Economic Efficiency
Sessions 6, 7 & 8
Economic Efficiency y Consumer Surplus
A buyer’s willingness to pay (WTP) for a good p y(
)
g is the maximum amount the buyer will pay for that good good.
WTP measures how much the buyer values the good.
Example:
4 buyers’ WTP for an iPod
name
Anthony
WTP
$250
Chad
175
Flea
300
John
125
Consumer Surplus
Q: If price of iPod is $200, who will buy an iPod, and what is quantity demanded? q y
A: Anthony & Flea will buy an iPod,
Chad & John will not.
Hence, Qd = 2 when P = $200.
Consumer Surplus
Derive the demand schedule:
P (price of iPod)
)
$301 & up
251 – 300
who buys nobody Flea
Qd
0
1
176 – 250
Anthony, Flea
2
126 – 175
Chad, Anthony,
Flea
3
,
,
John, Chad,
Anthony, Flea
4
0 – 125
Consumer Surplus
This D curve looks like a staircase with 4 steps – one per buyer.
If there were a huge no. of buyers, as in a competitive market, there would be a huge no. of very tiny steps and it would look more like a smooth curve.
$
$350
$300
$250
$200
$150
$100
$50
$0
0
1
2
3
4
Consumer Surplus
Consumer surplus is the amount a buyer is willing to pay minus the amount the buyer actually g p y y y pays:
CS = WTP – P
Suppose P = $260.
Flea’s CS = $300 – 260 = $40.
The others get no CS because they do not buy an iPod at this price.
Total CS = $40.
Consumer Surplus
Flea’s WTP
$
$350
$300
P = $260
Flea’s CS =
$300 – 260 = $40
$250
$200
Total CS = $40
$150
$100
$50
$0
0
1
2
3
4
Consumer Surplus
The lesson:
Total CS equals the area under the demand curve above the price, from
0 to Q.
Flea’s WTP
$
$350
$300
Anthony’s WTP
$250
$200
Suppose P = $220
Flea’s CS =
$300 – 220 = $80
$150
Anthony’s CS =
$100
$50
$250-220 = $30
Total CS = $110
$0
0
1
2
3
4
Consumer Surplus
P
CS
is the area b/w P
Economic Efficiency y Consumer Surplus
A buyer’s willingness to pay (WTP) for a good p y(
)
g is the maximum amount the buyer will pay for that good good.
WTP measures how much the buyer values the good.
Example:
4 buyers’ WTP for an iPod
name
Anthony
WTP
$250
Chad
175
Flea
300
John
125
Consumer Surplus
Q: If price of iPod is $200, who will buy an iPod, and what is quantity demanded? q y
A: Anthony & Flea will buy an iPod,
Chad & John will not.
Hence, Qd = 2 when P = $200.
Consumer Surplus
Derive the demand schedule:
P (price of iPod)
)
$301 & up
251 – 300
who buys nobody Flea
Qd
0
1
176 – 250
Anthony, Flea
2
126 – 175
Chad, Anthony,
Flea
3
,
,
John, Chad,
Anthony, Flea
4
0 – 125
Consumer Surplus
This D curve looks like a staircase with 4 steps – one per buyer.
If there were a huge no. of buyers, as in a competitive market, there would be a huge no. of very tiny steps and it would look more like a smooth curve.
$
$350
$300
$250
$200
$150
$100
$50
$0
0
1
2
3
4
Consumer Surplus
Consumer surplus is the amount a buyer is willing to pay minus the amount the buyer actually g p y y y pays:
CS = WTP – P
Suppose P = $260.
Flea’s CS = $300 – 260 = $40.
The others get no CS because they do not buy an iPod at this price.
Total CS = $40.
Consumer Surplus
Flea’s WTP
$
$350
$300
P = $260
Flea’s CS =
$300 – 260 = $40
$250
$200
Total CS = $40
$150
$100
$50
$0
0
1
2
3
4
Consumer Surplus
The lesson:
Total CS equals the area under the demand curve above the price, from
0 to Q.
Flea’s WTP
$
$350
$300
Anthony’s WTP
$250
$200
Suppose P = $220
Flea’s CS =
$300 – 220 = $80
$150
Anthony’s CS =
$100
$50
$250-220 = $30
Total CS = $110
$0
0
1
2
3
4
Consumer Surplus
P
CS
is the area b/w P