Slide 1

(ECEN 4503) Engineering EconomicsLecture #7:Consumers, Producers, and the Efficiency of MarketsJune 02nd 2015Lecturer: Nguyen Minh Y, Ph.D.Thai Nguyen UniversityThai Nguyen University of TechnologyFaculty of International TrainingReviewing6/4/2015Department of Electrical Engineering taught in English2Introduction 6/4/2015Department of Electrical Engineering taught in English3Always the caseBuyers want to pay lessSellers want to get paid moreThere 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.1. Consumer Surplus6/4/2015Department of Electrical Engineering taught in English41.1 Willingness to payWillingness 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 payRefuse to buy at a price more than his/her willingness to payBe 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.

1. Consumer Surplus6/4/2015Department of Electrical Engineering taught in English51.1 Willingness to payExample: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)

BuyersWillingness to payJohnPaulGeorgeRingo$100$80$70$50In which price the auction might stop?

If John buys the album at price of $80, his consumer surplus is?

Consumer surplus measures the benefit to buyers of participating in a market.1. Consumer Surplus6/4/2015Department of Electrical Engineering taught in English61.1 Willingness to payExample:Auction to sell Elvis Presleys first album.Suppose that there are two album and no buyer wants to buy more than one album.

BuyersWillingness to payJohnPaulGeorgeRingo$100$80$70$50In which price the auction might stop?

If the auction stops at price of $70, what is consumer surplus?John?Paul?Market?1. Consumer Surplus6/4/2015Department of Electrical Engineering taught in English71.2 Using the demand curve to measure consumer surplusThe willingness to pay and the demand scheduleUse the willingness to pay to construct the demand schedule.

BuyersWillingness to payJohnPaulGeorgeRingo$100$80$70$50PriceBuyersQuantity demandedMore than $100$80 to $100$70 to $80$50 to $ 79$50 or less01234NoneJohnPaul, JohnGeorge, Paul, JohnRingo, George, Paul, John1. Consumer Surplus6/4/2015Department of Electrical Engineering taught in English81.2 Using the demand curve to measure consumer surplusThe willingness to pay and the demand scheduleThe demand curve

The area below the demand curve and above the price measures the consumer surplus in a market.1. Consumer Surplus6/4/2015Department of Electrical Engineering taught in English91.3 How the price affects consumer surplusBuyers always want to pay less for the good?The lower price, the higher consumer surplus

When the price fallsFrom P1, Q1To P2, Q2

1. Consumer Surplus6/4/2015Department of Electrical Engineering taught in English101.4 What does consumer surplus measure?Calculated asWillingness to pay the actual priceBenefit to the buyersBuyers themselves perceive it (willingness to pay)

Practice6/4/2015Department of Electrical Engineering taught in English11Ex1. Melisa buys an iPod for $120 and gets consumer surplus of $80.What is her willingness to pay?If she had bought the iPod on sale for $90, what would her consumer surplus have been?If the price of an iPod were $250, what would her consumer surplus have been?

Practice6/4/2015Department of Electrical Engineering taught in English12Ex2. It is a hot day, and Bert is thirsty. Here is the value he places on a bottle of water:Value of first bottle:$7Value of second bottle:$5Value of third bottle:$3Value of fourth bottle:$1From this information, derive Berts demand schedule. Graph his demand curve for bottle water.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.If the price falls to $2, how does quantity demanded change? How hoes Berts consumer surplus change? Show these changes in your graph.

2. Producer Surplus6/4/2015Department of Electrical Engineering taught in English132.1 Cost and the willing to sellCost the value of everything a seller must give up to produce a good.

A seller wouldEager to sell if the price exceeds his/her costRefuse to sell if the price is lower than his/her costIndifferent 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.2. Producer Surplus6/4/2015142.1 Cost and the willing to sellExample: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

SellerWillingness to sellMarryFridaGeorgeGrandma$900$800$600$500In which price the auction might stop?

If Grandma get the job at price of $600, her producer surplus is?

Consumer surplus measures the benefit sellers receive from participating in a market.2. Producer Surplus6/4/2015152.1 Cost and the willing to sellExample: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.

SellerWillingness to sellMarryFridaGeorgeGrandma$900$800$600$500In which price the auction might stop?

If the auction stops at price of $800, what is producer surplus?Grandma?George?Market?2. Producer Surplus6/4/2015Department of Electrical Engineering taught in English162.2 Using the supply curve to measure producer surplusThe willingness to sell (cost) and the supply scheduleWe can use the willingness to sell to construct the supply schedulePriceBuyersQuantity demandedMore than $900$800 to $900$600 to $800$500 to $600$500 or lessMarry, Frida, George, GrandmaFrida, George, GrandmaGeorge, GrandmaGrandmaNone43210SellerWillingness to sellMarryFridaGeorgeGrandma$900$800$600$5002. Producer Surplus6/4/2015Department of Electrical Engineering taught in English172.2 Using the supply curve to measure producer surplusThe willingness to sell (cost) and the supply scheduleSupply curveThe area above the supply curve and below the price measures the producer surplus in a market.

2. Producer Surplus6/4/2015Department of Electrical Engineering taught in English182.3 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 risesFrom P1, Q1To P2, Q2

2. Producer Surplus6/4/2015Department of Electrical Engineering taught in English192.4 What does producer surplus measure?Calculated asThe actual price the costBenefit to the sellersBuyers themselves perceive the cost (willingness to pay)

Practice6/4/2015Department of Electrical Engineering taught in English20Ex3. 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:$1Cost of second bottle:$3Cost of third bottle:$5Cost of fourth bottle: $7From this information, derive Ernies supply schedule. Graph his supply curve for bottled water.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.If the price rises to $6, how does quantity supplied change? Show these changes in your graph.3. Market Efficiency6/4/2015Department of Electrical Engineering taught in English21Previously,Consumer surplus= welfare of buyers (well-being)Producer surplus= welfare of sellers (well-being)

Free market:Market equilibrium:Supply = DemandEquilibrium quantityEquilibrium price

Is the allocation of resources determined by free markets in any way desirable?3. Market Efficiency6/4/2015Department of Electrical Engineering taught in English223.1 The benevolent social plannerTo 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 buyersProducer surplus= Amount received by sellers Cost to sellersTotal 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.3. Market Efficiency6/4/2015Department of Electrical Engineering taught in English233.2 Evaluating the market equilibriumThe total surplus, the sum of consumer surplus and producer surplus

The total surplus at a market price? The area between the supply and demand curves up to the equilibrium quantity.

Which price gives the maximum total surplus?

Provider surplusConsumer surplusMarket price3. Market Efficiency6/4/2015Department of Electrical Engineering taught in English243.2 Evaluating the market equilibriumFree 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.

Provider surplusConsumer surplusMarket price3. Market Efficiency6/4/2015Department of Electrical Engineering taught in English253.2 Evaluating the market equilibriumThe job of benevolent social planner?Leave the market as it is (let it free)Invisible handTo allocate the economys resources that maximize the total surplus

Assumption?Perfectly competitive marketNo market powerThe outcome in market matters only buyers and sellersNo externalityMake the equilibrium may be inefficient from the standpoint of society as a whole.Practice 6/4/2015Department of Electrical Engineering taught in English26Ex5. The supply and demand for broccoli are described by the following equations:Supply:QS = 4P 80Demand:QD = 100 2P

where Q is in bushels and P is in dollars per bushel.Graph the supply curve and the demand curve. What is the equilibrium price and quantity?Calculate consumer surplus, producer surplus, and total surplus at the equilibrium.If a dictator who hated broccoli was to ban the vegetable, who would bear the larger burden: The buyers or sellers of broccoli?

4. The Cost of Taxation6/4/201527The effect of taxes on the total surplus?4.1 The deadweight loss of taxationA tax is enactedThe price paid by buyers risesThe price received by sellers fallsThe buyers and sellers share the burden of tax

4. The Cost of Taxation6/4/2015Department of Electrical Engineering taught in English284.1 The deadweight loss of taxationHow a tax affect market participants

Difference in the price Paid by buyers Received by sellersEquilibrium quantity reducesElasticity of supply and demandThe benefits of participating in the marketBuyers (area A)Sellers (area F)4. The Cost of Taxation6/4/2015Department of Electrical Engineering taught in English294.1 The deadweight loss of taxationTax revenue

The amount government collects from taxationArea (B + D)Tax revenue and the size of taxesTax size increase?4. The Cost of Taxation6/4/2015Department of Electrical Engineering taught in English304.1 The deadweight loss of taxationDeadweight loss

Economic welfareThe total surplus with a taxConsumer surplusProducer surplusTax revenue

Losses of buyers and sellers versus the tax revenue?

The fall in total surplus when a tax distorts a market outcomeArea (C + E)Practice 6/4/2015Department of Electrical Engineering taught in English31Ex2. 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.5. International Trade6/4/2015Department of Electrical Engineering taught in English32World 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 countryIf the domestic price is below the world price, after openingSellers?No seller would accept less than the world priceBuyers?No buyer would pay more than the world priceThe domestic price the world price

5. International Trade6/4/2015335.1 The gains and losses of an exporting countryThe domestic price the world price

Before tradeAfter tradeChangeConsumer surplusProducer surplusTotal surplusA + BCA + B + CAB + C + DA + B + C + D B+ (B + D)+ D5. International Trade6/4/2015345.1 The gains and losses of an exporting country

Summary,When a country allows trade and becomes an exporter of goodsDomestic producers of the good are better offDomestic 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.

5. International Trade6/4/2015355.2 The gains and losses of an importing countryIf the domestic price is above the world price, after openingThe domestic price the world price

Before tradeAfter tradeChangeConsumer surplusProducer surplusTotal surplusAC + BA + B + CA + B + DCA + B + C + D+ (B + D) B+ D5. International Trade6/4/2015365.2 The gains and losses of an importing country

Summary,When a country allows trade and becomes an importer of goodThe domestic consumers of the good are better offThe 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.

5. International Trade375.3 Trade policiesTariff a tax on goods produced abroad and sold domestically

Before tariffAfter tariffChangeConsumer surplusProducer surplusGovernment revenuesTotal surplusA+B+C+D+E+FGNoneA+B+C+D+E+F+GA+BC+GA+B+C+DA+B+C+E+G (C+D+E+F)+CCE(D+F)5. International Trade38Import quota a limit on the quantity of a good that can be produced abroad and sold domestically.

Before import quotaAfter import quotaChangeConsumer surplusProducer surplusLicense holdersTotal surplusA+B+C+D+E+E+FGNoneA+B+C+D+E+E+F+GA+BC+GE+EA+B+C+E+E+G (C+D+E+E+F)+C+(E+E) (D+F)Conclusion6/4/2015Department of Electrical Engineering taught in English39WelfareWilling to payConsumer surplusWilling to sellCostSupply surplusTotal surplusCost of taxesTax revenueDeadweight lossInternational tradeTariffImport quota