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AS Econs

Published in: Economics
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Consumer Surplus

Tan C / Kuching

14 years of teaching experience

Qualification: Degree

Teaches: Mathematics, Physics, Science, Additional Math, Chemistry, Additional Maths

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  1. The price System AS Level
  2. Consumer Surplus 7he individual consunw surplus is the diffæenæ the nnMnzun total priæ a onsunrr willing to pay (or roe-va tion priæ) for the annunt he hays and the a ctual total priæ.
  3. Example: Suppose you are in Wal-Mart and you see a DVD on the rack. No price is indicated on the package, so you bring it over to the register to check the price. As you walk to the register, you think to yourself that $20 is the highest price you would be willing to pay. At the register, you find out that the price is actually $ 12, so you buy the DVD. Your consumer surplus in this example is $8: the difference between the $20 you were willing to pay and the $ 12 you actually paid.
  4. If someone is willing to pay more than the actual price, their benefit in a transaction is how much they saved when they didn't pay that price. For example, a person is willing to pay a tremendous amount for water since he needs it to survive, however since there are competing suppliers of water he is able to purchase it for less than he is willing to pay.
  5. The maximum price a consumer would be willing to pay for a given amount is the sum of the maximum price he would be willing to pay for the first unit, the maximum additional price he would be willing to pay for the second unit, etc. Consumer Surplus 6000 5000 4030 2030 3 4 Market Price 6 5 8 9 Quantity Demanded (in millions) Consumer Surplus 10
  6. eooo 5000 4030 8 PI Ok 3000 2000 1000 3 3Alhen market price changes, Consumer surplus changes In this case the price increases and the consumer surplus is reduced as some consumers are unwlling to pay the higher price, New Consumer Surplus New Market Price 4 al 5 6 7 o 8 9 10 Qua ntity Demanded (in millions) New Consumer Surplus
  7. The rationing function of the price mechanism Prices play a very important part in the allocation of resources in markets. Whenever resources are particularly scarce, demand exceeds supply and prices are driven up. The effect of such a price rise is to discourage demand and conserve resources. The greater the scarcity, the higher the price and the more the resource is rationed. This can be seen in the market for oil. As oil slowly runs out, its price will rise, and this discourages demand and leads to more oil being conserved than at lower prices. The rationing function of a price rise is associated with a contraction of demand along the demand curve.
  8. The signalling function of the price mechanism Price changes send contrasting messages to consumers and producers about whether to enter or leave a market. Rising prices give a signal to consumers to reduce demand or withdraw from a market completely, and they give a signal to potential producers to enter a market. Conversely, falling prices give a positive message to consumers to enter a market while sending a negative signal to producers to leave a market. For example, a rise in the market price of 'smart' phones sends a signal to potential manufacturers to enter this market, and perhaps leave another one.
  9. Similarly, the provision of 'free' healthcare may signal to consumers' that they can pay a visit to their doctor for any minor ailment, while potential private healthcare providers will be deterred from entering the market. In terms of the labour market, a rise in the wage rate, which is the price of labour, provides a signal to the unemployed to join the labour market. The signalling function is associated with shifts in demand and supply curves.
  10. The incentive function of the price mechanism An incentive is something that motivates a producer or consumer to follow a course of action or to change behaviour. Higher prices provide an incentive to existing producers to supply more because they provide the possibility or more revenue and increased profits. The incentive function of a price rise is associated with an extension of supply along the existing supply curve.
  11. How market starts D = S Price In itial equiti brium s D Qua ntity Copyright: www.econom•csonl•ne.co.uk
  12. A supply shock reduces supply at each and every price. This creates an excess of demand at the existing price. Price A supply-side shock such as a rise in production costs Q2 s Creates excess at the old price 191) which drives up price la PIT D Qua ntity Copyright: www.economx;sonl•ne.co.uk
  13. The price is now forced up to a new price (PI) where the market clears. At the new price, demand and supply are brought into equilibrium through a contraction of demand (the rationing effect) and an extension of supply (the incentive effect). Rationing and incentive Price effects s Incentive Rationing p Excess demand drives up price This forces. consornærs to on de mamd to and encourages producers to more to Q2 D Qua ntity •Capyright: www.econom•:;sonl•ne-co.uk
  14. In the /ongrun, the higher price sends out signals, either for existing firms to introduce better production methods or by new firms entering the market. This causes the supply curve to shift to the right. Eventually, price may return to its existing Price Sig ng effects s In the 101jg the higher price (PI} to potential suppliers to enter the market. CSuppty shifts to S2} And leave the forstteaper substitutes. {Demand shifts to 01 D Quantity Copyright: www.econom•csonl•ne.co.uk