Market Efficiency

• Module 11: Consumer and Producer Surplus
• Module 12: Efficiency and Markets

MAKING GAINS BY THE BOOK

There is a lively market in second-hand college textbooks. At the end of each term, some students who took a course decide that the money they can make by selling their used books is worth more to them than keeping the books. And some students who are taking the course next term prefer to buy a somewhat battered but less expensive used textbook rather than pay full price for a new one.

Textbook publishers and authors are not happy about these transactions because they cut into sales of new books. But both the students who sell used books and those who buy them clearly benefit from the existence of the market. That is why many college bookstores facilitate their trade, buying used textbooks and selling them alongside the new books.

But can we put a number on what used textbook buyers and sellers gain from these transactions? Can we answer the question “How much do the buyers and sellers of textbooks gain from the existence of the used-book market?”

Yes, we can. In this section we will see how to measure benefits, such as those to buyers of used textbooks, from being able to purchase a good—known as consumer surplus. And we will see that there is a corresponding measure, producer surplus, of the benefits sellers receive from being able to sell a good.

The concepts of consumer surplus and producer surplus are useful for analyzing a wide variety of economic issues. They let us calculate how much benefit producers and consumers receive from the existence of a market. They also allow us to calculate how the welfare of consumers and producers is affected by changes in market prices. Such calculations play a crucial role in evaluating many economic policies.

What information do we need to calculate consumer and producer surplus? Surprisingly, all we need are the demand and supply curves for a good. That is, the supply and demand model isn’t just a model of how a competitive market works—it’s also a model of how much consumers and producers gain from participating in that market. Our first step will be to learn how consumer and producer surplus can be derived from the demand and supply curves. We will then see how these concepts can be applied to actual economic issues.