Consumers, Producers and the Efficiency of Markets

00:01 Hello, welcome back to your online presentation on microeconomics, my name is James deNicco.

00:06 This presentation is gonna be about consumers, producers and the efficiency of markets.

00:11 surplus to maximize the wellbeing of the consumers some pictures to make this consumer surplus make a little more sense alright so we have the product that with the market so we are prices on the vertical axis enquiries long horizontal axis and we ever downward-sloping demand curve represents the willing to pay for a service so here in this market price was determined to bpy so this is the actual price that's been paid so how do we We're gonna take a look at what welfare economics is.

00:15 It's not welfare in the sense that you might think of it but the economic wellbeing of an economy consumer We're gonna take a look at what consumer surplus and producer surplus are and how they affect the well-being of an economy.

00:28 That's how we measure the well-being of an economy through consumer surplus and producer surplus.

00:33 We're gonna find out how we maximize the well-being of an economy, how taxes affect that welfare, and how trade affects that welfare, that's what we'll be going through this presentation.

00:44 So first, what is welfare economics? It's the study how the allocation of resources affect economic well-being.

00:52 Okay, so we're looking at economic well-being here - that's what you study with welfare economics.

00:58 So first, let's take a look at the consumer side of this.

01:00 Alright, we measure how well the consumers are doing by measuring their consumer surplus.

01:06 So buyers have a willingness to pay, that's the maximum amount they're willing to pay for a good or service.

01:12 Consumer surplus measures the willingness to pay minus what they actually pay.

01:18 So if the price is below their willingness to pay, there's gonna be some consumer surplus.

01:24 We want to maximize that consumer surplus to maximize the wellbeing of the consumers.

01:30 So now let's take at some pictures to make this consumer surplus make a little more sense.

01:34 Alright, so we have the product, we have the market for some product here., so we have prices on the vertical axes and quantities along horizontal axes then we have our downward-sloping demand curve.

01:45 Our downward-sloping demand curve, that represents our willingness to pay or the maximum amount we're willing to pay for a good or service.

01:53 So here in this market, the equilibrium price was determined to P1, so this is the actual price that's being paid so how do we calculate our consumer surplus? Well it's gonna end up being the area of this triangle.

02:06 So you're gonna take a look at all these consumers right here which is willingness to pay above the actual price and they're all gonna have some consumer surplus.

02:15 we just add up each consumer surplus to get total consumer surplus which here will be the area of this triangle.

02:22 So now let's take a look how changes in prices affect consumer surplus.

02:27 Let's say we go from price 1 down to a lower price, price 2.

02:31 What does that mean? we're gonna have more people now with a willingness to pay above the actual price that's paid.

02:38 so we have this lower price here, we're gonna have an increase in total consumer surplus a little bit is gonna come from the existing consumers, the existing buyers so their willingness to pay before it was up here is still up here the price though dropped, right? so the difference between their willingness to pay and the price they pay is actually larger.

02:58 So this square right here is gonna represent the additional consumer surplus to the initial consumer.

03:05 Alright, cause our consumer surplus again is our willingness to pay minus the actual price that we pay.

03:10 The rice has gone lower, so the consumer surplus is larger.

03:14 Also, we're gonna have more people willing to buy now, because these people right here along this pink triangle right there, now this willingness to pay, all these buyers' willingness-to-pay is also above the price level.

03:28 so this triangle right here is gonna represent the consumer surplus to new consumers.

03:35 So we have a larger total consumer surplus, now it's gonna be this whole triangle right here, this whole big triangle, all these people have a willingness to pay above the actual price level.

03:48 That was the consumer side.

03:50 Now let's take a look at the supplier side.

03:53 Alright, first we need understand cost to understand producer surplus.

03:57 So the cost is the value of everything the seller must give up in order to produce a good.

04:03 Producer surplus is the amount the seller's paid for a good minus the cost of producing it.

04:10 Okay, so the producer surplus is gonna be calculated as what they actually get paid minus their cost.

04:17 So now let's take a look at another picture, alright.

04:19 So here, we're gonna be taking a look at producer surplus.

04:23 So supply is gonna represent the cost of The firm.

04:27 Alright, so the supply is how much it cost the firm to produce.

04:31 So if they're the able to get a price that's at least equal to their cost, we're gonna assume that they enter the market.

04:38 So here we have a price, P1 that is above the cost to all these producers up until that price.

04:48 So for each one of those producers, they're gonna have a price above cost, they're gonna have some producer surplus.

04:54 We're gonna add up the producer surplus of all those producers to get our total producer surplus, or we can just take the area of this triangle right here.

05:03 So now let's look at how a change of price affects producer surplus.

05:08 Let's say the price goes up.

05:10 Well that's gonna be an increase in producer surplus.

05:13 We're gonna to have the initial producers are gonna get more surplus, right? before they had some producer surplus because the price was above their cost.

05:22 pNow the price is even higher above their cost so they're gonna have more producer surplus, that's gonna be this beige or this tan rectangle right here.

05:31 Right? so their willingness to pay or their cost is right here, and the price they received is right here, so that's their producer surplus.

05:38 Also now, we're gonna have other firms that can enter the market because the price is now above their cost.

05:44 So the increase in new producer surplus is gonna be this green rectangle right here right along this curve, now this is their cost, this is the price.

05:54 The price is now above their cost, they enter the market, they have some producer surplus.

05:58 So now let's take a look at maximizing total welfare.

06:01 So if I was a benevolent dictator, this is what I will want right here on this slide, this maximizes total welfare.

06:09 From A to E, the value of the good is more than the price so buy the good.

06:14 From E to B, we don't want that, alright? The value the good is less than the price.

06:20 So the value of the good is less than the price, we don't want people buying - that takes away from our well-being.

06:25 From C to E, what do we have there? We have the price above cost.

06:29 Right, so we want all those firms in the marker that's gained producer surplus.

06:34 From E to D however, the cost is greater than the price so there's gonna be no selling of the good.

06:41 So if we were a benevolent dictator, this is what we would want.

06:44 What this is, this is the result of a perfectly competitive free market with no inefficiencies an no externalities.

06:52 This this is what we will come to, as a benevolent dictator - this is what we want to set in place.

06:57 Alright, now we're gonna take a look at why that maximizes total welfare.

07:02 So total welfare is maximized at this perfectly competitive free market, no efficiencies, no externalities.

07:10 Alright, this is our equilibrium right here.

07:12 So anywhere to the left doesn't maximize the total surplus because we're gonna have a willingness to pay above the price and we're gonna have a cost to the seller below the price, alright? So this is the value to this marginal buyer right here, this is the cost to the marginal seller.

07:32 We're gonna maximize total surplus when the value to the marginal buyer equals the cost to the marginal seller.

07:40 We don't want to move beyond that point because here, the cost to the marginal seller is above the value to the marginal buyer, alright? So we don't want to be to the right in a perfectly competitive free market, we won't go over there.

07:52 People won't want to buy the good at that price, alright, people won't want to sell at that price.

07:57 So we maximize our total surplus right here at the equilibrium, again with a value to the marginal buyer equals the cost to the marginal seller.

08:06 That maximizes our total surplus.

08:09 Alright so how do taxes affect this? Alright, so we implement a tax and that results in the tax wedge.

08:16 We're not gonna reach our perfectly competitive free market equilibrium here.

08:21 Alright, so the tax wedge is gonna move us to the left.

08:24 So how's that gonna affect our overall welfare? Alright, now this is gonna be the price the buyers pay, this is gonna be the price that sellers receive.

08:33 We're gonna have this tax wedge right here and that's gonna affect our surplus.

08:38 So let's take a little closer look at the tax.

08:41 Alright so we implement this tax wedge right here.

08:44 We're gonna see this is the price the buyers pay.

08:47 So the consumer surplus now is just gonna be this little rectangle, that's the only area where the willingness to pay is above the price.

08:56 Now for the producer, the producer surplus is just gonna be this little triangle right here.

09:01 Alright, this is the price the sellers receive and the only people with the cost below that are in this little white right triangle right here.

09:08 However we're not gonna lose all the surplus with this rectangle and is triangle.

09:14 Right, we're gonna get some of the surplus back because we're gonna be earning some tax revenue.

09:18 So what's the tax revenue? It's gonna be the quantity sold times the size of the tax.

09:23 The wedge is the size of our tax.

09:26 Alright, and this is the quantity that's sold, so quantity times the size will be this rectangle right here.

09:32 So we don't lose all that surplus, we get some of it back in tax revenue which the government can go ahead and hopefully spend efficiently.

09:40 So when we implement that tax, let's take a look at what happens.

09:44 We start off the price without any taxes right here, right? so what is our consumer surplus? It's gonna be A+B+C, alright, that's ourconsumer surplus without the tax.

09:58 What's our producer surplus without the tax? It's gonna be D, E and F - it's gonna be those three areas combined, it'll be the area of this big triangle.

10:07 Now we implement the tax, what happens? We're gonna have some deadweight loss, alriight, that's how taxes affect welfare.

10:12 They will take away some of the economic well-being, at least in this model right here.

10:20 So what are wee gonna see if you implement that tax? the consumer surplus is now A.

10:26 The producer surplus is now F.

10:28 We get some of the surplus back with B and D - that's our tax revenue.

10:33 The deadweight loss - what we lose out on is C, E right here.

10:38 The deadweght loss of the tax is not offset by the revenue.

10:42 So there's gonna be some inefficiencies when the governement gets involved and implements the tax.

10:48 There's gonna be some inefficiencies through that deadweight loss.

10:52 So now, what's the problem with the taxes? Why is is creating a deadweight loss? Well we know total welfare is maximized at the point where the value to the marginal buyer equals the cost to the marginal seller.

11:06 Well we implement that tax, you create the wedge between the price the buyers pay and the price the sellers receive.

11:13 So anywhere past that tax along here, you're gonna have the value to the marginal buyer above the cost of the marginal seller, however, you can't take advantage of those areas because the tax is through to that wedge.

11:27 So implementing that tax has some loss of efficiency, has that deadweight loss.

11:33 So how much of an effect are those taxes gonna have on our economic well-being? Well it's gonna depend on the relative elasticities of our supply and demand.

11:42 So here we'lll have an example, alright, we're gonna keep our demand curve the same in both of these examples and we're gonna havesame-sized tax and let's see how it affects our economic well-being.

11:54 We're gonna find that when supply becomes more elastic, there's gonna be a larger deadweight loss.

12:01 Now why is that the case? Well again, elasticity talks about how we change our behavior.

12:06 So say you're gonna tax the seller.

12:09 So the seller's gonna receive less for his product, he's gonna change his behavior.

12:15 But if supply is relatively inelastic, he's not gonna change his behavior that much He's gonna continue to produce a lot.

12:22 That means there won't be as big deadweight loss when supply is relatively inelastic.

12:30 Now the supply is relatively elastic, that means you change your behaviour a lot as the price you receive changes.

12:36 So if you change your behavior to avoid that tax, it's gonna result in a larger inefficiency and a larger deadweight loss.

12:44 You're gonna see that you're with a relatively inelastic supply and a relatively elastic supply.

12:50 This is keeping the same demand curve and the same size tax, right? A tax is a deadweight loss because it induces buyers and sellers to to change their behavior.

12:59 Alright, the elasticity of supply measures how much sellers respond to change of prices.

13:04 The more elastic the supply, the more they will change their behavior.

13:08 Here, it's just going from supply to demand.

13:12 So the more elastic the demand, again the the larger the deadweight loss is gonna be.

13:17 When demand is relatively inelastic, the buyer doesn't change his behavior that much, he continues the buy so there's not that large of a deadweight loss.

13:26 However, when demand is more elastic, he's gonna change his behavior a lot more when the price of that good goes up, so he's gonna buy a lot less of it.

13:35 So as he buys lot less of that good, that's gonna create a larger deadweight loss.

13:40 So the effect of the taxes on the well-being of the economy is gonna depend on the elasticity of supply, the elasticity of demand or how much the buyers and sellers change their behavior as their tax.

13:54 What about taxes and tax revenue? So one might assume as you increase taxes, you'll increase your tax revenue.

14:02 Well that's not necessarily the case.

14:04 So we'll see here a small tax, a medium tax and a large tax.

14:10 Alroght, you know the tax revenue is the size of the tax times the quantity.

14:14 So as you increase the size of the tax, your taxing each unit at a larger rate.

14:21 However, you notice that the larger the tax, the less quantity is gonna be produced and sold.

14:28 Okay, so at some point, we go from the small to the medium to the large tax, you're increasing the size of the tax but at some point, you will decrease the quantity sold so much that total tax revenue can go down.

14:41 What you do see as the size of the tax increases, the dead weight loss will increase, so as taxes increase, you'll always see an increase in the dead weight loss.

14:52 As taxes increases, sometimes it increases tax revenue, other times it can decrease tax revenue when the size of the tax gets too large, the quantity producers sold will get too small.

15:04 It's the idea, you take the flow of the industry.

15:07 If you tax the flow of the industry at 100%, at some point it's gonna cease to exist, they won't sell any more of these.

15:14 So you raise zero tax revenue That's an extreme case, it doesn't have to at 100%, it's just when the taxes get large enough, you induce the change in behavior of the suppliers and sellers so much they produce and buy so little that overall tax revenue can fall if taxes get too large but you always have an increase in deadweight loss.

15:35 Now down here, this shows the size of the tax versus the tax revenue.

15:40 This is what I was just saying in the previous slide, these are pictures again to show that.

15:44 Okay, so you see the deadweight loss will rise as the tax size increases.

15:49 Now this one over here on the right that's what we called the Laffer curve after Art Laffer.

15:54 Art Laffer was an economist, he worked for Reagan, he worked for Bill Clinton.

15:58 So Art Laffer came up with this Laffer curve that shows tax revenue will go up to a certain point with increases in taxes, but at some point, the taxes get too high and too burdensome so the tax revenue will go down thus, the buyers and sellers will change their behavior too much, the quantity produced and sold will be too low.

16:18 So now let's take a look if we open the economy up to the rest of the world so we can trade.

16:23 So here in this example, we're gonna have a world price above our domestic price.

16:28 So we open up the trade, we look at the rest of the world that means we can get higher price for our goods and services.

16:34 So that's good for the exporters, right? We want to export when that happens, we want to take advantage of those higher prices.

16:41 What does that mean? Well higher price means an increase in supply but it means an increase in demand So this was our market equilibrium before oursupply and demand met.

16:51 So that lower price , we have more people willing to buy.

16:54 Now the higher price we have less people willing to buy.

16:58 the difference between our supply and demand is gonna be our exports.

17:02 so everything we produced that's not bought domestically will be sold, it will be exported to other countries So let's see how this affects our welfare.

17:11 Alrigh, so before we open up the trade, what was our consumer surplus? It was A + B with this big triangle.

17:18 C was our producer surplus.

17:21 Now we face this higher real-world price, how does that affect consumer surplus? Well now consumer surplus is just this triangle A right here, the consumers lost some surplus.

17:33 However, the producers gained some surplus, right, they just went from this area C in this triangle here now they also have B + D, because the price now is even further above cost for the existing or the initial producers and we're also gonna have some more producers enter this area right here along this D triangle.

17:54 These producers are gonna enter because now they face a price that's higher than their cost as well.

17:59 so there's gonna be some winners and losers here.

18:02 Overall, trade will make us better off.

18:05 Alright, so our overall surplus has gone up, it's gone up by D right here, the area of this triangle D.

18:12 However, the consumers are the losers here, the producers are the winners, which is why sometimes trade is controversial.

18:20 Its overall benefits, well sometimes there are some winners and there's some losers.

18:24 Now if we face a lower world price, everything will be offset, we will be importing and then the consumers will win with that lower price and producers will lose out with that lower price.

18:36 Alright, now let's take a look at imports and let's throw a twist in there.

18:39 Let's take a look if we tax those imports, how does that affect our overall economic well-being? Alright, well let's take a look here, so now we face the lower world price.

18:49 Alright, as I said that's better for our consumers but it's bad for our producers so we're gonna start this black line near here, this is our initial line we're gonna start at.

18:59 We see the only producer surplus at this low price is G.

19:04 Alright, so that area of the triangle G.

19:06 In that area, those are the only people with cost below the price, so the only people getting producer surplus.

19:12 Now we're more importing - that's good for the consumer.

19:15 The consumer surplus is gonna be this whole big triangle: A+B+C+D+E+F Alright, now we're gonna implement a tariff, or a tax on imports.

19:27 So as we tax imports, that is gonna raise the price.

19:31 That's gonna be good for producers but it's gonna hurt consumers.

19:36 Alright, so let's take a look a t this, we raise this price with this tariff.

19:40 So now what is our producer surplus? Well this is our new price, so now we're gonna have C+G, those two areas together, that's our producer surplus now.

19:50 In that area now, we have all these people with a cost lower than the price.

19:56 So the initial producers get more producer surplus and now we have some new people entering the market, they'll get some producer surplus as well.

20:05 What's gonna happen to the consumer? They lose some surplus, now they're down to A and B.

20:10 They lost this C+D+E+F, they lost all that with the tariff.

20:16 However, that's not sort of dead weight loss, that's not the total loss we're gonna have for implementing that tariff.

20:22 It's really only gonna be D and F because we get some of it back with our taxes.

20:28 Alright, so we're taxing imports so the quantity imported here is gonna be the difference between our demand and our supply.

20:35 So we're only supplying a certain amount, the rest of the demand needs to come from imports so we tax those imports so the amount of the imported times the size of the tax, that's our tax revenue.

20:47 So we're gonna get back some of that lost welfare, some of that lost economic well-being, some of that deadweight loss, we'll get back with the tax revenue.

20:57 What we're gonna miss out on here is F and D.

21:00 So you'll see again, these taxes, they introduce some efficiencies through deadweight losses, where we're not gonna maximize our total surplus.

21:11 So what have we learned here? We learned about welfare economics, we learned about what factors affect economic well-being.

21:17 We understand consumer surplus and producer sueplus and how they affect the welfare of the economy.

21:23 We know how taxes affect the welfare of the economy and we know how openness to trade and taxes on trade affect the welfare of the economy as well.

21:32 That's your presentation on consumers, producers and the efficiency of markets.

21:36 Thank you.