Chapter 4: Consumer and Producer Surplus - Markets

Question 1

A market is efficient when the sum of _____ and ____ is maximized

Answer 1

consumer and producer surplus

Question 2

What is demand?

Answer 2

willingness to pay

Question 3

What is supply?

Answer 3

• willingness to accept

Question 4

WIllingness to Pay graph and how it does not maximize gains to trade

Answer 4

Question 5

Who does market equilibrium allocate consumption of the goods to?

Answer 5

• allocates consumption of the good to the potential buyers who value it the most
• so who has the highest willingness to pay, since resources are scarce
• but who benefits and who loses? hmm

Question 6

How does market equilibrium determine which seller values the right to sell a good? (3)

Answer 6

• they have the lowest cost
• want the producers with the lowest costs to be producing the goods
• using least valuable amounts of resources (land, labour, capital)

Question 7

How does the market ensure that all transactions are mutually beneficial? (2)

Answer 7

• every consumer who makes a purchase values the good more than every seller who makes a sale, so that all transactions are mutually beneficial
• transactions are voluntary

Question 8

How does the market ensure that no mutually beneficial transactions are missed? (2)

Answer 8

• every potential buyer who does not make a purchase values the good less than every potential seller who does not make a sale
• no “money left on the table”

Question 9

Aside from how the market ensures the four functions above, what happens if you allocate the good other than using market equilibrium?

Answer 9

• lowers total surplus

Question 10

What are the three caveats?

Answer 10

1. Although a market may be efficient, it is not always fair
2. Markets sometimes fail
3. Even when market equilibrium maximizes total surplus. it does not mean that it results in the best outcome for every INDIVIDUAL consumer and producer

Question 11

Why is an efficient market not always fair/equitable? (2)

Answer 11

• society cares more about equity
• government intervention in a market that reduces efficiency while increasing equity can be justified

Question 12

How does market failure affect total surplus?

Answer 12

• they can no longer maximize total surplus since they fail to deliver efficiency

Question 13

How does inefficient markets affect total surplus?

Answer 13

• some people can be made better off without making other people worse off

Question 14

What are the 3 principle sources of market failure?

Answer 14

1. Attempts to capture more resources that produce inefficiencies (Non-competitive markets)
2. Side effects from certain transactions (externalities)
3. Problems in the nature of the goods themselves (Information and public goods)

Question 15

Even when the market equilibrium maximizes total surplus, why does it not result in the best outcome for every individual consumer and producer? (5)

Answer 15

• ex, a price floor that kept the price up would benefit some sellers
• but in the market equilibrium, there is no way to make some people better off without making others worse off (efficiency)

Question 16

Well- functioning markets owe their effectiveness to what two powerful features?

Answer 16

• property rights and the role of prices as economic signals

Question 17

What are property rights?

Answer 17

• rights of owners of valuable items, whether resoruces or goods, to dispose of those items as they choose

Question 18

What is an economic signal?

Answer 18

• any piece of information that helps people make better economic decisions
• ie the invisible hand