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Dr. Clive Mairura ECON 101 2024 ECON 101: PRINCIPLES OF MICROECONOMICS. SUPPLEMENTARY NOTES. 2024 THE CONCEPT OF SCARCITY& HOW IT RELATES TO THE BASIC ECONOMIC PROBLEM OF CHOICE. Scarcity is the fundamental economic concept that resources are limited, while human wants and needs are virtually unlimited. Because resources such as time, money, labour, land, and raw materials are finite, there is not enough of everything to satisfy everyone's desires. This constraint forces individuals, businesses, and societies to make decisions about how to allocate their resources most effectively. Scarcity is directly linked to the basic economic problem of choice. Since resources are limited, individuals and societies must make choices about how to use them. Each choice involves an opportunity cost—the value of the next best alternative forgone. For example, if a government chooses to allocate more resources to healthcare, it might have to cut spending on education. The need to make such trade-offs is at the core of economics, driving decisions in all areas of resource allocation and prompting questions about what to produce, how to produce, and for whom to produce. In this way, scarcity necessitates choices, as we must prioritize certain needs and wants over others. This concept underpins the study of economics as the science of choice and decision-making. EXPLANATIONS OF HOW PPF ILLUSTRATES KEY ECONOMIC CONCEPTS, LIKE SCARCITY, OPPORTUNITY COST, AND ECONOMIC EFFICIENCY. The Production Possibility Frontier (PPF) is a graphical representation showing the maximum possible combinations of two goods or services that can be produced within an economy, given a fixed set of resources and technology. The PPF illustrates key economic concepts, including scarcity, opportunity cost, and economic efficiency..

Dr. Clive Mairura ECON 101 2024 1. Scarcity The PPF curve itself illustrates scarcity because it shows the limits of production with the available resources. Points outside the PPF are unattainable with the current resources, highlighting the fact that resources are limited. Example: Suppose an economy can produce either cars or computers. The PPF shows the maximum quantities of cars and computers that can be produced if all resources are fully employed. Points outside the curve, where more cars and computers could be produced than shown on the PPF, are impossible due to resource constraints. 2. Opportunity Cost Opportunity cost is illustrated by the slope of the PPF. Moving along the curve to increase the production of one good requires reducing the production of another due to limited resources. The forgone production of one good represents the opportunity cost of producing more of the other. Example: If the economy shifts resources from producing computers to producing more cars, the opportunity cost is the number of computers that are no longer produced. This trade-off illustrates that to produce more of one good, some quantity of the other must be sacrificed. 3. Economic Efficiency Economic efficiency is demonstrated by points on the PPF. Points on the curve represent efficient production levels, where resources are fully utilized without waste. Any point inside the curve indicates inefficiency, meaning that resources are underutilized or misallocated. Example: If the economy operates at a point inside the PPF, such as due to unemployment or resource misallocation, it could produce more of one or both goods by moving to a point on the curve. This movement toward the PPF shows an improvement in economic efficiency. Diagram Explanation The PPF curve typically bows outward, indicating increasing opportunity costs as resources are reallocated from producing one good to another, making production less efficient. A shift in the PPF outward (if, for example, resources or technology increase) represents growth, allowing more of both goods to be produced and illustrating how an economy can overcome scarcity to some extent by enhancing resource availability. Through these examples and interpretations, the PPF effectively illustrates the fundamental economic concepts of scarcity, opportunity cost, and efficiency in resource allocation. THE LAW OF DEMAND AND INFLUENCING FACTORS.

Dr. Clive Mairura ECON 101 2024 Main factors influencing demand of a product, which cause shifts in the demand curve. 1. Consumer Income o Higher income usually increases demand for normal goods and decreases demand for inferior goods. 2. Price of Related Goods o Substitute Goods: If the price of a substitute rises, demand for the product in question often increases. o Complementary Goods: If the price of a complementary good decreases, demand for the associated product usually increases. 3. Consumer Preferences and Tastes o Changes in trends, advertising, and consumer preferences can lead to an increase or decrease in demand for particular goods or services. 4. Expectations of Future Prices and Income o If consumers expect prices to rise in the future, they may increase current demand. Likewise, expectations of a higher future income can increase current demand. 5. Demographic Factors o Changes in population size, age distribution, or geographic distribution can affect the demand for various goods and services. 6. Seasonal Factors o Demand can fluctuate based on the season; for example, winter clothing is more in demand during colder months, and vacation travel peaks during holidays. 7. Government Policies and Regulations o Policies like taxes, subsidies, or regulations can impact demand. For instance, subsidies on electric cars may increase demand for eco-friendly vehicles. 8. Interest Rates and Credit Availability o Lower interest rates can make borrowing cheaper, potentially increasing demand for big-ticket items like homes and cars, while higher rates can reduce demand for these items. 9. Social and Cultural Trends o Shifts in social values, such as increased awareness of environmental issues, can increase demand for sustainable products. 10. Consumer Expectations for the Economy.

Dr. Clive Mairura ECON 101 2024  General economic outlooks, such as concerns about a recession, can reduce demand for non-essential goods as people prioritize saving. These factors affect demand independently of the price of the good or service itself, shifting the demand curve either to the right (increase) or to the left (decrease). THE CONCEPT OF PRICE ELASTICITY OF DEMAND AND HOW IT AFFECTS A FIRM’S PRICING STRATEGY AND TOTAL REVENUE. Price Elasticity of Demand (PED) is a measure of how responsive the quantity demanded of a good is to a change in its price. It shows the percentage change in quantity demanded in response to a one percent change in price. The formula for PED is: 1. Interpretation of PED Values: o Elastic Demand: If PED > 1, demand is elastic, meaning consumers are highly responsive to price changes. A small price decrease can lead to a large increase in quantity demanded, and vice versa. o Inelastic Demand: If PED < 1, demand is inelastic, meaning consumers are less responsive to price changes. A price increase may result in a smaller drop in quantity demanded. o Unitary Elasticity: If PED = 1, a change in price leads to a proportional change in quantity demanded. 2. How PED Affects Pricing Strategy: o For Elastic Goods: Firms with products that have elastic demand may benefit from lowering prices to boost sales volume. Lowering prices can lead to an overall increase in total revenue because the increase in quantity demanded is proportionally greater than the price reduction. o For Inelastic Goods: Firms with products that have inelastic demand can raise prices without causing a significant drop in sales volume. This approach can increase total revenue, as the decrease in quantity demanded is proportionally smaller than the price increase. 3. Impact on Total Revenue:.

Dr. Clive Mairura ECON 101 2024 o Elastic Demand: Lowering prices increases total revenue, as the percentage gain in quantity demanded outweighs the percentage drop in price. o Inelastic Demand: Increasing prices increases total revenue, as the decrease in quantity demanded is smaller than the increase in price. o Unitary Elasticity: Changes in price do not affect total revenue, as the change in quantity demanded offsets the change in price exactly. Understanding PED allows firms to set prices strategically, optimizing revenue by aligning pricing with consumer responsiveness. When the Price Elasticity of Demand (PED) is greater than 1, it means the demand for a good or service is elastic, meaning that consumers are relatively responsive to changes in price. In other words, a small percentage change in price leads to a larger percentage change in the quantity demanded. Example of PED > 1 (Elastic Demand) Example: Let's consider the market for luxury brand watches (e.g., Rolex, Omega, etc.).  Suppose that the price of a luxury watch increases by 10%.  As a result, the quantity demanded decreases by 20%. In this case, the price elasticity of demand can be calculated as: Since the absolute value of PED is 2 (which is greater than 1), we can say that the demand for luxury watches is elastic. Why is demand elastic for luxury watches?  Availability of Substitutes: There are many other luxury brands or alternative luxury goods that consumers can purchase. If the price of one brand increases, they can switch to another.  Luxury Good Nature: For luxury items, price increases can lead to a significant reduction in demand because consumers may be willing to postpone or cancel their purchases when prices rise, especially since they often buy these goods for status rather than necessity.  High Price Sensitivity: Luxury goods are typically expensive, and a price increase can make them unaffordable or less attractive to potential buyers..

Dr. Clive Mairura ECON 101 2024 In summary, luxury goods often have elastic demand (PED > 1) because consumers can easily switch to alternatives, and the high price means they are more sensitive to price changes. When Price Elasticity of Demand (PED) is less than 1, it means that the demand for the good or service is inelastic. In this case, a change in price leads to a smaller percentage change in the quantity demanded. Consumers are relatively unresponsive to price changes for these products. Example of PED < 1 (Inelastic Demand) Example: Consider the market for insulin for people with diabetes.  Suppose the price of insulin increases by 10%.  As a result, the quantity demanded decreases by only 2%. In this case, the price elasticity of demand can be calculated as: Since the absolute value of PED is 0.2 (which is less than 1), the demand for insulin is inelastic. Why is demand inelastic for insulin?  Necessity: Insulin is a necessity for people with diabetes. They need it to regulate their blood sugar levels and maintain their health. As a result, a price increase does not lead to a significant reduction in demand.  Lack of Substitutes: There are few substitutes for insulin; people with diabetes typically rely on insulin regardless of its price, making them less sensitive to price changes.  Small Proportion of Budget (for some consumers): For many consumers, the cost of insulin, although important, might not represent a large enough portion of their overall budget to significantly affect their decision to purchase. Other Examples of Inelastic Goods (PED < 1) 1. Basic utilities like water or electricity: Even if the price increases, people need these services for daily living, and they can't easily reduce consumption without significant hardship. 2. Salt: A price increase in salt is unlikely to result in a significant reduction in the quantity demanded because it is a very low-cost and essential item..

Dr. Clive Mairura ECON 101 2024 3. Medications for chronic conditions: Similar to insulin, many essential medications have inelastic demand because people cannot easily forgo or substitute them. In summary, necessities or goods with few substitutes tend to have inelastic demand (PED < 1), meaning that consumers' purchasing decisions are less influenced by price changes. Example of PED = 1 (Unitary Elastic Demand) Let's consider the market for mid-range restaurant meals. Suppose the price of an average meal increases by 10%. As a result, the quantity demanded decreases by exactly 10%. In this case, the price elasticity of demand can be calculated as: Since the absolute value of PED is 1, we can say that the demand for mid-range restaurant meals is unitary elastic. Why is demand unitary elastic for mid-range restaurant meals?  Balanced Price Sensitivity: Consumers of mid-range restaurant meals are somewhat responsive to price changes, but not as highly sensitive as luxury goods consumers might be. A moderate price increase or decrease results in an equal percentage change in quantity demanded.  Availability of Substitutes: While consumers have options, like eating at home or choosing cheaper or more expensive restaurants, they tend to show moderate sensitivity to changes in mid-range meal prices, leading to unitary elasticity rather than a more elastic or inelastic response.  Discretionary Spending with Moderate Price-Quality Ratio: Mid-range meals are a discretionary purchase, but they are not high-end or necessary. This balance keeps the demand at unitary elasticity, as consumers adjust demand in direct proportion to price changes without extreme shifts in behavior. In summary, mid-range restaurant meals often have unitary elastic demand (PED = 1) because the balanced nature of substitutes, moderate price sensitivity, and discretionary nature of the purchase lead to a proportional change in quantity demanded relative to the price change..

Dr. Clive Mairura ECON 101 2024 Another example of calculations on cross-price elasticity of demand Cross-price elasticity of demand (CPED) measures the responsiveness of the quantity demanded of one good to a change in the price of another good. It is calculated using the following formula: Cross-price elasticity of demand (CPED) = The formula can also be expressed as: CPED = where:  QA = change in quantity demanded of Good A  QA = initial quantity demanded of Good A  PB = change in price of Good B  PB = initial price of Good B Example Calculation Suppose:  The initial quantity demanded for Good A (say, tea) is 100 units.  The initial price of Good B (say, coffee) is $5.  After the price of coffee rises to $6, the quantity demanded of tea increases to 120 units. Step 1: Find the percentage change in quantity demanded of Good A (tea). ΔQA=120−100=20 Percentage change in QA=20/100×100=20% Step 2: Find the percentage change in the price of Good B (coffee). ΔPB=6−5=1 Percentage change in PB=1/5×100=20% Step 3: Calculate the cross-price elasticity of demand. Cross-price elasticity of demand (CPED) = CPED = Interpretation.

Dr. Clive Mairura ECON 101 2024 Since the CPED is positive (1), this indicates that tea and coffee are substitute goods. A positive cross-price elasticity suggests that as the price of coffee increases, the demand for tea increases, meaning consumers substitute tea for coffee. A CPED of 1 implies a proportional relationship; a 1% increase in the price of coffee leads to a 1% increase in the demand for tea. An example of calculations on income elasticity of demand. Income elasticity of demand (IED) measures how sensitive the quantity demanded of a good is to a change in consumer income. It is calculated using the formula: Income elasticity of demand (IED) = The formula can also be expressed as: IED = where:  Q= change in quantity demanded  Q= initial quantity demanded  I = change in income  I = initial income Example Calculation Suppose:  The initial income of a consumer is $50,000 per year.  The initial quantity demanded of Good X (say, organic vegetables) is 200 units per year.  After the consumer’s income increases to $60,000, the quantity demanded of organic vegetables increases to 250 units. Step 1: Calculate the percentage change in quantity demanded. Q=250−200=50 Percentage change in quantity demanded=50/200×100=25% Step 2: Calculate the percentage change in income. I=60,000−50,000=10,000 Percentage change in income=10,000/50,000×100=20%.

Dr. Clive Mairura ECON 101 2024 Step 3: Calculate the income elasticity of demand. IED=Percentage change in quantity demanded/Percentage change in income IED = Interpretation Since the IED is positive (1.25) and greater than 1, this indicates that organic vegetables are a normal luxury good (or income-elastic good). For goods with IED > 1, demand increases more than proportionally as income rises. In this case, a 1% increase in income leads to a 1.25% increase in the quantity demanded for organic vegetables. LAW OF SUPPLY The Law of Supply states that, all else being equal, an increase in the price of a good or service will lead to an increase in the quantity supplied, and a decrease in price will lead to a decrease in quantity supplied. This direct relationship between price and quantity supplied is because higher prices generally provide an incentive for producers to supply more, as they can achieve higher revenues. KEY DETERMINANTS THAT CAUSE THE SUPPLY CURVE TO SHIFT: 1. Input Prices: If the cost of inputs (like raw materials, labour, or energy) decreases, production becomes cheaper, making it profitable to supply more at every price level. Conversely, if input costs rise, the supply curve will shift leftward as production becomes more expensive. 2. Technology: Advances in technology can enhance productivity and lower production costs, enabling firms to supply more at each price level. This results in a rightward shift of the supply curve. 3. Number of Suppliers: An increase in the number of suppliers in a market will increase the overall market supply, shifting the supply curve to the right. Conversely, if some suppliers exit the market, the supply curve shifts leftward..

Dr. Clive Mairura ECON 101 2024 4. Expectations of Future Prices: If suppliers expect prices to rise in the future, they may withhold some supply now, reducing current supply and causing a leftward shift. Conversely, if they expect prices to drop, they may increase current supply to sell at a higher price. 5. Government Policies (Taxes and Subsidies): o Taxes: Higher taxes on production make it more costly, leading to a leftward shift in the supply curve. o Subsidies: Subsidies lower the cost of production, allowing producers to supply more at each price level, causing a rightward shift. 6. Prices of Related Goods: If a producer can switch between goods (like a farmer choosing to plant either wheat or corn), an increase in the price of one good might lead to a decrease in the supply of the other as resources are reallocated. 7. Natural Factors: Events like natural disasters, weather conditions, and seasonal changes can affect the supply of certain goods, especially in agriculture. For example, a drought might decrease the supply of crops, shifting the supply curve to the left. In summary, any change in these non-price determinants causes the entire supply curve to shift, either to the right (increase in supply) or to the left (decrease in supply), indicating that more or less of the good is supplied at every price. . DETERMINING EQUILIBRIUM PRICE AND QUANTITY IN A MARKET Equilibrium in a Market: The equilibrium price and quantity in a market are determined where the quantity demanded (Qd) equals the quantity supplied (Qs). This point, where the demand curve intersects with the supply curve, represents the price at which consumers are willing to buy exactly the amount suppliers are willing to sell. 1. At Equilibrium Price (P): The price at which Qd = Qs. 2. At Equilibrium Quantity (Q): The quantity bought and sold at the equilibrium price. Diagram: A diagram showing the downward-sloping demand curve (D) and the upward- sloping supply curve (S) intersecting at a point where price and quantity are in balance. Impact of an Increase in Demand: When demand increases, the demand curve shifts to the right (D1). This shift results in a higher equilibrium price (P1) and quantity (Q1), as the new intersection point with the supply curve (S) indicates..

Dr. Clive Mairura ECON 101 2024  Example: A surge in demand for electric vehicles could drive up both the price and quantity supplied due to consumer preference shifts. Impact of a Decrease in Supply: When supply decreases, the supply curve shifts to the left (S1). The new equilibrium results in a higher price (P2) but a lower quantity (Q2) as the intersection point changes.  Example: A disruption in oil supply would decrease available quantity and raise fuel prices. In summary, an increase in demand or a decrease in supply generally leads to a higher equilibrium price. However, with an increase in demand, equilibrium quantity rises, whereas with a decrease in supply, equilibrium quantity falls. Distinction between cross-price elasticity of demand and income elasticity of demand. Cross-price elasticity of demand and income elasticity of demand are both measures of how sensitive the demand for a good is to changes in other economic factors. However, they focus on different influences and provide insights into different aspects of consumer behavior. Here’s a breakdown of their distinctions: Cross-Price Elasticity of Demand (XED)  Definition: Cross-price elasticity of demand measures how the quantity demanded of one good (Good A) changes in response to a price change in another good (Good B).  Formula:  Interpretation: o Positive XED: If XED is positive, the goods are substitutes. For example, if the price of tea increases, the demand for coffee may increase as consumers switch from tea to coffee. o Negative XED: If XED is negative, the goods are complements. For example, if the price of printers decreases, the demand for ink cartridges may increase since they are often used together..

Dr. Clive Mairura ECON 101 2024  Use Case: Helps businesses and policymakers understand the relationships between products, such as how a price change in one good (e.g., gasoline) might affect demand for another (e.g., cars). Income Elasticity of Demand (YED)  Definition: Income elasticity of demand measures how the quantity demanded of a good changes in response to changes in consumer income.  Formula:  Interpretation: o Positive YED (> 0): If YED is positive, the good is a normal good (demand rises as income increases).  Luxury Goods (YED > 1): Highly responsive to income changes (e.g., vacations, designer clothing).  Necessities (0 < YED < 1): Less responsive to income changes (e.g., basic groceries). o Negative YED (< 0): If YED is negative, the good is an inferior good (demand decreases as income increases). For example, as income rises, people might buy less instant noodles and more fresh groceries.  Use Case: Useful for businesses and economists to predict demand changes with economic growth or downturns and for understanding consumer preferences related to income levels. Key Differences Aspect Cross-Price Elasticity of Demand (XED) Income Elasticity of Demand (YED) What it Measures Response of demand for a good to price change in another good Response of demand for a good to changes in income Indicates Substitute or complementary relationship Normal or inferior good classification Value Interpretation Positive = substitutes, Negative = complements Positive = normal good, Negative = inferior good Primary Influence Price of related goods Income of consumers Applications Pricing strategies, bundling or cross-selling Forecasting demand based on.

Dr. Clive Mairura ECON 101 2024 economic growth, targeting income groups In summary, cross-price elasticity of demand focuses on the interrelationship between two products, while income elasticity of demand focuses on how changes in consumer income affect the demand for a single product. Both metrics help businesses understand consumer behavior but from different angles. With Examples, How can firms use these concepts to make pricing and production decisions? Firms can use cross-price elasticity of demand (XED) and income elasticity of demand (YED) to make informed pricing, production, and marketing decisions that align with consumer behavior and market conditions. Here’s how firms can apply these concepts with examples: 1. Using Cross-Price Elasticity of Demand (XED) Cross-price elasticity of demand helps firms understand the relationship between their product and related products, whether they are substitutes or complements. This knowledge allows firms to set competitive prices, create effective bundling strategies, and anticipate the impact of competitors’ pricing. Example 1: Competing Brands with Substitute Goods If a firm sells soda and determines that its XED with another soda brand is positive and high, they are substitutes. This means that if the competitor raises its price, demand for the firm’s soda may increase. Here’s how the firm might use this insight:  Pricing Decision: The firm could raise its price slightly to capture increased demand without risking significant customer loss.  Promotional Strategy: The firm could also offer discounts or run marketing campaigns during peak times for competitors, capitalizing on consumers’ willingness to switch to their brand. Example 2: Complementary Goods for Bundling If a firm produces printers and observes that the XED with ink cartridges is negative (indicating they are complements), it may decide to bundle these products.  Bundling Strategy: The firm could offer a bundle deal, providing a slight discount on cartridges when purchased with a printer. This encourages initial printer sales while increasing cartridge demand, leading to increased long-term revenue..

Dr. Clive Mairura ECON 101 2024  Production Planning: Knowing these goods are complementary, the firm could also plan production levels to ensure enough cartridges are available to meet the anticipated demand from printer buyers. 2. Using Income Elasticity of Demand (YED) Income elasticity of demand helps firms understand how demand for their products will change with variations in consumer income levels. This is especially valuable for targeting specific market segments, forecasting sales in economic upturns or downturns, and adjusting product lines. Example 3: Luxury vs. Necessity Goods For a company that produces luxury watches (a good with high positive YED, greater than 1), demand is very sensitive to income changes. During economic growth periods, demand for luxury goods tends to rise sharply as disposable income increases.  Pricing and Production Decision: The firm may increase production and maintain or even raise prices during economic booms, expecting demand to rise. They may also enhance marketing efforts to capture the attention of high-income consumers who are likely to spend more on luxury items.  Downturn Strategy: In contrast, during economic downturns, the firm might reduce production or promote lower-priced product lines to maintain some sales, knowing that demand will likely drop as incomes fall. Example 4: Inferior Goods and Recession-Proof Strategy A company that sells instant noodles (an inferior good with negative YED) may see an increase in demand during economic downturns when incomes fall, as consumers shift from more expensive foods to cheaper options.  Pricing and Production Strategy: During a recession, the firm may boost production to meet rising demand and possibly lower prices slightly to further attract cost- conscious consumers. Conversely, in economic booms, the firm could maintain lower production, knowing demand might shift away from instant noodles toward higher- quality food options.  New Product Lines: Recognizing income-driven demand, the firm might develop premium variations to cater to consumers with more disposable income during economic growth, providing flexibility in product offerings. Summary of Firm Strategies Based on XED and YED:.

Dr. Clive Mairura ECON 101 2024 Elasticity Type Firm Strategy Example Cross-Price Elasticity Pricing based on substitute products Raising soda prices if competitors increase theirs Bundling with complementary goods Offering printer-ink bundles Income Elasticity Adjusting production based on YED Increasing luxury watch production during booms Targeting lower-income consumers Promoting instant noodles during recessions By using XED and YED effectively, firms can tailor their pricing, production, and marketing strategies to optimize revenue based on consumer responses to related goods’ prices and income changes. These insights provide a competitive edge in both stable and fluctuating economic conditions. Consumer and Producer Surplus. Consumer Surplus Consumer surplus is the difference between what consumers are willing to pay for a good or service and what they actually pay. It represents the benefit or utility consumers receive when they purchase a product for less than the maximum price they are willing to pay. Mathematically, it can be expressed as: Consumer Surplus=Willingness to Pay−Market Price Graphically, consumer surplus is represented as the area between the demand curve and the market price level, up to the quantity purchased. In other words,.

Dr. Clive Mairura ECON 101 2024 Consumer surplus is represented graphically as the area under the demand curve and above the equilibrium price. This area is usually triangular in shape. Consumer surplus is the monetary gain that a buyer receives when they pay less than they were willing to pay for a good or service. It increases when the price of a good decreases and decreases when the price of a good increases. Consumer surplus can be measured by calculating the difference between the maximum willingness to pay and the actual price for each consumer, and then summing those differences. Example 1. Let's illustrate consumer surplus with an example: Imagine a small market where three consumers are each willing to pay different amounts for a single unit of a product. Their maximum willingness to pay for one unit of this product is as follows: 1. Consumer A: willing to pay $50 2. Consumer B: willing to pay $40 3. Consumer C: willing to pay $30 Now, suppose the actual market price for this product is set at $25. To calculate the consumer surplus for each consumer:  Consumer A’s surplus: $50 (maximum willingness to pay) - $25 (actual price) = $25  Consumer B’s surplus: $40 - $25 = $15  Consumer C’s surplus: $30 - $25 = $5 Adding these individual surpluses together gives the total consumer surplus in this market: 25+15+5=4525 + 15 + 5 = 4525+15+5=45 So, the total consumer surplus for this product in the market is $45. This surplus represents the benefit consumers gain because they pay less than the maximum amount they were willing to pay. Example 2 Imagine you want to buy a concert ticket. You're willing to pay $100 for it because you love the artist. But when you check the price, it’s only $70. You buy the ticket and save $30 compared to what you were ready to spend. That $30 is your consumer surplus. Key Idea:  It’s the “extra value” you feel you got because the price was lower than what you thought it was worth..

Dr. Clive Mairura ECON 101 2024  Consumer surplus is the extra satisfaction or benefit you get when you buy something for less than what you were willing to pay.  It is the benefit or "extra happiness" a consumer gets when they buy something for less than the maximum amount they were willing to pay for it. Example 3. Imagine you really want to buy a pair of shoes and are willing to pay up to $100 for them. You go to the store and find the exact pair you want, but the price tag says $70. You buy the shoes and save $30 compared to what you were willing to pay. That $30 is your consumer surplus. Key Points: Consumer Surplus Formula: Consumer Surplus = Willingness to Pay− Actual Price Paid Why Does It Matter? It measures how much "extra value" consumers feel they get from a purchase. The larger the consumer surplus, the happier consumers are with the price they paid. Graphically: In a demand curve, consumer surplus is the area between the demand curve (representing willingness to pay) and the price line, up to the quantity purchased. Example 4 Suppose some fans buy concert ticket as follows: Willingness to Pay Price Paid Consumer Surplus $120 $70 $50 $100 $70 $30 $80 $70 $10 Total Consumer Surplus: Add up all individual surpluses: 50+30+10=90 Producer Surplus Producer surplus is the difference between what producers are willing to accept for a good or service and the price they actually receive. It reflects the benefit producers gain from selling at a market price that is higher than their minimum acceptable price. Mathematically, it can be expressed as: Producer Surplus = Market Price−Willingness to Accept.

Dr. Clive Mairura ECON 101 2024 Graphically, producer surplus is represented as the area between the supply curve and the market price level, up to the quantity sold. This area forms a triangle on the graph. Producer surplus is the extra money, utility, or benefits a producer receives when they sell a product at a price higher than their minimum acceptable price. The supply curve represents the minimum acceptable price for producers. In other words, Producer surplus is measured and represented graphically by the area above the supply curve and below the equilibrium price. Producer surplus can be measured by calculating the difference between the minimum acceptable price and the actual price for each unit sold, and then summing those differences. Let’s go through an example of producer surplus to make this concept clearer. Suppose a small market has three producers, each willing to accept a different minimum price to sell a unit of a product, due to differences in production costs or profit expectations: 1. Producer X: minimum acceptable price is $10 2. Producer Y: minimum acceptable price is $15 3. Producer Z: minimum acceptable price is $20 Now, let’s say the market price for this product is $25. To calculate the producer surplus for each producer:  Producer X’s surplus: $25 (actual price) - $10 (minimum acceptable price) = $15  Producer Y’s surplus: $25 - $15 = $10  Producer Z’s surplus: $25 - $20 = $5 Adding these individual surpluses together gives the total producer surplus in this market: 15+10+5=3015 + 10 + 5 = 3015+10+5=30.

Dr. Clive Mairura ECON 101 2024 So, the total producer surplus for this product in the market is $30. Let’s work through another example of total surplus, which is the sum of both consumer surplus and producer surplus in a market. Suppose we have the following setup in a small market: Consumer Side Three consumers are each willing to pay the following maximum amounts for a product:  Consumer A: willing to pay $50  Consumer B: willing to pay $40  Consumer C: willing to pay $30 The market price for the product is $25. Consumer Surplus for each consumer:  Consumer A: $50 - $25 = $25  Consumer B: $40 - $25 = $15  Consumer C: $30 - $25 = $5 The total consumer surplus is: 25+15+5=45 Producer Side Three producers are willing to accept the following minimum prices to sell the product:  Producer X: minimum acceptable price is $10  Producer Y: minimum acceptable price is $15  Producer Z: minimum acceptable price is $20 Since the market price is $25, each producer’s surplus is:  Producer X: $25 - $10 = $15  Producer Y: $25 - $15 = $10  Producer Z: $25 - $20 = $5 The total producer surplus is: 15+10+5=30 Total Surplus The total surplus is the sum of the consumer and producer surpluses:.

Dr. Clive Mairura ECON 101 2024 Total Surplus = Consumer Surplus + Producer Surplus=45+30=75 Summary In this example, the total surplus in the market, which reflects the overall economic benefit, is $75. This represents the total value that consumers and producers gain due to the transaction occurring at a market price of $25. Therefore This surplus represents the additional benefit producers receive because the market price is higher than the minimum amount they were willing to accept. Figure 1. Consumer and Producer Surplus. The somewhat triangular area labeled by F shows the area of consumer surplus, which shows that the equilibrium price in the market was less than what many of the consumers were willing to pay. Point J on the demand curve shows that, even at the price of $90, consumers would have been willing to purchase a quantity of 20 million. The somewhat triangular area labeled by G shows the area of producer surplus, which shows that the equilibrium price received in the market was more than what many of the producers were willing to accept for their products. For example, point K on the supply curve shows that at a price of $45, firms would have been willing to supply a quantity of 14 million. Shifts in supply and demand can affect consumer and producer surplus in the following ways: Consumer surplus.