
• Supply schedule

  – Derived from the costs of the suppliers
• Marginal seller - Seller who would leave the market first if the price were any lower
• Supply curve

  – Reflects sellers’ costs

  – Used to measure producer surplus
• Producer surplus in a market

  – Area below the price and above the supply curve
• The benevolent social planner

  – All-knowing, all-powerful, well-intentioned dictator

  – Wants to maximize the economic well-being of everyone in society
• Total surplus - Sum of consumer and producer surplus
• Efficiency

  – Property of a resource allocation

  – Maximizing the total surplus received by all members of society
• Equality

  – Property of distributing economic prosperity uniformly among the members of society
• Market equilibrium

  – Efficient allocation of resources
• Free markets

  – Best way to organize economic activity
• Adam Smith’s invisible hand

  – Takes all the information about buyers and sellers into account

  – Guides everyone in the market to the best outcome

  – Economic efficiency
• Forces of supply and demand

  – Allocate resources efficiently
• Market power

  • A single buyer or seller (small group) • Control market prices

  • Markets are inefficient
• Market failure

  – E.g.: market power and externalities

  – The inability of some unregulated markets to allocate resources efficiently
• Public policy - Can potentially remedy the problem and increase economic efficiency