Transcript Uses of Demand Theory

Surplus Measures
1
An Alternative View of the
Demand Curve
An alternative interpretation of the demand
curve is that it represents the consumer’s
marginal willingness to pay or $marginal benefit
for the quantity specified.
 So, another way of looking at the demand curve
is that it tells you the $marginal benefit at each
unit of consumption.
 $Total benefit of consumption would then be the
sum of all the marginal benefits up to, say, X
units.

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Willingness to Pay
 Think
of the total amount you would
pay for X units (say it is $27) and then
for X-1 units (say it is $25). Your
marginal willingness to pay for that Xth
unit is $2 (= 27 -25).
 Alternatively, we could say that your
quantity demanded at the price $2/unit
is X because you are willing to pay up
to $2/unit for the Xth unit.
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Consumers Surplus
For one individual: consumer’s surplus (CS)
is the difference between the consumer’s
total willingness to pay ($total benefit) and
what the consumer actually did pay ($total
expenditure).
 CS = the area between the consumer’s
demand curve and the market price line.
 To go from individual consumer’s surplus to
market consumers’ surplus, just use the
market demand, which aggregates all the
individuals.

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Example: Li’s Willingness to Pay for
Wheat and Consumer Surplus





The table at the right shows Li’s
willingness to pay for the indicated
quantities of wheat.
Her marginal marginal willingness to
pay (marginal benefit) is the difference
between her willingness to pay for X
and X-1 units of wheat.
Li’s demand curve would be the plot of
her marginal willingness to pay against
number of units.
Marginal consumer surplus on each
unit is the difference between marginal
willingness to pay and the price she
actually pays, PW=$2/lb in this
example.
Total consumer surplus is the sum of
all entries in the marginal consumer
surplus column.
Quantity
of Wheat
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
Li's Willingness to Pay
Total
Marginal
Marginal
Total
Willingness Willingness
Mark et Consumer Consumer
to Pay
to Pay
Price
Surplus
Surplus
0.00
2.00
34.00
34.00
2.00
32.00
32.00
49.00
15.00
2.00
13.00
45.00
61.25
12.25
2.00
10.25
55.25
70.75
9.50
2.00
7.50
62.75
77.50
6.75
2.00
4.75
67.50
81.50
4.00
2.00
2.00
69.50
85.00
3.50
2.00
1.50
71.00
88.00
3.00
2.00
1.00
72.00
90.50
2.50
2.00
0.50
72.50
92.50
2.00
2.00
0.00
72.50
94.33
1.83
2.00
96.00
1.67
2.00
97.50
1.50
2.00
98.83
1.33
2.00
100.00
1.17
2.00
101.00
1.00
2.00
101.88
0.88
2.00
102.63
0.75
2.00
103.25
0.63
2.00
2.00
103.75
0.50
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Consumer Surplus and
Quantity Demanded




If the price of wheat is $2/lb., then
Li buys 10 lbs. of wheat, the point
where her marginal benefit of
wheat equals its price.
Notice that the marginal
willingness to pay column
(marginal benefit) is just Li’s
demand for wheat.
When PW=$2 and W=10, Li’s
consumer surplus is $72.50,
indicating that she would have
been willing to pay an additional
$72.50 for the wheat she
consumed (above the $20 she had
to pay).
Try it for PW = $4.00
Quantity
of Wheat
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
Li's Willingness to Pay
Total
Marginal
Marginal
Total
Willingness Willingness
Mark et Consumer Consumer
to Pay
to Pay
Price
Surplus
Surplus
0.00
2.00
34.00
34.00
2.00
32.00
32.00
49.00
15.00
2.00
13.00
45.00
61.25
12.25
2.00
10.25
55.25
70.75
9.50
2.00
7.50
62.75
77.50
6.75
2.00
4.75
67.50
81.50
4.00
2.00
2.00
69.50
85.00
3.50
2.00
1.50
71.00
88.00
3.00
2.00
1.00
72.00
90.50
2.50
2.00
0.50
72.50
92.50
2.00
2.00
0.00
72.50
94.33
1.83
2.00
96.00
1.67
2.00
97.50
1.50
2.00
98.83
1.33
2.00
100.00
1.17
2.00
101.00
1.00
2.00
101.88
0.88
2.00
102.63
0.75
2.00
103.25
0.63
2.00
2.00
103.75
0.50
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Graphical Measure of Li’s
Consumer Surplus

The area under the
demand curve and
above the market price
is the total consumer
surplus.

The arrow on the right
shows Li’s total
consumer surplus when
the market price of
wheat is $2/lb.
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Market Consumer Surplus
Question
 The
table at the right
is a sample market
demand curve.
 Question: At a market
price of $2.00, what is
the total consumer
surplus?
Sample Market Demand Curve
Marginal
Willingness to
Pay = Marginal
Benefit =
Quantity
Demand Price
0
1
12.00
2
8.00
3
6.00
4
5.00
5
4.00
6
3.00
7
2.00
8
1.00
9
0.50
10
0.25
11
0.13
12
0.00
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Market Consumer Surplus
Answer




At a market price of $2.00,
total expenditures are $14
= 7 x $2.00
Total willingness to pay is
$40 = 12 + 8 + 6 + 5 + 4 +
3 + 2.
Total consumer surplus =
$40 - $14 = $26.
Total consumer surplus =
sum of marginal consumer
surplus = 26 = 10 + 6 + 4 +
3 + 2 + 1 + 0.
Quantity
0
1
2
3
4
5
6
7
8
9
10
11
12
Sample Market Demand Curve
Marginal
Willingness
to Pay =
Marginal
Marginal
Benefit =
Consumer
Demand Market Price
Surplus
2.00
12.00
2.00
10.00
8.00
2.00
6.00
6.00
2.00
4.00
5.00
2.00
3.00
4.00
2.00
2.00
3.00
2.00
1.00
2.00
2.00
0.00
1.00
2.00
0.50
2.00
0.25
2.00
0.13
2.00
0.00
2.00
Total
Consumer
Surplus
10
16
20
23
25
26
26
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Graph of Market Consumer
Surplus
 As
in the case of
individual consumer
surplus, the area
below the demand
curve and above the
market price
measures the total
market consumer
surplus.
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Why Measure Consumer
Surplus?
 An
individual’s total consumer surplus
on a purchase measures the gain to the
consumer from the market transaction.
 In the market as a whole, the total
consumer surplus measures the gain to
society from the existence of the market
equilibrium price.
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Producers Surplus






Producers surplus measures the gain to firms from selling all units at
the market price.
Producers surplus is the supply-side equivalent of consumers
surplus.
Think of the supply curve as measuring the marginal costs of
production.
For one firm: producer’s surplus (PS) is the difference between
what the firm gets in revenue ($total revenue) and what the sum of
the marginal costs are ($total variable costs).
PS = the area between the market price line and the firm’s supply
curve.
To go from individual producer’s surplus to market producers’
surplus, just use the market supply, which aggregates all the firms.
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Producers Surplus

P
Supply=MC


P*
B

Demand=MB
A
O
X*
Quantity
Suppose the market
equilibrium occurs at
P* & X*.
Total revenue to
producers is the
area OP*BX*.
Sum of marginal
costs is the area
OABX*.
Producers surplus is
the red shaded area
AP*B.
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Demand and Supply Revisited
 Market
demand reflects marginal benefit.
 Market supply reflects marginal costs.
 Consumers surplus measures the gains from
trade to the consumers.
 Producers surplus measures the gains from
trade to the producers.
 Total gains from trade - or total surplus - or
net social surplus - is the sum of consumers
and producers surplus. It can also be
thought of as $total benefit-sum of $marginal
costs.
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Net Social Surplus

$
Supply=MC
C



B
P*


Demand=MB
A
O
X*

Quantity

The market equilibrium
occurs at P* & X*.
$TB = area OCBX*
$total expenditure = area
OP*BX*
$CS is the top blue
shaded area P*CB
$total revenue =area
OP*BX*
sum of $mc = OABX*
$PS = bottom red
shaded area AP*B
$Net social surplus =
area ACB = the top and
bottom triangles.
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Selling My House
Old address: 133 Tompkins St.
 New address: 132 Tompkins St.
 Problem: we bought the new house before
selling the old one.
 Our minimum selling price (after 2 years) =
$55,000.
 Potential buyer Abe: maximum buying price
= $45,000
 So, no deal with Abe.

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Selling My House





Potential (and last) buyer Betty: maximum price = $95,000
Trade should occur! Net social surplus on trade = $40,000
Remember: Our minimum selling price (after 2 years) = $55,000.
Division of surplus to the Wissink’s and to Betty depends on the strike
price - what we sell the house for.
Suppose we sold it for $90,000.
 HA!
 Consumers surplus=$5,000 and Producers surplus=$35,000.
 What did we sell it for?
 Don’t ask!
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