welcome back to the discussion uh we have been talking about policy intervention by
the government and we discussed about and everything we are discussing in the demand
supply framework still and in the previous modules we looked at uh price regulations
by the government we looked at taxes by the government and what happens to incidence of
tax how does elasticity impact taxes etc we have talked discussed about all that and
in this last module of this entire uh uh session or in this entire uh section of the lecture
on demand supply uh we are going to talk about something a little more theoretical uh in
the very first class we said that market is usually a best of way of allocating resources
and today we are going to try to understand why we said so so we are going to talk about
that and we are going to say that uh so does that mean that the market equilibrium is the
most efficient outcome uh in case of any uh market transaction so is that the most efficient
outcome .
this is what we are going to discuss and in the process the concepts we will be talking
about introducing and understanding a few basic concepts which are firstly we are going
to talk about something called producer surplus so how is it related to the supply curve so
we are going to discuss about something like producer surplus and how is it related to
the supply curve then we are going to talk about consumer surplus
how is it related to the demand curve then we are going to define market efficiency or
we are going to see how what is market efficiency and how producer surplus and consumer surplus
they can explain market efficiency and next we are going to see what happens to efficiency
when government intervenes .
so this is all about very uh fundamental of of a area of economics called welfare economics
where uh we are going to basically try to define efficiency and we are going to say
what is welfare economics is basically it talks about the wellbeing of all the participants
in the market so any kind of market equilibrium if it is what is it doing to the wellbeing
of the producers and what is it doing to the wellbeing of the consumers
so market equilibrium leads to allocation of resources this we already discussed in
the earlier lectures and we said that in the market equilibrium it is decided that uh the
intersection of the demand and supply is going to give us the equilibrium price and quantity
so the quantity is decided in the market how much quantity of any good the supplier will
be selling in the market and that decides how much of resources are going to be allocated
and who buys this good that is also decided through the market equilibrium people who
are willing to pay the most for that good are going to buy that good
so the market equilibrium that we get is that a efficient outcome that is also what we are
going to see and what happens to economic wellbeing of producers and consumers and economic
wellbeing of producers and consumers we define or we explain the economic wellbeing through
something called the consumer surplus for the buyers and something called the producer
surplus for the sellers so let me explain .
so first let me explain what uh consumer surplus is let me start with consumer surplus and
let me explain what consumer surplus is and uh so the consumer surplus i am going to illustrate
through the demand curve . so basically we are defining there is something
called willingness to pay and what is the demand curve what is the demand curve demand
curve is basically every point on the demand curve every point on the demand curve so every
point on the demand curve gives us shows us how much of the quantity the buyers are willing
to pay so at so if the quantity is this much so if
this is the quantity of say 10 units buyers are willing to pay a amount of say p 10 so
these are the various willingness to pays of the so every point on the demand curve
is the expression of willingness to pay by the consumers so this is the willingness to
pay by the consumers and lets start with a very simple economy .
lets start with a very simple economy where there are uh say 5 people a b c d and e and
say they are purchasing say tshirts tshirts of iit probably so they are buying tshirts
and the prices that they would be willing to pay so they have the demand curve they
come to the market with some kind of demand curve
so may be a is willing to pay a price of 1000 per tshirt now b is willing to pay a little
less he would like to pay 800 c pays even less say 600 and uh d pays and e has a very
low willingness to pay of say rupees 200 so in such a situation in such a situation uh
what happens in the market if the price is more than 1000 rupees so if the price is more
than 1000 rupees there are no takers so there are basically 0 people who are willing to
uh buy this tshirt when the price is 1000 there is one person
who is willing to purchase or in terms of tshirts you can say that there is 1 tshirt
can be sold or if the price is 800 there is one more person if the price is 800 b is willing
to purchase and obviously a is also willing to purchase because his maximum willingness
to pay is 1000 so here 2 tshirts will be sold when the price is 600 c enters the market
he is willing to buy one b is willing to buy one and a is also willing to buy one so here
the price is then 3 tshirts will be sold so this is how we uh so so we can draw a step
diagram over here so if the prices are 200 400 600 800 1000 and say 1200 so if the price
is more than 1000 0 people are willing to buy the tshirt
so when its 100 one tshirt will be sold 2 3 4 5 so basically it is 0 then 1 tshirt will
be sold and here 2 tshirts will be sold 3 will be sold 4 will be sold and 5 will be
sold so basically the this is this step diagram that i have drawn from here this is this kind
of looks like the demand curve its a negatively sloping curve or where the price when the
price is falling the amount demand is increasing so this is a step diagram and this is how
the demand curve is drawn and imagine a market where there are infinite number of buyers
lot of plenty of buyers are there in that case these steps will come closer to each
other and gradually when the number is too high you we are going to get a smooth demand
curve we are going to get a continuous demand curve .
now so coming back to the slides a buyers willingness
to pay is the maximum amount that the buyer would be willing to pay for a unit of good
and consumers surplus is the amount a buyer is willing to pay minus the amount the buyer
actually pays so let me again explain through the diagram so basically when the second when
the price is 800 b is paying a amount of 800 which is exactly equal to the amount that
he would like to pay it is not less than that but for a he is paying 800 so for him there
is a extra benefit that he is getting by buying the t shirt at 800 so for a there is a surplus
there is a kind of surplus of consuming this t shirt for a price of 800 so basically a
gets a surplus of 200 so in case of when the price is 600 a gets a surplus of 400 and B
gets a surplus of 200 . so basically what we are seeing here is that
all this area this is the surplus so for a this is the surplus when he buys it for 800
rupees for both of them this is the total area of the surplus when it is when the price
is 600 this entire area of 400 this is for a and additional this amount of 200 is for
b so similarly if the price goes down even lower then this is the amount of surplus that
all the people all the people who are entering the market or buying the product they are
going to get . so if it is a very smooth lot of people are
there and its a smooth demand curve we can imagine if it is a smooth demand curve its
easy to imagine that if the price is 600 all the people who are buying the t shirt and
who had willingness to pay more than 600 they all have entered the market and they all are
going to buy the t shirt for 600 rupees and together they are going to get a surplus equal
to this area of the triangle so they are going to get a surplus which is equal to the area
of the triangle so this is the market if this is the market
price if the say p e is the market price if the market price p e is 600 all these people
if the market price is 600 3 t shirts will be sold and all these people who were who
had willingness to pay in this region in this region every person if every buyer in this
region has a willingness to pay which is more than 600 or equal to 600 this last person
has a equal to 600 so all the people who are here they everyone is going to buy the t shirt
and for all these people this is the consumer surplus that they are going to get
so consumer surplus is the amount the buyer is willing to pay minus the amount the buyer
actually pays so a higher price in the market reduces the consumer surplus so obviously
higher price in the market reduces the consumer if the price now goes up to 800 if the price
goes up to 800 we lose the consumer surplus in this area and consumer surplus is now less
its only this portion so this is the consumer surplus now so a higher price in the market
reduces the consumer surplus now that was our uh illustration of the consumer
surplus this is consumer surplus so this is consumer surplus and now we are
going to talk about the supply curve and we are talk about something similar the surplus
that a seller also gets in the market and that is called the producer surplus .
so for the seller the cost is a measure of willingness to sell so cost is a measure of
willingness to sell that is every seller has to incur some cost to supply a product in
the market so every seller has to incur a cost to supply a product in the market and
uh and that is the that that cost is the minimum amount that he would like to charge to supply
any product in the market and what is that cost that cost is anything
any or the cost of all his ingredients his labour his opportunity cost uh every kind
of cost that he incurs in supplying a product in the market that is the minimum price that
he would accept from the market to stay in the market if the price goes below that cost
it does not make sense for he is going to make a loss and it does not make sense for
him to continue to supply in the market so basically cost is a measure of willingness
to sell in the market . so so let me draw a supply curve here so this
is we are we are trying to draw the producer surplus so as i said this is the say this
is the supply curve this is the supply curve of the producer and every seller every seller
there are there are again like the same way that we had buyers there could be sellers
in the market so this is say 200 400 600 800 and 1000 these are the prices and there is
one seller in the market who can actually supply at uh when the price is 200
when the price is as low as 200 there is probably one person who is willing to supply when the
price goes up 400 there one more person enters the market he is willing to supply a unit
and so he is willing to supply and the second the the first person for him also now the
price is more than his cost so he is also willing to supply so say 2 3 so this way so
as the price goes up in the market more and more sellers enter the market and they are
willing to supply now imagine a situation where the equilibrium
price in the market that is arrived at P e is equal to 600 when p e is equal to 600 this
last person the last seller who has entered the market because the price has reached 600
he does not make any profit for him the cost is this is his willingness to pay and this
is the price that he is getting so he is good he is fine with it he sells the product in
the market his price is equal to his uh equal to the willingness to sell
so he enters the market but every other sellers in the market for whom the willingness to
pay or sorry im sorry its not willingness to pay its willingness to sell so every seller
in the market for whom the willingness to sell was at a price lower than 600 they all
are going to sell in the market so they are all going to sell so imagine this first person
the the first seller in the market who has who operates at a very low cost
his minimum cost is 200 uh or his his willingness to sell is at the price of 200 that is 200
is the minimum price that he is willing to accept and because his cost is 200 now when
the market price is 600 he gets a surplus for him there is a surplus so he gets a surplus
so the next person who is willing to for whom the willingness to sell is at a price slightly
more than 200 he also gets a surplus so similarly every person here who have uh
willingness to sell at a price which is lower than 600 they all get a surplus or a profit
by being in the market so they all get a surplus and this is the total amount of producer surplus
or this is the total amount of surplus that the producer is getting in the market so this
is the total amount of the surplus that the producer is getting in the market and this
is called the producer surplus or p s . so what happens when the price the producer
surplus what happens to producer surplus when the price goes up when price goes up more
sellers enter the market with more surplus say if it becomes 800 the producer surplus
goes up now when the producer when price goes down if it is 400 this region of producer
surplus is these producers all exit the market because price is now lower than their willingness
to sell and so producer surplus goes down so basically producer surplus is the amount
the seller gets from the market minus the sellers cost a lower price reduces the producer
surplus now hence total surplus in the market so what is the total surplus in the market
lets draw it neatly .
so this is the supply curve and this is the demand curve this is equilibrium price this
is equilibrium price now which part is the producer surplus as we already drew this is
the producer surplus this is the producer surplus p s and this is the this is the consumer
surplus or c s so when a market reaches a equilibrium they intersect it reaches a equilibrium
at a price of the intersection of the two both the producers and the both the producers
and the consumers receive some surplus in the market and these surpluses are shown in
this diagram so this these surpluses are as shown in this diagram so this total surplus
in the market is then now what is the total so we going back to our original uh uh topic
of discussion is efficiency we we were saying that if it is a efficient outcome so we are
saying that uh or or we talked about wellbeing of the producers and suppliers in the market
so what happens to wellbeing of the consumers so wellbeing of the consumer is measured by
this region so the consumers wellbeing is the this region and the producers wellbeing
is measured by this region and total wellbeing of the market players or the total wellbeing
of the economy is equal to this total surplus so total surplus
is equal to producer surplus plus consumer surplus so total surplus is equal to this
region of producer surplus and consumer surplus and efficiency in the market means total surplus
is maximized so we have found a way of measuring the uh
wellbeing of the consumer as this consumer surplus wellbeing of the producer as producer
surplus and so the wellbeing of the entire market is maximized if we can show that this
area is maximum in the case of the market equilibrium or in other words if we are asking
the question that if the market is left to itself the outcome that happens in the market
the demand supply intersection and the market equilibrium that we get is that maximizing
the wellbeing of the market if it is maximizing the wellbeing of the market then it is a efficient
outcome this is what we are saying and this is what we are trying to find out .
so let us let us try to understand what exactly we mean by efficiency uh efficiency a market
outcome would be efficient if the goods are consumed by the buyers who value them most
highly and the goods are produced by the producers with the lowest cost so is that happening
in this situation this is what we are asking that we will say
that a market equilibrium or a market left to itself the equilibrium that is reached
or the market outcome we are going to call this efficient if the goods are consumed by
buyers who value them the most high value them the most and the goods are produced by
the producers with the lowest cost raising or quantity raising or lowering the
quantity of a good will not increase the total surplus so is there any way that uh the equilibrium
that we have reached is there any way of increasing this consumer surplus or producer surplus
any other uh level of output or any other level of price is that going to give us a
better outcome in terms of maximizing the c s and p s
this is what we are trying to see here and we are trying to answer the question is the
market equilibrium and efficient outcome so finally we are asking that is this the most
efficient outcome now looking at this diagram what we can see is uh what happens if uh what
happens if quantity falls . say say for example if if it is decided that
due to whatever reason that instead of 3 units 2 units will be uh produced and so the so
if 2 units are produced what happens is the suppliers would the suppliers would be charging
a smaller price and the demand so and the the buyers would be the buyer since they are
getting less than what was available in the market so the price goes up they would be
willing to purchase more at a lower price and similarly the supplier see that it makes
sense to increase the production in the market because theyll be uh they they will be able
to sell in the market so basically both of them move towards a so the producers basically
uh start increasing they see that there is demand for for the product in the market because
the buyers are willing to pay a high price so obviously they start producing more to
get a higher price so they move towards this equilibrium and similarly the consumers also
do so and in both the situations and and what happens to producer surplus and consumer surplus
what we see here is if they are producing uh if if in the market the market is producing
2 units then the price the demand the the the producers the buyers are willing to pay
is here and what and the amount of consumer surplus and producer surplus that is foregone
is given by this area so in both the situations they see in this
situation the producer see that it makes sense for them to keep on increasing a little uh
increasing production a more little more to a greater higher price and they move towards
this point so their producer surplus is enhanced and similarly consumers and as the production
increases the consumers also the the amount of availability in the market goes up and
prices go down and more and more buyers enter the market so the consumer surplus also goes
up by this amount similarly the opposite is going to happen if the quantity somehow the
production is say at here 4 so if the production is here there is too
much of supply at a high price and there is and and the price that the buyers are willing
to pay is low so here again the same thing happens and they move towards this point and
uh and obviously since here the supply is uh here the looking at the producer surplus
and consumer surplus point of view here the price the quantity is high and here the price
is that the supplier would like to charge is at this point and there is there are no
takers for this at this price so obviously they are going to reduce their
the production and come back to a lower price they are going to come back to a lower price
and hence uh and hence producer surplus gets maximized over here so here the supply when
the at these points the cost is too high for the supplier and for the buyer the willingness
to pay that is the the price that they are willing to pay is much lower than the cost
of the suppliers so they here there is no region where there can be any producer surplus
or consumer surplus so basically this is the region where uh total surplus is maximized
and market equilibrium hence actually is the most efficient outcome
in the following classes we are going to discuss the different policies of the government that
we already discussed in the context of this efficiency we are going to see what happens
to producer surplus consumer surplus etc when there is a regulation of price when there
is price regulation what happens to producer surplus consumer surplus or efficiency in
the market thank you