emba sem i managerial economics session5-consumer surplus, producer surplus and market...

8/10/2019 EMBA Sem I Managerial Economics Session5-Consumer Surplus, Producer Surplus and Market Efficiency.ppt

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Welfare Economics

Welfare economics is the study of how

the allocation of resources affectseconomic well-being.Buyers and sellers receive benefits

from taking part in the market. Consumer surplus measures economic

welfare from the buyers side. Producer surplus measures economic

welfare from the sellers side.The equilibrium in a market maximizesthe total welfare of buyers and sellers.


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WTP and the Demand Curve

Derive thedemandschedule:

4John, Chad, Anthony, Flea0 125

3Chad, Anthony,Flea126 175

2 Anthony, Flea176 250

1Flea251 300

0nobody$301 & up

Q dwho buysP (priceof iPod)

name WTP

Anthony $250

Chad 175

Flea 300

John 125


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$0

$50

$100

$150$200

$250

$300$350

0 1 2 3 4

WTP and the Staircase shaped DemandCurve

P Q d

$301 & up 0

251 300 1

176 250 2

126 175 30 125 4

P

Q


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$0

$50

$100

$150$200

$250

$300$350

0 1 2 3 4

WTP and the Staircase Demand Curve

At any Q ,the height ofthe D curve isthe WTP of them arginal buyer ,the buyer whowould leave themarket if P wereany higher.

P

Q

Fleas WTP

Anthonys WTP

Chads WTP

JohnsWTP


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Mathematical Calculation of Consumer Surplus(CS)Consumer surplus is the amount a buyer is willingto pay minus the buyer actually pays:

CS = WTP P

name WTP

Anthony $250

Chad 175

Flea 300

John 125

Suppose P = $260.Fleas CS = $300 260 = $40.

The others get no CS because

they do not buy an iPod at thisprice.

Total CS = $40.


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$0

$50

$100

$150$200

$250

$300$350

0 1 2 3 4

CS and the Demand CurveP

Q

Fleas WTP P = $260

Fleas CS =$300 260 = $40

Total CS = $40


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$0

$50

$100

$150$200

$250

$300$350

0 1 2 3 4

CS and the Demand CurveP

Q

Fleas WTP

Anthonys WTP

Instead, supposeP = $220Fleas CS =$300 220 = $80

Anthonys CS = $250 220 = $30

Total CS = $110


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0

10

20

30

40

50

60

0 5 10 15 20 25 30

P

Q

Further Calculations of CS with Smooth DCurve

The demand for shoes

D

CS is the area b/w

P and the D curve, from 0 toQ .Recall: area of

a triangle equals x base x heightHeight ofthis triangle is

$60 30 = $30.So,CS = x 15 x$30

= $225.

h

$


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0

10

20

30

40

50

60

0 5 10 15 20 25 30

P

Q

How a Higher Price Reduces CS

D

If P rises to $40,

CS = x 10 x $20= $100.

Two reasons forthe fall in CS.

1. Fall in CSdue to buyersleaving market

2. Fall in CS due to

remaining buyerspaying higher P


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PRODUCER SURPLUS

Producer surplus is the amount aseller is paid for a good minus thesellers cost .

It measures the benefit to sellersparticipating in a market.Its the benefit that producers receive

from their own perspective.


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Cost and the Supply Curve

335 & up

220 34110 19

0$0 9

Q sPDerive the supply schedulefrom the cost data:

name cost

Angelo $10Hunter 20

Kitty 35


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$0

$10

$20

$30

$40

0 1 2 3

Cost and the Supply Curve

P

Q

At each Q , theheight of the S curveis the cost of them arginal seller ,the seller who wouldleave the market ifthe price were anylower.

Kittyscost

Hunterscost

Angelos cost


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$0

$10

$20

$30

$40

0 1 2 3

Producer Surplus

P

Q

Producer surplus (PS):the amount a selleris paid for a good

minus the sellers cost.

PS = P cost


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$0

$10

$20

$30

$40

0 1 2 3

Producer Surplus and the S Curve

P

Q

PS = P cost

Suppose P = $25.

Angelos PS = $15

Hunters PS = $5 Kittys PS = $0

Total PS = $20

Kittyscost

Hunterscost

Angelos cost

Total PS equals thearea above the supplycurve under the price,

from 0 to Q .


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0

10

20

30

40

50

60

0 5 10 15 20 25 30

P

Q

PS with Lots of Sellers & a Smooth S Curve

The supply of shoes

S

PS is the area b/wP and the S curve,from 0 to Q .

The height of thistriangle is$40 15 = $25.

So,PS = x b x h

= x 25 x $25= $312.5

h


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Total Surplus

Total surplus= Consumer surplus + Producer surplus

= Value to buyers Amount paid by buyers +

Amount received by sellers Cost to sellers

Total surplus = Value to buyers Cost tosellers

Represents the entire area between themaximum price that buyers want to pay and

the lowest cost that sellers would incur.


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va ua ng e ar eEquilibrium

Market eqm: P = $30Q = 15,000

Total surplus= CS + PS

0

10

20

30

40

50

60

0 5 10 15 20 25 30

P

Q

S

D

CS

PS


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Market Efficiency

Market is considered efficient if it maximizesthe total surplusMaximizing total surplus:Maximizing consumer surplus by involvingmaximum number of consumers in themarket for trade

+

Maximizing producer surplus by involvingmaximum number of producers in the marketfor trade


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Does Eqm Q Maximize Total Surplus?

0

10

20

30

40

50

60

0 5 10 15 20 25 30

P

Q

S

D

At Q = 10,

consumerswants to pay as muchas $40 for the goodsand

cost of producingthe marginal unitis $25Since there is an

excess demandsellers will be able toincrease total surplusby producing more.


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Does Eqm Q Maximize Total Surplus?

0

10

20

30

40

50

60

0 5 10 15 20 25 30

P

Q

S

D

At Q = 20,

cost of producingthe marginal unitis $35But consumers

wants to pay only$20.Since there is anexcess supply, some

sellers will not be ableto sell, causing totalsurplus to decrease.


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Numerical ProblemsCons ider a m arket wi th d emand cu rve q = 500

20p and supply curve q = - 50 + 25p . Hereq i s in m i ll ion k i logram s p er day and p i s inrup ees per k i logram .

2) Find consumer and producer surpluses in thismarket. (Hint: to find maximum price that consumer

pays and minimum cost price of suppliers, put Q = 0 ineach functions)(Ans. :Consumer Surplus = Rs. 1633.28Producer surplus = Rs. 1306.12


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1633.28

1306.12


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3) Calculate price elasticity of demand and priceelasticity of supply for this market.

(Ans. :PED = - 0.96PES = 1.19


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Effect of Tax on Consumer andProducer surplus


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Surplus after the tax is imposed

010

20

30

40

50

60

0 5 10 15 20 25 30

P

Q

S

D

TaxBp

Sp

Q

CS

PS

Govt. Revenue


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Tax Effect and Consumer and Producer Surplus

Taxrevenue(T Q)

Size of tax ( T )

Quantitysold ( Q)

Quantity 0

Price

Demand

Supply

Quantity

without tax

Quantity

with tax

Price buyerspay

Price sellersreceive

CS

PS


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4) Imagine that the government imposes a Rs.2per-unit tax on the buyers. Find the new marketequilibrium price and quantity. How much of thetax burden is borne by the buyers, and howmuch by the sellers?(Ans. :P = Rs. 11.33/kg/day; Q = 233.4 m Kgs.Buyers Tax burden = Rs. 1.11/kg Sellers tax burden = Rs. 0.89/kg


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5) Find the change in consumer and producersurpluses in this market after the govt. imposeRs. 2 per unit tax on buyers. (Ans. :Change in C.S. = Rs. 271.39Change in P. S. = Rs. 217.31


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Numerical Problems6) Now imagine that the government instead

decides to impose a Rs.2 per-unit tax on thesellers. Find the new market equilibrium priceand quantity. Calculate the change in consumerand producer surpluses in this market.

(Ans. :P = Rs.13.33/kg/dayQ = 233.4 m kg.Change in C.S. = Rs. 271.39Change in P. S. = Rs. 217.31


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Numerical Problems7) Now imagine that the government instead

decides to impose a sales tax of 20% on thesellers. Find the new market equilibrium priceand quantity. Tax burdens on buyers andsellers and calculate the change in consumer

and producer surpluses in this market.(Ans. :P = Rs.13.75/kg/dayQ = 225 m kg.Buyers tax burden = Rs. 1.53/kg Sellers tax burden = Rs. 1.22/kg Change in C.S. = Rs. 367.65Change in P. S. = Rs. 293.62


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emba sem i managerial economics session5-consumer surplus, producer surplus and market...

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