Market Efficiency vs.

Efficiency Loss

Market Efficiency Basics

• Consumer surplus– The amount a consumer is willing to pay for a

good minus what he actually pays for it.

Cookie Monster may be willing to pay $100 for one cookie.

But, Cookie Monster is happy to find out that the price of a cookie is just $1.

So Cookie Monster’s consumer surplus per cookie is $99!

Market Efficiency Basics

• Producer surplus– The amount a seller sold the item for minus what

they were willing to sell it for

Best Buy is willing to sell a television as low as $500

A customer buys that same television for $600

Best Buy had a producer surplus of $100

Market Efficient Basics

• Total surplus– consumer surplus + producer surplus

• So, when do you think a market is most efficient…?

When total surplus is maximized!

Measuring surplus on a graph

• Consumer surplus– The area below the demand curve and above the

price

• Producer surplus– The area above the supply curve and below the

price

Consumer and Producer Surplus in the Market Equilibrium

Producersurplus

Consumersurplus

Price

0 Quantity

Equilibriumprice

Equilibriumquantity

Supply

Demand

A

C

B

D

E

Can you label:-Consumer surplus- Producer surplus- Total surplus

Total Surplus

Efficiency Loss• Also known as deadweight loss or welfare

loss• Total surplus is NOT maximized • Resources and products are underutilized • Many causes– Government Regulations– Externalities– Monopoly pricing

Government Regulation

What do you think is the market price for renting an apartment in Plainfield?• What happens to the quantity of demand and

supply after the price change?• List four outcomes that would most likely

occur if the price was set there– Think like an economist!

Price Ceiling

• Maximum price that can be legally charged for a good or service

• It’s called “binding” if the ceiling price is set below market equilibrium– It’s “not binding” if it’s set above market

equilibrium

Rent Control (Price ceiling)• Allows people to live in neighborhoods they

could not afford• Causes a shortage of apartments• Causes bad quality apartments• Property value in surrounding area’s can

decline• Causes deadweight loss!

What do you think the average wage is for a cashier at a Plainfield Meijer?

• What happens to the quantity of demand and supply after the wage change?

• List four outcomes that would most likely occur if the price was set there– Think like an economist!

Price Floors

• Minimum price that is set that must be paid for a good or service

• It is called “binding” if the floor price is set above market equilibrium– It’s “not binding” if it’s set below market

equilibrium

Minimum Wage (price floor)• Minimum price that an employer can pay a

worker for an hour of labor• Increases worker’s income• Can cause a surplus of workers• Younger people may not be hired for low

skilled jobs• Many, many, many more outcomes

National & Illinois Minimum Wage

• National = $7.25• Illinois = $8.25• Is that enough or even needed?

UTILITY

We are not talking about

us!

Market Efficiency Basics

• Utility– The amount of satisfaction or benefits one gets

out of consuming a good.

What do you think happens to the utility of this good after you consume more

and more of it?

Market Efficiency Basics

• Diminishing marginal utility– There will be a decline in utility with each

additional unit consumed

Holy pizza! My utility from each slice of pizza

really started to decline….think I’ll just

order a small pizza next time.

Market Efficiency Basics

• Utility maximization rule– Maximize your utility with each dollar you spend– You do this by weighing your marginal utility per

dollar spent

$1 Slice of Pizza Total Utility Marginal Utility

1 100 100

2 220 120

3 350 130

4 450 100

5 490 40

6 491 1