5: CONSUMERS, PRODUCERS AND THE EFFICIENCY OF MARKETS

Question 1

Willingness to Pay

Answer 1

the maximum amount a buyer is willing to pay for a good.

It is a measure (in dollars) of the value of the good to the buyer

Question 2

Consumer Surplus

Answer 2

Buyer’s willingness to pay for a good minus the amount the buyer actually pays for it.

It is a measure of the buyer’s benefit from purchasing the good

Question 3

Producer Surplus

Answer 3

the amount a seller is actually paid minus the seller’s cost.
It is a measure (in dollars) of the benefit a producer receives from selling the good.

Question 4

Total Surplus FORMULA

Answer 4

Total Surplus = CS + PS = value to buyers – cost of sellers

Question 5

3 insights into free markets

Answer 5

1. Allocate supply of goods to buyers who value them most highly
2. Allocate the demand for goods to the sellers who can produce them at the least cost
3. Produce the quantity of goods that maximises the sum of consumer and producer surplus (equilibrium outcome is efficient)

Question 6

A tax…

Answer 6

• Causes the buyer’s price to rise and seller’s price to fall
• Causes the quantity sold and bought to fall
• Allows the government to collect revenues to fund goods and services for its citizens

Question 7

Deadweight Loss

Answer 7

• The area C+E is called deadweight loss
• It is the reduction in total surplus that results when a tax is introduced
• Taxes cause deadweight losses because some potential gains from trade are lost to buyers and sellers
• The size of the deadweight loss depends on the price elasticities of supply and demand