Ch 7. Consumers, Producers, and the Efficiency of Markets

.title[
# Ch 7. Consumers, Producers, and the Efficiency of Markets
]
.subtitle[
## Microeconomics for Students of Accounting, Finance, and Digital Applications
]
.author[
### Lyuben Ivanov, PhD; Georgi Ganev, PhD
]
.institute[
### Sofia University St. Kliment Ohridski
]
.date[
### Fall Term 2024/2025
]

---

.pull-right-2[
_It will be my most cherished ambition to increase the numbers who Cambridge University sends out into the world with cool heads but warm hearts, willing to give some of their best powers to grappling with the social suffering around them; resolved not to rest content till they have opened up to all the material means of a refined and noble life._
<hr style="background-color: black; margin: 0em 0em 0em 0em;">
<span style="float: right; font-variant: small-caps; "> Alfred Marshall </span>
]

---

# What is Welfare?

<br>

<table class="none">
  <tr style="background-color: transparent;">
    <td style="text-align: center; vertical-align: top; width: 240px;"><b>economic <br>point of view</b></td>
    <td> </td>
    <td> </td>
    <td>welfare is the degree of satisfaction of the material needs of people with the scarce resources available to society &mdash; the more needs get satisfied with the available resources, the higher the social welfare</td>
  </tr>
</table>

<br>

<table class="none">
  <tr style="background-color: transparent;">
    <td style="text-align: center; vertical-align: top; width: 240px;"><b>economic agent <br> point of view</b></td>
    <td> </td>
    <td> </td>
    <td>welfare is the subjective value difference between what the agent obtains and what she has to give up to obtain it</td>
  </tr>
</table>

---

# Assumptions Underlying Welfare Analysis

<br>

There are some major assumptions that are key to understanding welfare implications of market transactions:

<table class="none">
  <tr style="background-color: transparent;">
    <td style="text-align: center; vertical-align: top; width: 5px;"><b>1.</b></td>
    <td> </td>
    <td> </td>
    <td>every market transaction is a <b>voluntary transaction</b> between people with equal rights and equal dignity, requiring that <b>all sides</b> to the transaction are satisfied by it</td>
  </tr>
</table>

<table class="none">
  <tr style="background-color: transparent;">
    <td style="text-align: center; vertical-align: top; width: 5px;"><b>3.</b></td>
    <td> </td>
    <td> </td>
    <td>there are no positive or negative external effects (simplifying assumption that can be relaxed later)</td>
  </tr>
</table>

---

class: clear, middle, no-scribble
  
  .font200[
<strong>  Consumer Surplus</strong>
]
<hr>

---

# Identifying Consumer Surplus

Conceptually, consumer surplus exists because there is a gain from exchange when the consumer gives up something she values relatively less (a certain sum of money) and obtains something she values relatively more (a good or service).

Since we assume that the transaction is voluntary, the very fact of the transaction is sufficient to conclude that the consumer realizes a gain, but how do we identify and quantify the gain?

<table class="none">
  <tr style="background-color: transparent;">
    <td style="text-align: center; vertical-align: top; width: 240px;"><b>revealed preference</b></td>
    <td> </td>
    <td> </td>
    <td>otherwise unobservable, invisible to other people, preferences of a person are revealed through her decisions and actions</td>
  </tr>
</table>

---

# Identifying Consumer Surplus

If a consumer is willing to pay a higher price for a good (e.g. avocado), then the consumer must be valuing it more than a good for which she is willing to pay lower price (e.g. apple).

<table class="none">
  <tr style="background-color: transparent;">
    <td style="text-align: center; vertical-align: top; width: 240px;"><b>willingness to pay</b></td>
    <td> </td>
    <td> </td>
    <td>the maximum which a buyer (consumer) is willing to pay for a good (the highest value she is willing to give up to have the good), assumed to be a monetary measure of her marginal benefit from acquiring the good</td>
  </tr>
</table>

<table class="none">
  <tr style="background-color: transparent;">
    <td style="text-align: center; vertical-align: top; width: 240px;"><b>consumer surplus</b></td>
    <td> </td>
    <td> </td>
    <td>excess of the willingness to pay above what is actually paid (the price) for the good</td>
  </tr>
</table>

---

# <span style = "position: relative; top: -75px"> Consumer Surplus and the Demand Curve </span>

The demand curve can be considered an ordering of all consumers' willingnesses to pay (marginal benefits) for different units ranked from highest to lowest and plotted on a graph.

The leap of thought relating marginal benefit (willingness to pay) for the consumers to the demand curve allows the supply and demand model to be extended and used for analysis of social welfare.

---

# Consumer Surplus

<br>

.panelset.sideways.right[

]

]

---

# Self-Test

<div>
    <p>Belva is willing to pay $65 for a pair of shoes for a formal dance. She finds a pair at her favorite outlet shoe store for $48. How much is Belva’s consumer surplus?</p>
</div>

<div style="position: relative; top: 330px">
    <input type="text" id="userAnswer1" placeholder="Answer" class="input-field"><button onclick="checkAnswerO(17, 'result1', 'userAnswer1')" class="submit-button">Check</button>
</div>
<div id="result1"></div>

---

# Self-Test

<div>
    <p>Nathan buys a new sound system for his dorm room for $500. He receives consumer surplus of $400 from the purchase. How much does Nathan value his sound system?</p>
</div>

<div style="position: relative; top: 330px">
    <input type="text" id="userAnswer2" placeholder="Answer" class="input-field"><button onclick="checkAnswerO(900, 'result2', 'userAnswer2')" class="submit-button">Check</button>
</div>
<div id="result2"></div>

---

# Self-Test

<div>
    <p>Jeff decides that he would pay as much as $3,000 for a new laptop computer. He buys the computer and realizes consumer surplus of $700. How much did Jeff pay for his computer?</p>
</div>

<div style="position: relative; top: 330px">
    <input type="text" id="userAnswer3" placeholder="Answer" class="input-field"><button onclick="checkAnswerO(2300, 'result3', 'userAnswer3')" class="submit-button">Check</button>
</div>
<div id="result3"></div>

---

# A Drop in Price and Consumer Surplus

<br>

.panelset.sideways.right[

]

]

]

---

# Price Fall and Consumer Welfare

A drop in the market price leads to increased welfare for consumers due to two effects:

<table class="none">
  <tr style="background-color: transparent;">
    <td style="text-align: center; vertical-align: top; width: 5px;"><b>1.</b></td>
    <td> </td>
    <td> </td>
    <td>each unit that would have been purchased at the old price generates greater surplus for conusmers at the lower price</td>
  </tr>
</table>

---

# Price Rise and Consumer Welfare

A rise in the market price leads to decreased welfare for consumers due to two effects:

<table class="none">
  <tr style="background-color: transparent;">
    <td style="text-align: center; vertical-align: top; width: 5px;"><b>1.</b></td>
    <td> </td>
    <td> </td>
    <td>some units that would have been purchased at the old price are not purchased at the higher price and do not generate surplus for consumers</td>
  </tr>
</table>

---

class: clear, middle, no-scribble
  
  .font200[
<strong>  Producer Surplus</strong>
]
<hr>

---

# Producer Surplus

A producer gains welfare (profit) by giving up a produced good/providing a service in order to get the price paid by a consumer.

The reason for this to happen in a market exchange is that the producer prefers the price obtained (the revenue per unit) to having the product itself.

The willingness of a producer to voluntarily incur costs in order to produce a product which is then given up to a consumer for a price, indicates that the cost of production (including opportunity cost) for that particular unit is lower than the price charged to the consumer.

---

# Producer Surplus

This is yet another case of **revealed preference** as well as utilization of **dispersed knowledge** about the availability (and therefore cost!) of resources in society.

The intensity of a producer's preference toward getting the revenue instead of having the product is a measure of producer welfare and can also be identified by using the concepts of **willingness** (in this case **willingness to sell**) and **surplus** (in this case **producer surplus**).

---

# Willingness to Sell and Producer Surplus

<table class="none">
  <tr style="background-color: transparent;">
    <td style="text-align: center; vertical-align: top; width: 240px;"><b>willingness to sell</b></td>
    <td> </td>
    <td> </td>
    <td>the minimum price which a seller (producer) of a good/service is willing to accept to give up the good to the consumer, assumed to be a monetary measure of his marginal (opportunity!) cost for producing the good/providing the service</td>
  </tr>
</table>

<table class="none">
  <tr style="background-color: transparent;">
    <td style="text-align: center; vertical-align: top; width: 240px;"><b>producer surplus</b></td>
    <td> </td>
    <td> </td>
    <td>excess of the price paid for the good above the producer's willingness to sell</td>
  </tr>
</table>

---

# Producer Surplus and the Supply Curve

The supply curve can be considered an ordering of all producers' willingnesses to sell (marginal costs) for different units ranked from lowest to highest and plotted on a graph.

The leap of thought relating marginal cost (willingness to sell) for the producers to the supply curve allows the supply and demand model to be extended and used for analysis of social welfare.

---

# Producer Surplus Diagram

<br>

.panelset.sideways.right[
.panel[
.panel-name[Individual]

<img src="7_files/figure-html/fig_7.4-1.svg" style="display: block; margin: auto;" />
]

<img src="7_files/figure-html/fig_7.5-1.svg" style="display: block; margin: auto;" />
]
]

---

# Self-Test

<div>
    <p>Roger produces computer boards. His production cost is $10 per board. He sells the boards for $25 each. How much is his producer surplus per board?</p>
</div>

<div style="position: relative; top: 330px">
    <input type="text" id="userAnswer4" placeholder="Answer" class="input-field"><button onclick="checkAnswerO(15, 'result4', 'userAnswer4')" class="submit-button">Check</button>
</div>
<div id="result4"></div>

---

# Self-Test

<div>
    <p>The costs for 5 potential producers in a market are as follows Dale - $1,500; Jill - $1,200; Denise - $1,000; Catherine - $750; Jackson - $500. According to the data, if the price is $1,100, what would be the monetary value of the producer surplus realised in that market?</p>
</div>

<div style="position: relative; top: 291px">
    <input type="text" id="userAnswer5" placeholder="Answer" class="input-field"><button onclick="checkAnswerO(1050, 'result5', 'userAnswer5')" class="submit-button">Check</button>
</div>
<div id="result5"></div>

---

# A Rise in Price and Producer Surplus

<br>

.panelset.sideways.right[
.panel[
.panel-name[Panel A]

<img src="7_files/figure-html/fig_7.6.1-1.svg" style="display: block; margin: auto;" />
]

<img src="7_files/figure-html/fig_7.6.2-1.svg" style="display: block; margin: auto;" />
]

<img src="7_files/figure-html/fig_7.6.3-1.svg" style="display: block; margin: auto;" />
]
]

---

# Price Change and Producer Welfare

A rise in market prices leads to increased welfare for producers due to two effects:

<table class="none">
  <tr style="background-color: transparent;">
    <td style="text-align: center; vertical-align: top; width: 5px;"><b>1.</b></td>
    <td> </td>
    <td> </td>
    <td>each unit that would have been produced (and sold!) at the old price generates greater surplus for producers at the higher price</td>
  </tr>
</table>

---

# Price Change and Producer Welfare

A fall in market prices leads to decreased welfare for producers due to two effects:

<table class="none">
  <tr style="background-color: transparent;">
    <td style="text-align: center; vertical-align: top; width: 5px;"><b>1.</b></td>
    <td> </td>
    <td> </td>
    <td>some units that could have been produced (and sold!) at the old (higher!) price are no longer produced and do not generate surplus for the producers</td>
  </tr>
</table>

---

class: clear, middle, no-scribble
  
  .font200[
<strong>  Total Surplus</strong>
]
<hr>

---

# Defining Total Surplus

<table class="none">
  <tr style="background-color: transparent;">
    <td style="text-align: center; vertical-align: top; width: 240px;"><b>total surplus</b></td>
    <td> </td>
    <td> </td>
    <td>the sum of consumer and producer surpluses realized on a given market under given conditions</td>
  </tr>
</table>

---

# Total Surplus Redefined

<table class="none">
  <tr>
    <td style="width: auto; text-align: right;">total surplus</td>
    <td style="width: 0.1cm;">=</td>
    <td style="width: auto;">consumer surplus + producer surplus</td>
  </tr>
  <tr>
    <td></td>
    <td>=</td>
    <td>(willingness to pay - price paid) +<br>(price obtained - willingness to sell)</td>
  </tr>
  <tr>
    <td></td>
    <td>=</td>
    <td>willingness to pay - willingness to sell</td>
  </tr>
  <tr>
    <td></td>
    <td>=</td>
    <td>intensity of human needs satisfied -<br>(opportunity!) cost of production</td>
  </tr>
</table>

---

class: clear, middle, no-scribble
  
  .font200[
<strong>  Efficiency of Markets</strong>
]
<hr>

---

# Defining Efficiency

<table class="none">
  <tr style="background-color: transparent;">
    <td style="text-align: center; vertical-align: top; width: 240px;"><b>efficient resource allocation</b></td>
    <td> </td>
    <td> </td>
    <td>an allocation of resources leading to the maximum possible surplus for society</td>
  </tr>
</table>

---

# Graphical Analysis of Market Efficiency

<br>

.panelset.sideways.right[
.panel[
.panel-name[Panel A]

<img src="7_files/figure-html/fig_7.7.1-1.svg" style="display: block; margin: auto;" />
]

<img src="7_files/figure-html/fig_7.7.2-1.svg" style="display: block; margin: auto;" />
]

<img src="7_files/figure-html/fig_7.7.3-1.svg" style="display: block; margin: auto;" />
]
]

---

# Insights For Market Outcomes

The graphical welfare analysis suggests three conclusions:

<table class="none">
  <tr style="background-color: transparent;">
    <td style="text-align: center; vertical-align: top; width: 5px;"><b>1.</b></td>
    <td> </td>
    <td> </td>
    <td>free markets allocate the supply of goods to the buyers who value them most, as measured by their willingness to pay</td>
  </tr>
</table>

<table class="none">
  <tr style="background-color: transparent;">
    <td style="text-align: center; vertical-align: top; width: 5px;"><b>3.</b></td>
    <td> </td>
    <td> </td>
    <td>free markets produce the quantity of goods that maximizes the sum of consumer and producer surplus (the total surplus)</td>
  </tr>
</table>

---

# <span style = "position: relative; top: -75px;"> Inefficiency Under Prices Different Than the Market Price </span>

.panelset.sideways.right[
  .panel[
  .panel-name[Lower Price]
    
<img src="7_files/figure-html/fig_7.8-1.svg" style="display: block; margin: auto;" />
]

.panel[
  .panel-name[Higher Price]
  
<img src="7_files/figure-html/fig_7.9-1.svg" style="display: block; margin: auto;" />
]
]

---

# Reasons for Market Inefficiency

Market interaction can be theoretically inefficient when:

<table class="none">
  <tr style="background-color: transparent;">
    <td style="text-align: center; vertical-align: top; width: 5px;"><b>1.</b></td>
    <td> </td>
    <td> </td>
    <td>the curves of supply and demand for some reason do not truthfully reflect the willingness to pay and/or to sell (is this a truly market interaction then!?)</td>
  </tr>
</table>

<table class="none">
  <tr style="background-color: transparent;">
    <td style="text-align: center; vertical-align: top; width: 5px;"><b>2.</b></td>
    <td> </td>
    <td> </td>
    <td>the willingness to pay and/or to sell by individual agents are not an adequate measure for the welfare of society ensuing from the production and consumption of a certain goods by certain producers and consumers (due to external effects and/or myopic behavior)</td>
  </tr>
</table>

---

# Reasons for Market Inefficiency

<table class="none">
  <tr style="background-color: transparent;">
    <td style="text-align: right; vertical-align: top; width: 50px;"><i class="fa fa-globe"</td>
    <td style="width: 20px"> </td>
    <td style="text-align: left; vertical-align: top; width: auto;">addicted drug users do demand drugs and have huge willingness to pay while drugs may be very cheap to produce but it is difficult to argue that increased demand for (and hence production of) drugs would increase the welfare of society</td>
  </tr>
  <tr style="background-color: transparent;">
    <td style="text-align: right; vertical-align: top;"><i class="fa "</td>
    <td> </td>
    <td style="text-align: left; vertical-align: top;">  </td>
  </tr>
  <tr style="background-color: transparent;">
    <td style="text-align: right; vertical-align: top;"><i class="fa "</td>
    <td> </td>
    <td style="text-align: left; vertical-align: top;">  </td>
  </tr>
  <tr style="background-color: transparent;">
    <td style="text-align: right; vertical-align: top;"><i class="fa "</td>
    <td> </td>
    <td style="text-align: left; vertical-align: top;">  </td>
  </tr>
  <tr style="background-color: transparent;">
    <td style="text-align: right; vertical-align: top;"><i class="fa "</td>
    <td> </td>
    <td style="text-align: left; vertical-align: top;">  </td>
  </tr>
  <tr style="background-color: transparent;">
    <td style="text-align: right; vertical-align: top;"><i class="fa "</td>
    <td> </td>
    <td style="text-align: left; vertical-align: top;">  </td>
  </tr>
</table>

---

# Reasons for Market Inefficiency

An especially serious set of problems results when the supply curve does not reflect the true, complete cost for society as a whole:

<table class="none">
  <tr style="background-color: transparent;">
    <td style="text-align: center; vertical-align: top; width: 5px;"><b>1.</b></td>
    <td> </td>
    <td> </td>
    <td>when competition is limited and some producers can manipulate market conditions in their own favor due to having high market power and political influence</td>
  </tr>
</table>

<table class="none">
  <tr style="background-color: transparent;">
    <td style="text-align: center; vertical-align: top; width: 5px;"><b>2.</b></td>
    <td> </td>
    <td> </td>
    <td>when some costs borne by the society as a whole are not internalized by the producers, hence not included in their rational calculation of costs (their willingness to sell), these are the so called external effects of production (the external costs being borne by economic agents different from producers)</td>
  </tr>
</table>

---

# Reasons for Market Inefficiency

<table class="none">
  <tr style="background-color: transparent;">
    <td style="text-align: right; vertical-align: top; width: 50px;"><i class="fa fa-globe"</td>
    <td style="width: 20px"> </td>
    <td style="text-align: left; vertical-align: top; width: auto;">production of electricity from coal may be cheaper than alternative technologies if only the cost of coal, the cost of capital, and the wages of workers are considered but it may turn out to be much more expensive to society as a whole if the costs borne by people living nearby (or not so nearby) are taken into account</td>
  </tr>
  <tr style="background-color: transparent;">
    <td style="text-align: right; vertical-align: top;"><i class="fa "</td>
    <td> </td>
    <td style="text-align: left; vertical-align: top;">  </td>
  </tr>
  <tr style="background-color: transparent;">
    <td style="text-align: right; vertical-align: top;"><i class="fa "</td>
    <td> </td>
    <td style="text-align: left; vertical-align: top;">  </td>
  </tr>
  <tr style="background-color: transparent;">
    <td style="text-align: right; vertical-align: top;"><i class="fa "</td>
    <td> </td>
    <td style="text-align: left; vertical-align: top;">  </td>
  </tr>
  <tr style="background-color: transparent;">
    <td style="text-align: right; vertical-align: top;"><i class="fa "</td>
    <td> </td>
    <td style="text-align: left; vertical-align: top;">  </td>
  </tr>
  <tr style="background-color: transparent;">
    <td style="text-align: right; vertical-align: top;"><i class="fa "</td>
    <td> </td>
    <td style="text-align: left; vertical-align: top;">  </td>
  </tr>
</table>

---

# Questions?

<br>

</body>
</html>

---

# Thank You!

<br>