Topic 2.6-
Market Equilibrium and Consumer and Producer Surplus
Scissors Analogy
Question: When you use scissors, which blade cuts the paper: the top blade or the bottom blade?
Answer: Both blades. Scissor are only effective when both blades are used together. Using only one blade is useless.
The Point: Like scissor blades, supply and demand are valuable when used together. They are a tool to help us understand and predict changes in a market. Understanding one or the other is not enough. You need to be able to put them together.
2
Q
$5
4
3
2
1
P
Demand Schedule
10 20 30 40 50 60 70 80
3
P | Qd |
$5 | 10 |
$4 | 20 |
$3 | 30 |
$2 | 50 |
$1 | 80 |
D
S
Supply Schedule
P | Qs |
$5 | 50 |
$4 | 40 |
$3 | 30 |
$2 | 20 |
$1 | 10 |
Supply and Demand are put together to determine equilibrium price and equilibrium quantity
Q
$5
4
3
2
1
P
Demand Schedule
10 20 30 40 50 60 70 80
4
P | Qd |
$5 | 10 |
$4 | 20 |
$3 | 30 |
$2 | 50 |
$1 | 80 |
Supply Schedule
P | Qs |
$5 | 50 |
$4 | 40 |
$3 | 30 |
$2 | 20 |
$1 | 10 |
Supply and Demand are put together to determine equilibrium price and equilibrium quantity
Equilibrium Price = $3 (Qd=Qs)
Equilibrium Quantity is 30
D
S
Q
$5
4
3
2
1
P
Demand Schedule
10 20 30 40 50 60 70 80
5
P | Qd |
$5 | 10 |
$4 | 20 |
$3 | 30 |
$2 | 50 |
$1 | 80 |
Supply Schedule
P | Qs |
$5 | 50 |
$4 | 40 |
$3 | 30 |
$2 | 20 |
$1 | 10 |
D
S
At $4, there is disequilibrium. The quantity demanded is less than quantity supplied.
Surplus
(Qd<Qs)
How much is the surplus at $4?
Answer: 20
Q
$5
4
3
2
1
P
Demand Schedule
10 20 30 40 50 60 70 80
6
P | Qd |
$5 | 10 |
$4 | 20 |
$3 | 30 |
$2 | 50 |
$1 | 80 |
Supply Schedule
P | Qs |
$5 | 50 |
$4 | 40 |
$3 | 30 |
$2 | 20 |
$1 | 10 |
D
S
At $2, there is disequilibrium. The quantity demanded is greater than quantity supplied.
Shortage
(Qd>Qs)
How much is the shortage at $2?
Answer: 30
Q
$5
4
3
2
1
P
Demand Schedule
10 20 30 40 50 60 70 80
7
P | Qd |
$5 | 10 |
$4 | 20 |
$3 | 30 |
$2 | 50 |
$1 | 80 |
Supply Schedule
P | Qs |
$5 | 50 |
$4 | 40 |
$3 | 30 |
$2 | 20 |
$1 | 10 |
D
S
Answer: 70
How much is the shortage if the price is $1?
Q
$5
4
3
2
1
P
Demand Schedule
10 20 30 40 50 60 70 80
8
P | Qd |
$5 | 10 |
$4 | 20 |
$3 | 30 |
$2 | 50 |
$1 | 80 |
Supply Schedule
P | Qs |
$5 | 50 |
$4 | 40 |
$3 | 30 |
$2 | 20 |
$1 | 10 |
D
S
When there is a surplus, producers lower prices
The FREE MARKET system automatically pushes the price toward equilibrium.
When there is a shortage, producers raise prices
2008 Audit Exam
Price Signals
Economists use the term “price signals” to describe how prices convey information and help society use scarce resources more efficiently
10
“The most important single central fact about a free market is that no exchange takes place unless both parties benefit.”
-Milton Friedman
Consumer Surplus and Producer Surplus
Voluntary Exchange
You want to buy a truck so you go to the local dealership.
You are willing to spend up to $20,000 for a new 4x4.
The seller is willing to sell this truck for no less than $15,000.
After some negotiation you buy the truck for $18,000.
Analysis:
Buyer’ Maximum-
Sellers Minimum-
Price-
Consumer Surplus-
Producer Surplus-
$20,000
$15,000
$18,000
$2,000
$3,000
Consumer Surplus is the difference between what you are willing to pay and what you actually pay.
CS = Buyer’s Maximum – Price
Producer Surplus is the difference between the price the seller received and how much they were willing to sell it for.
PS = Price – Seller’s Minimum
Voluntary Exchange
The ideas of consumer surplus, producer surplus, and deadweight loss are going to come up again and again throughout the course.
Deadweight loss is the lost efficiency due to the fact that a mutually beneficial transactions (when the value to consumers is greater than the cost to producers) is not able to take place.
14
Student Tip
Where is CS and PS on the graph?
Q
P
PS
15
$35
$30
$25�$20
$15
$10
$5
10 20 30 40 50 60
D
S
CS
Calculate the following
(show your work)
1. Consumer surplus at $20
2. Producer surplus at $20
3. Total surplus at $20
Where is CS and PS on the graph?
Q
P
PS
16
$35
$30
$25�$20
$15
$10
$5
10 20 30 40 50 60
D
S
CS
Calculate the following
(show your work)
1. Consumer surplus at $20
2. Producer surplus at $20
3. Total surplus at $20
Answers
1. $225 = ($35-$20)x30/2
2. $150 = ($20-$10)x30/2
3. $375 = $225 + $150
Where is CS and PS on the graph?
Q
P
PS
17
$35
$30
$25�$20
$15
$10
$5
10 20 30 40 50 60
D
S
CS
Assume only 10 units where produced, what would happen to total surplus?
Total surplus would decrease. This is called deadweight loss.
You will see it again later.
S
P
Q
D
Review
$22
20
18
16
14
20
CS
PS
18
Calculate the area of: