The imposition of a price floor or a price ceiling will prevent a market from adjusting to its equilibrium price and quantity, and thus will create an inefficient outcome. Inefficiency of Price Floors and Price Ceilings In addition, at the efficient level of output, it is impossible to produce greater consumer surplus without reducing producer surplus, and it is impossible to produce greater producer surplus without reducing consumer surplus. This demonstrates the economic efficiency of the market equilibrium. Social surplus is larger at equilibrium quantity and price than it would be at any other quantity. In Figure 3.9 we show social surplus as the area F + G. The sum of consumer surplus and producer surplus is social surplus, also referred to as economic surplus or total surplus. In Figure 3.9, producer surplus is the area labeled G-that is, the area between the market price and the segment of the supply curve below the equilibrium. The amount that a seller is paid for a good minus the seller’s actual cost is called producer surplus. Those producers who would have been willing to supply the tablets at $45, but who were instead able to charge the equilibrium price of $80, clearly received an extra benefit beyond what they required in order to supply the product. For example, point (K) in Figure 3.9 illustrates that, at $45, firms would still have been willing to supply a quantity of 14 million. The supply curve shows the quantity that firms are willing to supply at each price. For example, point (K) on the supply curve shows that at a price of $45, firms would have been willing to supply a quantity of 14 million. The somewhat triangular area labeled by G shows the area of producer surplus, which shows that the equilibrium price received in the market was more than what many of the producers were willing to accept for their products. Point (J) on the demand curve shows that, even at the price of $90, consumers would have been willing to purchase a quantity of 20 million. Consumer surplus is the area labeled F-that is, the area above the market price and below the demand curve.įigure 3.9 Consumer and Producer Surplus The somewhat triangular area labeled by F shows the area of consumer surplus, which shows that the equilibrium price in the market was less than what many of the consumers were willing to pay. The amount that individuals would have been willing to pay, minus the amount that they actually paid, is called consumer surplus. Remember, the demand curve traces consumers’ willingness to pay for different quantities. Those consumers who would have been willing to pay $90 for a tablet (based on the utility they expect to receive from it) were able to pay the equilibrium price of $80, clearly received a benefit beyond what they had to pay. This portion of the demand curve shows that at least some demanders would have been willing to pay more than $80 for a tablet.įor example, point (J) shows that if the price were $90, 20 million tablets would be sold. To see the benefits to consumers, look at the segment of the demand curve above the equilibrium point and to the left. The equilibrium price is $80 and the equilibrium quantity is 28 million. Consumer Surplus, Producer Surplus, Social SurplusĬonsider a market for tablet computers, as Figure 3.9 shows. In 1890, the famous economist Alfred Marshall wrote that asking whether supply or demand determined a price was like arguing “whether it is the upper or the under blade of a pair of scissors that cuts a piece of paper.” The answer is that both blades of the demand and supply scissors are always involved. The demand and supply model emphasizes that prices are not only set by demand or supply, but also by the interaction between the two. In other words, the optimal amount of each good and service is produced and consumed. Conversely, if a situation is inefficient, it becomes possible to benefit at least one party without imposing costs on others.Įfficiency in the demand and supply model has the same basic meaning: The economy is getting as much benefit as possible from its scarce resources and all the possible gains from trade have been achieved. One typical way that economists define efficiency is when it is impossible to improve the situation of one party without imposing a cost on another. The familiar demand and supply diagram holds within it the concept of economic efficiency. Explain why price floors and price ceilings can be inefficient.Contrast consumer surplus, producer surplus, and social surplus.By the end of this section, you will be able to:
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