Chapter 7

Consumers, Producers, and the Efficiency

of Markets

Professor Galvez-Soriano
N. Gregory Mankiw, lecture
Principles Of Micro notes.
Economics, Based
9th Edition on N.
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Cengage. Mankiw,
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 Welfare economics
The study of how the allocation of resources
affects economic well-being
• Benefits for buyers and sellers
• How society can make these benefits as large
as possible
• In any market, the equilibrium of supply and
demand maximizes the total benefits received
by all buyers and sellers combined

Professor Galvez-Soriano
N. Gregory Mankiw, lecture
Principles Of Micro notes.
Economics, Based
9th Edition on N.
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Cengage. Mankiw,
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 Consumer Surplus
• Willingness to pay
– Maximum amount that a buyer will pay for
a good
– How much that buyer values the good
• Consumer surplus
– Amount a buyer is willing to pay for a good
minus amount the buyer actually pays
– Willingness to pay minus price paid

Professor Galvez-Soriano
N. Gregory Mankiw, lecture
Principles Of Micro notes.
Economics, Based
9th Edition on N.
© 2021 Gregory
Cengage. Mankiw,
All Rights Principles
Reserved. May not be of Microeconomics,
scanned, 9th
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Edition.
 Consumer Surplus
• Consumer surplus
– Measures the benefit buyers receive from
participating in a market
• Demand schedule
– Derived from the willingness to pay of the
possible buyers

Professor Galvez-Soriano
N. Gregory Mankiw, lecture
Principles Of Micro notes.
Economics, Based
9th Edition on N.
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Cengage. Mankiw,
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 Table 1 Four Possible Buyers’ Willingness to Pay in
the market of Elvis Presley’s first album

Buyer Willingness to Pay

$100
Taylor
80
Carrie
70
Rihanna
50
Gaga

Professor Galvez-Soriano
N. Gregory Mankiw, lecture
Principles Of Micro notes.
Economics, Based
9th Edition on N.
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Cengage. Mankiw,
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Edition.
 Figure 1 The Demand Schedule and the Demand
Curve

Quantity
Price Buyers
Demanded
More than $100 None 0
$80 to $100 Taylor 1
$70 to $80 Taylor, Carrie 2
$50 to $70 Taylor, Carrie, 3
Rihanna
$50 or less Taylor, Carrie, 4
Rihanna, Gaga

The table shows the demand schedule for the buyers (listed in Table 1) of the mint-condition
copy of Elvis Presley’s first album. The graph shows the corresponding demand curve. Note that
the height of the demand curve reflects the buyers’ willingness to pay.

Professor Galvez-Soriano
N. Gregory Mankiw, lecture
Principles Of Micro notes.
Economics, Based
9th Edition on N.
© 2021 Gregory
Cengage. Mankiw,
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Reserved. May not be of Microeconomics,
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Edition.
 Figure 2 Measuring Consumer Surplus with the
Demand Curve

Professor Galvez-Soriano
N. Gregory Mankiw, lecture
Principles Of Micro notes.
Economics, Based
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Cengage. Mankiw,
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 Consumer Surplus
• A lower price raises consumer surplus
1. Existing buyers: increase in consumer
surplus
• Buyers who were already buying the good at
the higher price are better off because they
now pay less
2. New buyers enter the market: increase in
consumer surplus
• Willing to buy the good at the lower price

Professor Galvez-Soriano
N. Gregory Mankiw, lecture
Principles Of Micro notes.
Economics, Based
9th Edition on N.
© 2021 Gregory
Cengage. Mankiw,
All Rights Principles
Reserved. May not be of Microeconomics,
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or posted to a publicly accessible website, in whole or in part.
Edition.
 Figure 3 How Price Affects Consumer Surplus

Professor Galvez-Soriano
N. Gregory Mankiw, lecture
Principles Of Micro notes.
Economics, Based
9th Edition on N.
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Cengage. Mankiw,
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Edition.
 Producer Surplus
– Measure of willingness to sell
– Amount a seller is paid for a good minus
the seller’s cost of providing it
– Price received minus willingness to sell

Professor Galvez-Soriano
N. Gregory Mankiw, lecture
Principles Of Micro notes.
Economics, Based
9th Edition on N.
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Cengage. Mankiw,
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 Producer Surplus
• Supply schedule
– Derived from the costs of the suppliers
• At any quantity
– Price given by the supply curve shows the
cost of the marginal seller

Professor Galvez-Soriano
N. Gregory Mankiw, lecture
Principles Of Micro notes.
Economics, Based
9th Edition on N.
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Cengage. Mankiw,
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 Table 2 The Costs of Four Possible Sellers in
the market of house painting

Seller Cost

Vincent $900

Claude 800

Pablo 600

Andy 500

Professor Galvez-Soriano
N. Gregory Mankiw, lecture
Principles Of Micro notes.
Economics, Based
9th Edition on N.
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Cengage. Mankiw,
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 Figure 4 The Supply Schedule and Supply Curve

Quantity
Price Sellers
Demanded
$900 or more Vincent, Claude, 4
Pablo, Andy
$800 to $900 Claude, Pablo, 3
Andy
$600 to $800 Pablo, Andy 2
$500 to $600 Andy 1
Less than $500 None 0

The table shows the supply schedule for the sellers (listed in Table 2) of painting services. The
graph shows the corresponding supply curve. Note that the height of the supply curve reflects
the sellers’ costs.

Professor Galvez-Soriano
N. Gregory Mankiw, lecture
Principles Of Micro notes.
Economics, Based
9th Edition on N.
© 2021 Gregory
Cengage. Mankiw,
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Edition.
 Figure 5 Measuring Producer Surplus with the
Supply Curve

In panel (a), the price of the good is $600 and the producer surplus is $100.
In panel (b), the price of the good is $800 and the producer surplus is $500.

Professor Galvez-Soriano
N. Gregory Mankiw, lecture
Principles Of Micro notes.
Economics, Based
9th Edition on N.
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Cengage. Mankiw,
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Edition.
 Producer Surplus
• A higher price raises producer surplus
1. Existing sellers: increase in producer
surplus
• Sellers who were already selling the good at
the lower price are better off because they
now get more for what they sell
2. New sellers enter the market: increase in
producer surplus
• Willing to produce the good at the higher
price
Professor Galvez-Soriano
N. Gregory Mankiw, lecture
Principles Of Micro notes.
Economics, Based
9th Edition on N.
© 2021 Gregory
Cengage. Mankiw,
All Rights Principles
Reserved. May not be of Microeconomics,
scanned, 9th
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or posted to a publicly accessible website, in whole or in part.
Edition.
 Figure 6 How Price Affects Producer Surplus

Professor Galvez-Soriano
N. Gregory Mankiw, lecture
Principles Of Micro notes.
Economics, Based
9th Edition on N.
© 2021 Gregory
Cengage. Mankiw,
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 Market Efficiency
• The benevolent social planner
– Wants to maximize the economic well-
being of everyone in society
• Economic well-being of a society
– Total surplus
– Sum of consumer and producer surplus

Professor Galvez-Soriano
N. Gregory Mankiw, lecture
Principles Of Micro notes.
Economics, Based
9th Edition on N.
© 2021 Gregory
Cengage. Mankiw,
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 Market Efficiency
• Total surplus = Consumer surplus +
Producer surplus
• Consumer surplus = Value to buyers –
Amount paid by buyers
• Producer surplus = Amount received by
sellers – Cost to sellers

• Total surplus = Value to buyers – Cost to

sellers

Professor Galvez-Soriano
N. Gregory Mankiw, lecture
Principles Of Micro notes.
Economics, Based
9th Edition on N.
© 2021 Gregory
Cengage. Mankiw,
All Rights Principles
Reserved. May not be of Microeconomics,
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Edition.
 Market Efficiency
• Efficiency
– Maximizing the total surplus received by
all members of society
• Equality
– Property of distributing economic
prosperity uniformly among the members
of society

Professor Galvez-Soriano
N. Gregory Mankiw, lecture
Principles Of Micro notes.
Economics, Based
9th Edition on N.
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Cengage. Mankiw,
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 Market Efficiency
• Gains from trade in a market
– Like a pie to be shared among the
market participants
• The question of efficiency
– Whether the pie is as big as possible
• The question of equality
– How the portions are distributed among
members of society

Professor Galvez-Soriano
N. Gregory Mankiw, lecture
Principles Of Micro notes.
Economics, Based
9th Edition on N.
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Cengage. Mankiw,
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 Market Efficiency
• Market outcomes
1. Free markets allocate the supply of
goods to the buyers who value them
most highly
• Measured by their willingness to pay
2. Free markets allocate the demand for
goods to the sellers who can produce
them at the least cost

Professor Galvez-Soriano
N. Gregory Mankiw, lecture
Principles Of Micro notes.
Economics, Based
9th Edition on N.
© 2021 Gregory
Cengage. Mankiw,
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 Figure 7 Consumer and Producer Surplus in the
Market Equilibrium

Professor Galvez-Soriano
N. Gregory Mankiw, lecture
Principles Of Micro notes.
Economics, Based
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Cengage. Mankiw,
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 Figure 8 The Efficiency of the Equilibrium Quantity

Professor Galvez-Soriano
N. Gregory Mankiw, lecture
Principles Of Micro notes.
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 Market Efficiency
• Adam Smith’s invisible hand
– Takes all the information about buyers
and sellers into account
– Guides everyone in the market to the best
outcome
– Economic efficiency
• Free markets
– Best way to organize economic activity

Professor Galvez-Soriano
N. Gregory Mankiw, lecture
Principles Of Micro notes.
Economics, Based
9th Edition on N.
© 2021 Gregory
Cengage. Mankiw,
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 Market Efficiency & Market Failure

• Forces of supply and demand

– Allocate resources efficiently
• Several assumptions about how markets
work
1. Markets are perfectly competitive
2. Outcome in a market matters only to the
buyers and sellers in that market

Professor Galvez-Soriano
N. Gregory Mankiw, lecture
Principles Of Micro notes.
Economics, Based
9th Edition on N.
© 2021 Gregory
Cengage. Mankiw,
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 Market Efficiency & Market Failure

• When these assumptions do not hold

– “Market equilibrium is efficient” may no
longer be true
• In the world, competition is far from
perfect
– Market power
• A single buyer or seller (small group)
• Control market prices
• Markets are inefficient

Professor Galvez-Soriano
N. Gregory Mankiw, lecture
Principles Of Micro notes.
Economics, Based
9th Edition on N.
© 2021 Gregory
Cengage. Mankiw,
All Rights Principles
Reserved. May not be of Microeconomics,
scanned, 9th
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Edition.
 Market Efficiency & Market Failure

• In the world
– Decisions of buyers and sellers
• Affect people who are not participants in the
market at all
• Externalities - cause welfare in a market to
depend on more than just the value to the
buyers and the cost to the sellers
• Inefficient equilibrium - from the standpoint of
society as a whole

Professor Galvez-Soriano
N. Gregory Mankiw, lecture
Principles Of Micro notes.
Economics, Based
9th Edition on N.
© 2021 Gregory
Cengage. Mankiw,
All Rights Principles
Reserved. May not be of Microeconomics,
scanned, 9th
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or posted to a publicly accessible website, in whole or in part.
Edition.