1.1.6 Market Efficiency

Syllabus Statement: Explain the concept of consumer surplus Identify consumer surplus on a demand and supply diagram

CONSUMER SURPLUS

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CONSUMER SURPLUS (CS): Highest price consumers are willing to pay for a good or service minus the actual price paid; hence, the consumer surplus is the marginal benefit enjoyed by consumers from paying a price that is less than what they were willing to pay

• Referring to Figure (a), the Consumer Surplus is the area below the consumer’s demand curve and above the market price

Syllabus Statement: Explain the concept of producer surplus Identify producer surplus on a demand and supply diagram

 

PRODUCER SURPLUS

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PRODUCER SURPLUS (PS) : Price received by firms for selling their good or service minus the lowest price that they are willing to accept to produce the good or service; hence, the producer surplus is the benefit enjoyed by producers from selling a good or service at a price that is higher than their marginal cost

• Referring to Figure (b), the Producer Surplus is the area above the firm’s supply curve and below the market price

Syllabus Statement: Evaluate the view that the best allocation of resources from society’s point of view is at competitive market equilibrium, where social (community) surplus (consumer surplus and producer surplus) is maximized (marginal benefit = marginal cost)

COMPETITIVE MARKET EQUILIBRIUM: MAXIMUM SOCIAL SURPLUS AND ALLOCATIVE EFFICIENCY

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SOCIAL SURPLUS: Sum of consumer surplus and producer surplus

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• Social Surplus = Consumer Surplus + Producer Surplus

At the point of competitive market equilibrium, where the marginal benefit (MB) equals marginal cost (MC), the social surplus is maximized and allocative efficiency is achieved:

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• The competitive market equilibrium occurs at the intersection between the demand and supply curve

• However, if the demand curve is interpreted as the marginal benefit curve, and the supply curve is interpreted as the marginal cost curve, the market equilibrium occurs at the point where marginal benefit equals marginal cost (MB = MC)

• This equality of marginal benefit and marginal cost indicates that at the market equilibrium, the extra benefit from consuming an additional unit of output (consumer surplus) is equal to the extra cost of producing an additional unit of output (producer surplus); hence, the situation of one party can no longer be improved without imposing a cost on the other

• As the social surplus is therefore maximized, scarce resources are used efficiently to maximize consumer benefit at the lowest cost to producers, thereby achieving allocative efficiency