- Slides: 31
Consumer surplus Willingness to Pay: • A consumer’s willingness to pay for a good is the maximum price at which he or she would buy that good. It’s the maximum amount that a buyer will pay for a good. • P> willingness to pay: the buyer doesn’t buy • P< willingness to pay: the buyer will buy • P= willingness to pay: the buyer is indifferent between buying or not the good
Consumer surplus Consider this demand curve, with only 5 buyers: Price 10 8 Babul Abul Mokbul 6 4 2 Putul Mitul Quantity of chocolates
Consumer surplus Consumer Surplus: • Individual consumer surplus is the net gain to an individual buyer from the purchase of a good. It is equal to the difference between the buyer’s willingness to pay and the price paid. • It is a measure of the benefit a buyer has when participating in the market.
Consumer surplus • If the price is 5 yuan: Price 10 8 6 Individual surplus Babul Abul Mokbul 5 4 2 Putul Mitul Quantity of chocolates
Consumer surplus • Total consumer surplus is the sum of the individual consumer surpluses of all the buyers of a good. In our example: (10 -5) + (8 -5) + (6 -5)= 9 yuan. • The term consumer surplus is often used to refer to both individual and to total consumer surplus.
Consumer surplus • When we have many more consumers the demad curve will be smooth, but the surplus analisys is made the same way.
Consumer surplus How Changing Prices Affect Consumer Surplus: Price 10 8 Mark Frank 6 Alex 5 4 Paul 3 2 Guy Quantity of chocolates
Consumer surplus Conclusions: • The consumer surplus will increase when the price decreases. • The consumer surplus will decrease when the price increases.
Producer Surplus • Consider this supply curve, with only 5 sellers: P S 10 E 8 D 6 C 4 2 B A
Producer Surplus • A potential seller’s cost is the lowest price at which he or she is willing to sell a good. • Individual producer surplus is the net gain to a seller from selling a good. It is equal to the difference between the price received and the seller’s cost. • Total producer surplus in a market is the sum of the individual producer surpluses of all the sellers of a good. • Economists use the term producer surplus to refer both to individual and to total producer surplus.
Producer Surplus • Individual surplus: A, B or C • Total surplus: A + B +C Graph: P S 10 8 6 E D 7 C 4 2 B Individual surplus A Q
Producer Surplus With many producers:
Indifference Curve • Indifference curve – a curve that shows combinations of goods among which an individual is indifferent. • The slope of the indifference curve is the ratio of marginal utilities of the two goods.
Graphing the Indifference Curve
The Marginal Rate of Substitution • The Marginal Rate of Substitution(MRS) tells us how much of one good one would willingly trade for an incremental unit of the other good and remain indifferent. • The MRS=|slope| of the indifference curve at a bundle. • Common to assume the MRS declines as we move down an indifference curve.
Characteristics of Indiference curve • 1. Indifference Curve is downward slopping. • 2. Indiference curve is convex to the origin.
• 3. Higher indifference curve shows higher level of satisfaction.
• 4. Two indifference curve can not intersact each other. • If indifference curves crossed, it would violate the “prefer-more-to-less” principle.
Why Indifference Curves Cannot Cross
Graphing the Budget Constraint • Chocolate bars cost $1 and sodas cost 50 cents each. • X has $10 to spend. • X can buy 10 chocolate bars or 20 sodas or some combination of each.
Graphing the Budget Constraint
Graphing the Budget Constraint • The slope of the budget constraint is the ratio of the prices of the two goods. • The slope changes when the prices change.
Indifference Curves and Budget Constraints • Sophie will maximize her utility by consuming on the highest indifference curve as possible, given her budget constraint.
Indifference Curves and Budget Constraints • The best combination is the point where the indifference curve and the budget line are tangent.
Indifference Curves and Budget Constraints • The best combination is the point where the slope of the budget line equals the slope of the indifference curve.
Indifference Curves and Budget Constraints
Deriving a Demand Curve from the Indifference Curve • Demand is the quantity of a good that a person will buy at various prices.
Deriving a Demand Curve from the Indifference Curve • The point of tangency of the indifference curve and the budget line gives the quantity that a person would buy at a given price.
Deriving a Demand Curve from the Indifference Curve • By varying the price of one of the goods while holding the price of other constant, the points of tangency will change. • This gives alternative price/quantity combinations. Let price of soda is $ 1 instead of 0. 50
Deriving a Demand Curve from the Indifference Curve