Thai Nguyen University

Thai Nguyen University of Technology

Faculty of International Training

(ECEN 4503)
Engineering Economics
Lecture #7:

Consumers, Producers, and the

Efficiency of Markets
June 02nd 2015
Lecturer: Nguyen Minh Y, Ph.D.

Reviewing

Elasticity and
its applications
- Price
elasticity
- Determinants
- Income
elasticity
- Cross-price
elasticity

Supply,
demand and
government
policies
- Controls of
price
- Taxes

Department of Electrical Engineering taught in English

Market and
welfare
- Consumer,
producer and
the efficiency
of markets

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Introduction
Always the case
Buyers want to pay less
Sellers want to get paid more

There is a right price from the standpoint of society as whole.

Welfare economics the study of how the allocation of resource

affects economics well-being.

How buyers and sellers benefit from taking parts in a market?
How society can make these benefits as large as possible?
Does the market equilibrium of supply and demand maximizes the

total benefits received and paid by buyers and seller.

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1. Consumer Surplus
1.1 Willingness to pay
Willingness to pay the maximum amount that a buyer will pay for

a good.
A buyer would
Be eager to buy at a price less than his/her willingness to pay
Refuse to buy at a price more than his/her willingness to pay
Be indifferent if the price is exactly equal to his/her willingness to

pay
Consumer surplus a buyers willingness to pay minus the amount

that buyer actual pays.

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1. Consumer Surplus
1.1 Willingness to pay
Example:
Auction to sell Elvis Presleys first album.
Elvis Presley fans show up to express the maximum price that they

would pay for it (How much buyers value the good)

In which price the auction might

stop?
If John buys the album at price of

$80, his consumer surplus is?

Buyers

Willingness to pay

John

$100

Paul

$80

George

$70

Ringo

$50

Consumer surplus measures the

benefit to buyers of participating in

a market.
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1. Consumer Surplus
1.1 Willingness to pay
Example:
Auction to sell Elvis Presleys first album.
Suppose that there are two album and no buyer wants to buy more

than one album.

In which price the auction might

stop?
If the auction stops at price of $70,

what is consumer surplus?

John?
Paul?
Market?
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Buyers

Willingness to pay

John

$100

Paul

$80

George

$70

Ringo

$50

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1. Consumer Surplus
1.2 Using the demand curve to measure consumer surplus
The willingness to pay and the demand schedule
Use the willingness to pay to construct the demand schedule.

Buyers

Willingness to

Price

Buyers

demanded

pay
John

$100

Paul

$80

George

$70

Ringo

$50

More than
$100
$80 to $100
$70 to $80
$50 to $ 79
$50 or less

Quantity

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None
John

0
1

Paul, John

George, Paul, John

Ringo, George, Paul, John 4

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1. Consumer Surplus
1.2 Using the demand curve to measure consumer surplus
The willingness to pay and the demand schedule
The demand curve

The area below the demand

curve and above the price
measures the consumer surplus
in a market.

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1. Consumer Surplus
1.3 How the price affects consumer surplus
Buyers always want to pay less for the good?
The lower price, the higher consumer surplus

When the price falls

From P1, Q1
To P2, Q2

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1. Consumer Surplus
1.4 What does consumer surplus measure?
Calculated as

Willingness to pay the actual price

Benefit to the buyers
Buyers themselves perceive it (willingness to pay)

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Practice
Ex1. Melisa buys an iPod for $120 and gets consumer surplus

of $80.
What is her willingness to pay?
b) If she had bought the iPod on sale for $90, what would her
consumer surplus have been?
c) If the price of an iPod were $250, what would her consumer
surplus have been?
a)

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Practice
Ex2. It is a hot day, and Bert is thirsty. Here is the value he

places on a bottle of water:

Value of first bottle:

$7
Value of second bottle:
$5
Value of third bottle: $3
Value of fourth bottle:$1

From this information, derive Berts demand schedule. Graph his

demand curve for bottle water.
b) If the price of a bottle is $4, how many bottles does Bert buy? How
much consumer surplus does Bert get from his purchases? Show
Berts consumer surplus in your graph.
c) If the price falls to $2, how does quantity demanded change? How
hoes Berts consumer surplus change? Show these changes in your
graph.
a)

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2. Producer Surplus
2.1 Cost and the willing to sell
Cost the value of everything a seller must give up to produce a

good.
A seller would
Eager to sell if the price exceeds his/her cost
Refuse to sell if the price is lower than his/her cost
Indifferent if the price is exactly the cost

Producer surplus the amount a seller is paid for a good minus

the sellers cost of providing it.

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2. Producer Surplus
2.1 Cost and the willing to sell
Example:
Auction of painting house and four people (sellers) can provide
the service.
Four sellers show up and bid for the cost they are willing to provide

the service of painting

In which price the auction might

stop?
If Grandma get the job at price of

$600, her producer surplus is?

Seller

Willingness to sell

Marry

$900

Frida

$800

George

$600

Grandma

$500

Consumer surplus measures the

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benefit sellers receive from

participating in a market.

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2. Producer Surplus
2.1 Cost and the willing to sell
Example:
Auction of painting house and four people (sellers) can provide
the service.
Suppose that there two houses need to be painted, no seller is able to

paint two houses.

In which price the auction might

stop?
If the auction stops at price of $800,

what is producer surplus?

Grandma?
George?
Market?
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Seller

Willingness to sell

Marry

$900

Frida

$800

George

$600

Grandma

$500

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2. Producer Surplus
2.2 Using the supply curve to measure producer surplus
The willingness to sell (cost) and the supply schedule
We can use the willingness to sell to construct the supply schedule
Seller

Willingness to sell

Price

Buyers

Quantity
demanded

Marry

$900

Marry, Frida, George, Grandma 4

$800

More than
$900

Frida

Frida, George, Grandma

George

$600

$800 to $900

George, Grandma

Grandma

$500

$600 to $800

Grandma

$500 to $600

None

$500 or less

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2. Producer Surplus
2.2 Using the supply curve to measure producer surplus
The willingness to sell (cost) and the supply schedule
Supply curve

The area above the supply curve

and below the price measures
the producer surplus in a
market.

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2. Producer Surplus
2.3 How a higher price raises producer surplus?
The sellers always want to get paid more for the good?
The higher price, the more producer surplus

When price rises

From P1, Q1
To P2, Q2

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2. Producer Surplus
2.4 What does producer surplus measure?
Calculated as

The actual price the cost

Benefit to the sellers
Buyers themselves perceive the cost (willingness to pay)

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Practice
Ex3. Ernie owns a water pumps. Because pumping large amounts of

water is harder than pumping small amounts, the cost of producing a

bottle of water rises as he pumps more. Here is the cost he incurs to
produce each bottle of water:
Cost of first bottle:
$1
Cost of second bottle: $3
Cost of third bottle: $5
Cost of fourth bottle: $7

From this information, derive Ernies supply schedule. Graph his supply
curve for bottled water.
b) If the price of a bottle of water is $4, how many bottles does Ernie
produce and sell? How much producer surplus does Ernie get from these
sales? Show Ernies producer surplus in your graph.
c) If the price rises to $6, how does quantity supplied change? Show these
changes in your graph.
a)

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3. Market Efficiency
Previously,
Consumer surplus
Producer surplus

= welfare of buyers (well-being)

= welfare of sellers (well-being)

Free market:
Market equilibrium: Supply = Demand
Equilibrium quantity
Equilibrium price

Is the allocation of resources determined by free markets in any

way desirable?
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3. Market Efficiency
3.1 The benevolent social planner
To maximize the economic well-being of the society as a whole.
How to measure the economic well-being of a society?

Consumer surplus = Value to buyers Amount paid by buyers

Producer surplus = Amount received by sellers Cost to sellers
Total surplus = Value to buyers Cost to sellers
Total surplus the total value to buyers (willingness to pay) minus

the total cot to sellers of providing the good.

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3. Market Efficiency
3.2 Evaluating the market equilibrium
The total surplus, the sum of consumer surplus and producer

surplus
The total surplus at a market

price?
o The area between the supply
and demand curves up to the
equilibrium quantity.

Consumer
surplus
Provider
surplus

Market price

Which price gives the

maximum total surplus?

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3. Market Efficiency
3.2 Evaluating the market equilibrium
Free market always a good way to organize the economy

(Principle #7)
Free market allocate the supply of

good to the buyers who value them

most, measured as willingness to
pay.
Free market allocate the demand
for goods to the sellers who can
produce them at least cost.
Free market produce the quantity
of goods that maximize the sum of
consumers and producer surplus.
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Consumer
surplus
Provider
surplus

Market price

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3. Market Efficiency
3.2 Evaluating the market equilibrium
The job of benevolent social planner?
Leave the market as it is (let it free)

Invisible hand
To allocate the economys resources that maximize the total surplus

Assumption?
Perfectly competitive market
No

market power
The outcome in market matters only buyers and sellers
No externality
Make the equilibrium may be inefficient from the standpoint of
society as a whole.
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Practice
Ex5. The supply and demand for broccoli are described by the

following equations:

Supply:
Demand:

QS = 4P 80
QD = 100 2P

where Q is in bushels and P is in dollars per bushel.

b) Graph the supply curve and the demand curve. What is the
equilibrium price and quantity?
c) Calculate consumer surplus, producer surplus, and total surplus
at the equilibrium.
d) If a dictator who hated broccoli was to ban the vegetable, who
would bear the larger burden: The buyers or sellers of broccoli?
a)

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4. The Cost of Taxation

The effect of taxes on the total surplus?

4.1 The deadweight loss of taxation

A tax is enacted
The price paid by buyers rises
The price received by sellers falls
The buyers and sellers share the burden of tax

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4. The Cost of Taxation

4.1 The deadweight loss of taxation
How a tax affect market participants
Difference in the price
Paid by buyers
Received by sellers

Equilibrium quantity reduces

Elasticity of supply and demand

The benefits of participating in

the market
Buyers (area A)
Sellers (area F)

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4. The Cost of Taxation

4.1 The deadweight loss of taxation
Tax revenue
The amount government

collects from taxation

Area (B + D)

Tax revenue and the size of

taxes
Tax size increase?

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4. The Cost of Taxation

4.1 The deadweight loss of taxation
Deadweight loss
The fall in total surplus when a

tax distorts a market outcome

Area (C + E)

Economic welfare
The total surplus with a tax
Consumer surplus
Producer surplus
Tax revenue

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Losses of buyers and sellers versus the tax revenue?

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Practice
Ex2. Hotel rooms in Smalltown go for $100, and 1,000 rooms

are rented on a typical day.

To raise revenue, the mayor decides to charge hotels a tax of $10

per rented room. After the tax is imposed, the going rate for hotel
rooms rented rises to $108, and the number of rooms rented falls
to 900. Calculated the amount of revenue this tax raises for
Smalltown and the deadweight loss of the tax.
The mayor now doubles the tax to $20. The price rises to $116,
and the number of rooms rented falls to 800. Calculate tax
revenue and deadweight loss with this larger tax. Do they double,
more than double, or less than double? Explain.

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5. International Trade
World price the price of a good that prevails in the world market

for that good.

The world market is competitive market?

5.1 The gains and losses of an exporting country

If the domestic price is below the world price, after opening
Sellers?
No

seller would accept less than the world price

Buyers?
No buyer would pay more than the world price
The domestic price the world price

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5. International Trade
5.1 The gains and losses of an exporting country
The domestic price the world price

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Consumer surplus

Before trade
A+ B

After trade
A

Change
B

Producer surplus

B+C+D

+ (B + D)

Total surplus

A+ B + C

A+ B + C + D

+D
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5. International Trade
5.1 The gains and losses of an exporting country
Summary,
When a country allows trade and becomes an exporter of goods
Domestic producers of the good are better off
Domestic consumers of the good are worse off.

The trade raises the economic well-being of a nation

The gains of the winners exceed the losses of the losers.

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5. International Trade
5.2 The gains and losses of an importing country
If the domestic price is above the world price, after opening
The domestic price the world price

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Before trade
Consumer surplus A

After trade
A+ B + D

Change
+ (B + D)

Producer surplus

C+B

Total surplus

A+B +C

A+ B + C + D

+D

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5. International Trade
5.2 The gains and losses of an importing country
Summary,
When a country allows trade and becomes an importer of good
The domestic consumers of the good are better off
The producers of the good are worse off.

Trade raises the economic well-being of a nation

The gains of the winners exceed the losses of the losers.

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5. International Trade
5.3 Trade policies
Tariff a tax on goods produced abroad and sold domestically

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Consumer surplus

Before tariff
A+B+C+D+E+F

After tariff
A+B

Change
(C+D+E+F)

Producer surplus

C+G

+C

Government revenues

None

A+B+C+D

CE

Total surplus

A+B+C+D+E+F+G

A+B+C+E+G

(D+F)

5. International Trade
Import quota a limit on the quantity of a good that can be

produced abroad and sold domestically.

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Consumer surplus

Before import quota

A+B+C+D+E+E+F

After import quota

A+B

Change
(C+D+E+E+F)

Producer surplus

C+G

+C

License holders

None

E+E

+(E+E)

Total surplus

A+B+C+D+E+E+F+G

A+B+C+E+E+G

(D+F)

Conclusion
Welfare
Willing to pay
Consumer surplus
Willing to sell
Cost
Supply surplus
Total surplus

Cost of taxes
Tax revenue
Deadweight loss
International trade
Tariff
Import quota

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