WELCOME TO

FHBM1024
Microeconomics
and
Macroeconomics
11

MAIN TEXT
Irvin B. Tucker (2011)
Economics For Todays
World 7th edition
Publisher: Thomson
South Western

12

Method of Assessment
Mid

Term Test (Week 8-tentatively)

Group Report (Week 10)
Group Presentation (Week 5 &6 )
Total Coursework
Final Examination
TOTAL

15%
15%
10%
40%
60%
100%

13

COURSE MATERIALS
Lecture

Notes
Tutorial Questions
Assignment Question
Unit Plan
Obtain

from WBLE
http://wble.utar.edu.my
14

OVERVIEW

1 Consumer and Producer surplus

Topic 2 Consumer Choice Theory
Topic 3 Production and Cost
Topic 4 Market Structure (Part 1): Perfect
Competition
Topic 5 Market Structure (Part 2):
Monopoly
Topic 6 Market Structure (Part 3):
Monopolistic Competition & Oligopoly
Topic

15

OVERVIEW Continued..
7 Macroeconomic Problems (Part 2)
Topic 8 Aggregate Demand (AD) and
Aggregate Supply (AS)
Topic 9 Fiscal Policy
Topic 10 Monetary Policy
Topic

16

Chapter 1
Consumer and
Producer Surplus

17

Learning Objective
Consumer surplus
2. Producer surplus
3. Market efficiency and Deadweight
Loss
4. Price Floors and Ceilings
1.

18

1. Consumer Surplus
Measures

the value between the price

consumers are willing to pay for a
product along the demand curve and the
price they actually pay.

19

Consumer Surplus
Using

the demand curve to measure

consumer surplus
Consumer surplus

Closely related to the demand curve

Demand schedule
Derived from the willingness to pay of the
possible buyers

110

Consumer Surplus
Using

the demand curve to measure

consumer surplus
Demand curve
Reflects buyers willingness to pay
Measure consumer surplus
Consumer

surplus in a market

Area below the demand curve and above the

price
111

Example: Consumer Surplus

for Ice Tea

12
112

How the price affects consumer surplus

(b) Consumer surplus at price P2

(a) Consumer surplus at price P1

Price

Price
A

Consumer
surplus

Initial
consumer
surplus

P1

P1

C
new Consumer
surplus

P2
Demand

Q1

Quantity

Demand

Q1

Q2

Quantity

In panel (a), the price is P1, the quantity demanded is Q1, and consumer surplus equals the area of
the triangle ABC. When the price falls from P1 to P2, as in panel (b), the quantity demanded rises
from Q1 to Q2, and the consumer surplus rises to the area of the triangle ADF. The increase in
consumer surplus (area BCFD)
113

Consumer Surplus

What does consumer surplus mean?

Consumer surplus
Benefit that buyers receive from a good
As the buyers themselves perceive it
Good measure of economic well-being
Exception: Illegal drugs
Drug addicts
Willing to pay a high price for heroin
Societys standpoint
Drug addicts dont get a large benefit from
being able to buy heroin at a low price
114

2. Producer Surplus

Measures

the value between the

actual selling price of a product and
the price along the supply curve at
which sellers are willing to sell the
product.

115

Producer Surplus
Using

the supply curve to measure

producer surplus
Producer surplus

Closely related to the supply curve

Supply schedule
Derived from the willingness to sell of the
possible sellers

116

Producer Surplus
Using

the supply curve to measure

producer surplus
Supply curve
Reflects sellers willingness to sell.
Measure producer surplus
Producer

surplus in a market

Area below the price and above the supply

curve

117

How the price affects producer surplus

Price

(a) Producer surplus at price P1

(b) Producer surplus at price P2

Price

P2
P1

B
Producer
surplus

Supply

New producer
surplus

Supply

P1

D
B
Initial
consumer
surplus

Q1
Q2 Quantity
0
Quantity
In panel (a), the price is P1, the quantity supplied is Q1, and producer surplus equals the area of the
triangle ABC. When the price rises from P1 to P2, as in panel (b), the quantity supplied rises from Q1
to Q2, and the producer surplus rises to the area of the triangle ADF. The increase in producer
surplus (area BCFD)
0

Q1

118

3. Market Efficiency and Deadweight Loss

Efficiency

Property of a resource allocation

Maximizing the total surplus

Received by all members of society

Equality

Property of distributing economic prosperity

Uniformly distributing among the members of

society

119

Consumer and producer surplus in the market

equilibrium
Price
Supply

Equilibrium
price

Consumer
surplus

E
Producer
surplus
B
C

Demand

Equilibrium
Quantity
quantity
Total surplusthe sum of consumer and producer surplusis the area
between the supply and demand curves up to the equilibrium quantity
120

Market Efficiency
Adam

Smiths invisible hand

Takes all the information about buyers and

sellers into account

Guides everyone in the market to the best
outcome
Economic efficiency
Free

markets = best way to organize

economic activity

121

Adam Smith and the Invisible Hand

Passages from The Wealth of Nations, 1776
Man has almost constant occasion
for the help of his brethren, and it is
vain for him to expect it from their
benevolence only. He will be more
likely to prevail if he can interest their
self-love in his favor, and show them
that it is for their own advantage to do
for him what he requires of them
It is not from the benevolence of the
butcher, the brewer, or the baker that
we expect our dinner, but from their
regard to their own interest.

Adam Smith
(1723 - 1790)
122

Adam Smith and the Invisible Hand

Passages from The Wealth of Nations, 1776
Every individualneither intends to
promote the public interest, nor knows
how much he is promoting it.
He intends only his own gain, and he is
in this, as in many other cases, led by
to promote an end
which was no part of his intention.
Nor is it always the worse for the society
that it was no part of it. By pursuing his
own interest he frequently promotes
that of the society more effectually than
when he really intends to promote it.

Adam Smith
(1723 - 1790)
123

Market Efficiency & Market Failure

Forces

of supply and demand allocate

resources efficiently
Several assumptions about how markets

work
1. Markets are perfectly competitive
2. Outcome in a market matters only to the
buyers and sellers in that market
When these assumptions do not hold
Our conclusion that the market equilibrium
is efficient may no longer be true
124

Market Efficiency & Market Failure

In

the world

Competition - far from perfect

Market power
A single buyer or seller (small group)
Control market prices
Markets are inefficient
Keeps the price and quantity away
from the equilibrium of supply and
demand
125

Market Efficiency & Market Failure

In

the world

Decisions of buyers and sellers

Affect people who are not participants in the

market at all
Externalities
Cause welfare in a market to depend on
more than just the value to the buyers and
the cost to the sellers
Inefficient equilibrium
From the standpoint of society as a whole
126

Market Efficiency & Market Failure

Market

failure

E.g.: market power and externalities

The inability of some unregulated markets to

allocate resources efficiently

Public policy
Can potentially remedy the problem
Increase economic efficiency

127

Deadweight Loss
Deadweight loss is the reduction in
economic surplus resulting from a
market not being in competitive
equilibrium.
The net loss of both consumer &
producer surplus resulting from
underproduction or overproduction of
a product.

128

Deadweight Loss

FIGURE
4-7 Is Not in Equilibrium, There Is a Deadweight Loss
When
a Market
Economic surplus is maximized when a market is in competitive equilibrium. When a
market is not in equilibrium, there is a deadweight loss.
When the price of Thai tea is $2.20, instead of $2.00, consumer surplus declines from an
amount equal to the sum of areas A, B, and C to just area A. Producer surplus increases
from the sum of areas D and E to the sum of areas B and D. At competitive equilibrium,
there is no deadweight loss. At a price of $2.20, there is a deadweight loss equal to the
sum of areas C and E.

129

4. Price Ceilings & Price Floors

A price ceiling is a legal maximum on the price of a good.

An example is rent control. If the price ceiling is below the
equilibrium price, it is binding and causes a shortage.

A price floor is a legal minimum on the price of a good. An

example is the minimum wage. If the price floor is above the
equilibrium price, it is binding and causes a surplus. The
labor surplus caused by the minimum wage is
unemployment.

130

Price Ceiling
Price

Supply
Equilibrium
price
$3
Price
ceiling

Shortage

Demand
0

75
Quantity
supplied

125
Quantity
demanded

Quantity
131

Price Floor
Price

Supply
Price
Floor

4
$3
Equilibrium
price

Demand
0

100
Equilibrium Quantity

Quantity
132

Example of Price Floors: Government Policy in

Agricultural Markets
The Economic Effect of a Price
Floor in the Wheat Market
If wheat farmers convince the government
to impose a price floor of $3.50 per bushel,
the amount of wheat sold will fall from 2.0
billion bushels per year to 1.8 billion.
If we assume that farmers produce 1.8
billion bushels, producer surplus then
increases by the red rectangle Awhich is
transferred from consumer surplusand
falls by the yellow triangle C.
Consumer surplus declines by the red
rectangle A plus the yellow triangle B.
There is a deadweight loss equal to the
yellow triangles B and C, representing the
decline in economic efficiency due to the
price floor. In reality, a price floor of $3.50
per bushel will cause farmers to expand
their production from 2.0 billion to 2.2 billion
bushels, resulting in a surplus of wheat.

133

Example of Price Floors in Labor Markets:

The Debate over Minimum Wage Policy

134

Example Price Ceilings: Government Rent

Control Policy in Housing Markets
The Economic Effect of a Rent Ceiling
Without rent control, the equilibrium rent
is $1,500 per month. At that price,
2,000,000 apartments would be rented.
If the government imposes a rent ceiling
of $1,000, the quantity of apartments
supplied falls to 1,900,000,
and the quantity of apartments
demanded increases to 2,100,000,
resulting in a shortage of 200,000
apartments.
Producer surplus equal to the area of the
blue rectangle A is transferred from
landlords to renters, and there is a
deadweight loss equal to the areas of
yellow triangles B and C.

135

Summary
Consumer

surplus equals buyers

willingness to pay for a good minus the
amount they actually pay for it.
Consumer surplus measures the benefit
buyers get from participating in a market.
Consumer surplus can be computed by
finding the area below the demand curve
and above the price.
136

Summary
Producer

surplus equals the amount

sellers receive for their goods minus their
costs of production.
Producer surplus measures the benefit
sellers get from participating in a market.
Producer surplus can be computed by
finding the area below the price and above
the supply curve.
137

Summary
The

equilibrium of demand and supply

maximizes the sum of consumer and
producer surplus.
This is as if the invisible hand of the
marketplace leads buyers and sellers to
allocate resources efficiently.
Deadweight loss is the reduction in
economic surplus resulting from a market
not being in competitive equilibrium.
138

Summary

A price ceiling is a legal maximum on the price of a

good. An example is rent control. If the price
ceiling is below the equilibrium price, it is binding
and causes a shortage.

A price floor is a legal minimum on the price of a

good. An example is the minimum wage. If the
price floor is above the equilibrium price, it is
binding and causes a surplus. The labor surplus
caused by the minimum wage is unemployment.
139