This document provides an overview of chapter 7 from an economics textbook. It introduces the concepts of consumer surplus, producer surplus, and total surplus to analyze the efficiency of markets. Consumer surplus is the difference between what consumers are willing to pay and the actual price paid, while producer surplus is the difference between the selling price and production costs. The sum of consumer and producer surplus, known as total surplus, is maximized in a competitive market equilibrium, demonstrating the efficiency of free markets. However, market power and externalities can cause markets to fail to maximize total surplus.

1. A.S.Akat EC101- Chapter 7 1
CONSUMERS, PRODUCERS,
AND THE EFFICIENCY OF
MARKETS
Chapter 7
PART THREE
SUPPLY AND DEMAND – II
MARKETS AND WELFARE

2. A.S.Akat EC101- Chapter 7 2
What did we learn so far?
• Part One introduced us to some basic concepts as
well as tools of economics as a science
– Ten principles (Ch.1)
– Thinking like an economist (Ch.2)
– Exchange and trade (Ch.3)
• Part Two introduced us to markets and how they
work through the forces of supply and demand
– Supply and Demand (Ch.4)
– Elasticities (Ch.5)
– Markets and government policies (Ch.6)
• Part Three looks on the welfare implications of the
market system

3. A.S.Akat EC101- Chapter 7 3
What do we learn in this part?
• We search for an answer to the following question
• Are markets a good way to organise the social
process of production?
• To answer it we develop the concepts of consumer
surplus, producer surplus and total surplus
• They allow us to explain market efficiency
• We then apply our new tools to understand the costs
of taxation and the benefits of international trade
• Part Three is made of
• Ch.7 : Consumers, producers and market efficiency
• Ch.8 : Application: Costs of taxation
• Ch.9 : Application: International trade

4. A.S.Akat EC101- Chapter 7 4
Market equilibrium revisited
• Market equilibrium reflects the way markets
allocate scarce resources
• Supply and demand determines the equilibrium
price and quantity for each good
• Thus the resources that goes into its production as
well as who shall benefit from its consumption
• The next question is to find out if the equilibrium
price and quantity maximize the total welfare of
buyers and sellers?
• Welfare economics answers this question
• And determines whether the market allocation is
desirable or not from the perspective of society

5. A.S.Akat EC101- Chapter 7 5
Welfare economics
• Welfare economics study how the allocation of
resources affects economic well-being in society
• It uses a new concept called “surplus”
• And shows that buyers and sellers both receive
benefits from taking part in the market
• Therefore the equilibrium in a market maximizes the
total welfare of buyers and sellers
• Consumer surplus measures economic welfare from
the buyer side
• Producer surplus measures economic welfare from
the seller side
• Together they allow us to evaluate the allocation of
scarce resources by markets

6. A.S.Akat EC101- Chapter 7 6
Willingness to pay
• Willingness to pay is the maximum price that a
buyer is willing and able to pay for a good or service
• It corresponds to the value attributed by the buyer to
the good or service demanded
• The willingness to pay cannot always be directly
measured in the market but it is still there
• How much a buyer will be willing to pay for a good
or service is the maximum price at which he/she will
purchase that good or service
• What determines the maximum price?
• The benefits that the buyer expect to receive from
the consumption of that good or service

7. A.S.Akat EC101- Chapter 7 7
Consumer surplus
• Consumer surplus is the key concept of welfare
economics
• The market demand curve shows the various
quantities that buyers would be willing and able to
purchase at different prices
• As the price goes down, the quantity bought goes up
• Consumer surplus is the difference between the
willingness to pay for the good or service and the
actual spending for it
• Consumer surplus is the amount a buyer is willing
to pay for a good minus the amount the buyer
actually pays for it

8. A.S.Akat EC101- Chapter 7 8
Willingness to pay with four
possible buyers
Buyer Willingness to Pay
John $100
Paul 80
George 70
Ringo 50

9. A.S.Akat EC101- Chapter 7 9
Price Buyer Quantity
Demanded
More than $100 None 0
$80 to $100 John 1
$70 to $80 John, Paul 2
$50 to $70 John, Paul, George 3
$50 or less Ringo 4
Willingness to pay with four
possible buyers

10. A.S.Akat EC101- Chapter 7 10
Measuring consumer surplus with
the demand curve
Price of
Album
50
70
80
0
$100
Demand
1 2 3 4
Total
consumer
surplus ($40)
Quantity of
Albums
John’s consumer surplus ($30)
Paul’s consumer surplus ($10)

11. A.S.Akat EC101- Chapter 7 11
Consumer surplus, demand and price
• Consumer surplus is the area that lies below the
demand curve and above the market price
• Consumer surplus depends on the demand curve,
which represents the willingness to pay
• And the market price which represents market
equilibrium
• Ceteris paribus, changes in price and demand affect
consumer surplus
– Lower market price increases consumer surplus
– Higher market price reduces consumer surplus
– Higher demand increases consumer surplus
– Lower demand reduces consumer surplus

12. How the price affects consumer
surplus
Quantity
Price
0
Demand
P1
P2
A
B
D
C
E
F
Q1 Q2
Consumer surplus
to new consumers
Additional
consumer
surplus to
initial
consumers
Initial
consumer
surplus

13. A.S.Akat EC101- Chapter 7 13
Willingness to sell
• We can now apply the concept of surplus to the
producers
• Market supply curve shows the various quantities
that producers would be willing and able to sell at
different prices
• It may be seen as a measure of supplier costs, that
is, the opportunity cost of supplying various
quantities of the good.
• The marginal opportunity cost of production
increases as market output expands
• Because a producer’s cost is the lowest price he/she
will accept, cost is a measure of his/her willingness
to sell

14. A.S.Akat EC101- Chapter 7 14
Producer surplus
• Producer surplus is the symetric image of consumer
surplus on the supply curve
• It is measured by the difference between the
willingness to sell of the producers for a good or
service and the actual revenue they receive from it
• Producer surplus is therefore the amount a seller is
paid minus the cost of production of the good or
service
• It is the area that lies above the supply curve and
below the price line
• Producer surplus measures the benefit to sellers of
participating in a market

15. A.S.Akat EC101- Chapter 7 15
The costs of four possible sellers
Seller Cost
Mary $900
Louise 800
Georgia 600
Grandma 500

16. A.S.Akat EC101- Chapter 7 16
Supply schedule with four
possible sellers
Price Sellers Quantity
Supplied
$900 or more Mary, Louise, Georgia,
Grandma
4
$800 to $900 Louise, Georgia, Grandma 3
$600 to $800 Georgia, Grandma 2
$500 to $600 Grandma 1
Less than $500 none 0

17. A.S.Akat EC101- Chapter 7 17
Measuring producer surplus with the
supply curve
Quantity of
Houses Painted
Price of
House
Painting
500
800
$900
0
Supply
600
1 2 3
Georgia’s producer
surplus ($200)
Grandma’s producer
surplus ($300)
Total
producer
surplus ($500)

18. A.S.Akat EC101- Chapter 7 18
How price affects producer
surplus
Quantity
Price
0
P2
P1
B
C
Supply
A
D
Initial
producer
surplus
E
F
Q1 Q2
Producer surplus
to new producers
Additional producer
surplus to initial
producers

19. A.S.Akat EC101- Chapter 7 19
Market efficiency
• The sum of consumer surplus and producer surplus
is a good measure of the well-being of society
• A market with perfect competition and without
externatilities maximises society’s well-being
• Consumer surplus = value to buyers – amount paid
by buyers
• Produces surplus = amount received by sellers –
cost to sellers
• Total surplus = value to buyers – cost to sellers
• Market efficiency is attained when the allocation of
resources maximizes total surplus
• Competitive markets are therefore efficient

20. A.S.Akat EC101- Chapter 7 20
Efficiency versus equity
• It is very important to understand the limitations of
the word “efficiency”
• In an efficient solution, nobody can be better off
without someone else becoming worse off
• If it possible to increase one person’s well-being
without reducing that of the others the solution is
clearly inefficient
• But efficiency does not mean equity nor equality
• Our sense of fairness may not be satisfied with an
efficient situation which corresponds to a very
unequal distribution of well-being among members
of society
• Equity is also very important for society

21. A.S.Akat EC101- Chapter 7 21
Consumer and producer surplus in
the market equilibrium
Price
Equilibrium
price
0 Quantity
Equilibrium
quantity
A
Supply
C
B
Demand
D
Producer
surplus
Consumer
surplus
E

22. A.S.Akat EC101- Chapter 7 22
Efficiency of equilibrium
Quantity
Price
0 Equilibrium
quantity
Supply
Demand
Cost
to
sellers
Cost
to
sellers
Value
to
buyers
Value
to
buyers
Value to buyers is greater
than cost to sellers.
Value to buyers is less
than cost to sellers.

23. A.S.Akat EC101- Chapter 7 23
Market efficiency: three observations
• Welfare economics allow us to evaluate the meaning
and benefits of a market economy for the society
• We highlight three aspects that makes the market
economy desirable for society
• Free and competitive markets allocate the supply of
goods to the buyers who value them most highly
• Free and competitive markets allocate the demand
for goods to the sellers who can produce them at
least cost
• Free and competitive markets produce the quantity
of goods that maximizes the sum of consumer and
producer surplus

24. A.S.Akat EC101- Chapter 7 24
Market as an “invisible hand”
• In a free market there is no centralised social
authority to allocate scarce resources
• The many buyers and sellers in a market economy
are motivated by self-interest, not by altruism
• A process of coordination and communication takes
place so that buyers and sellers are directed to the
most efficient outcome
• As if by an invisible hand, the free market system
reaches efficiency
• Scottish economist Adam Smith first coined the term
“invisible hand” in his book The Wealth of Nations,
published in 1776

25. A.S.Akat EC101- Chapter 7 25
Tickets on the sidewalk
• Let us look at an interesting example
• Assume you decide to go to a show or a football
game at the last minute?
• Your only chance is to go to the theater or the
stadium with the hope that someone will be selling
tickets
• But you have to pay a higher price
• Is it “black market”? Or is it a service?
• For the economist the enterpreneurs who buy tickets
in advance to sell them with profit at the door take
risks which explain their profits
• The economist will be worried about whether they
pay or not income tax on this income

26. A.S.Akat EC101- Chapter 7 26
Market failure: market power and
externalities
• Market power is the ability of one buyer or seller to
control market price
• Market power reduces total surplus
• It is called market failure because it causes markets
to be inefficient
• Externalities are the benefits or costs imposed on a
third party who is not the consumer or the producer
• Such as the cost of pollution to the society which is
not included in the price of the good
• Externalities result in lower total surplus
• Causing markets to be inefficient, and thus fail

27. A.S.Akat EC101- Chapter 7 27
Conclusion
• Welfare economics evaluate the market from the
perspective of society
• Consumer and producer surplus measures the
benefits of buyers and sellers from participating in
the market
• An allocation of resources that maximizes the sum
of consumer and producer surplus is said to be
efficient
• Policymakers are concerned with efficiency and
also equity
• Market power and externalities can cause markets
to be inefficient and to fail