4.9 SUMMARY

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  1. The demand curve is determined by each individual consumer’s willingness to pay. When price is less than or equal to the willingness to pay, the consumer purchases the good. The difference between willingness to pay and price is the net gain to the consumer, the individual consumer surplus. Total consumer surplus in a market, the sum of all individual consumer surpluses in a market, is equal to the area below the market demand curve but above the price.

  2. The supply curve is determined by the cost to each potential producer—the lowest price at which the producer is willing to produce a unit of that good. If the price of a good is above the producer’s cost, a sale generates a net gain to the producer, known as the individual producer surplus. Total producer surplus in a market is the sum of the individual producer surpluses. This is equal to the area above the market supply curve but below the price.

  3. Total surplus, the total gain to society from the production and consumption of a good, is the sum of consumer and producer surpluses.

  4. Even when a market is efficient, governments often intervene to pursue greater fairness or to please a powerful interest group. Interventions can take the form of price controls or quantity controls, both of which generate predictable and undesirable side effects consisting of various forms of inefficiency and illegal activity.

  5. A price ceiling, a maximum market price below the equilibrium price, benefits successful buyers but creates persistent shortages. Because the price is maintained below the equilibrium price, the quantity demanded is increased and the quantity supplied is decreased compared to the equilibrium quantity. This leads to predictable problems: inefficiencies in the form of deadweight loss from inefficiently low quantity, inefficient allocation to consumers, wasted resources, and inefficiently low quality. It also encourages illegal activity as people turn to black markets to get the good. Because of these problems, price ceilings have generally lost favor as an economic policy tool. But some governments continue to impose them either because they don’t understand the effects or because the price ceilings benefit some influential group.

  6. A price floor, a minimum market price above the equilibrium price, benefits successful sellers but creates persistent surplus. Because the price is maintained above the equilibrium price, the quantity demanded is decreased and the quantity supplied is increased compared to the equilibrium quantity. This leads to predictable problems: inefficiencies in the form of deadweight loss from inefficiently low quantity, inefficient allocation of sales among sellers, wasted resources, and inefficiently high quality. It also encourages illegal activity and black markets. The most well known kind of price floor is the minimum wage, but price floors are also commonly applied to agricultural products.

  7. Quantity controls, or quotas, limit the quantity of a good that can be bought or sold. The quantity allowed for sale is the quota limit. The government issues licenses to individuals, giving them the right to sell a given quantity of the good. The owner of a license earns a quota rent, earnings that accrue from ownership of the right to sell the good. It is equal to the difference between the demand price at the quota limit, what consumers are willing to pay for that quantity, and the supply price at the quota limit, what suppliers are willing to accept for that quantity. Economists say that a quota drives a wedge between the demand price and the supply price; this wedge is equal to the quota rent. Quantity controls lead to deadweight loss in addition to encouraging illegal activity.