[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

Thinking Like an Economist
EXCHANGE AND DISTRIBUTION
The concepts of consumer surplus and producer surplus
remind us that exchange in competitive markets can benefit
both buyers and sellers. The demand curve for a good shows
the total willingness to pay for each unit of the good. Though
consumers are willing to pay more for the marginal unit at
lower quantities, all units are purchased at the market price,
which reflects the value of the last unit purchased. Thus, the
total utility of the units purchased by consumers is greater
than the total cost to consumers. Similarly, the supply curve
reflects the marginal cost of producing each unit of a good.
The market equilibrium price will equal the marginal cost
of the last unit produced. Because marginal cost increases
as the firm produces more, the price the firm receives is
greater than the marginal cost of producing every unit except
the last.
Consumer surplus and producer surplus also remind us
that exchange has distributional effects. The gains from
exchange need not be evenly distributed. If demand is relatively
elastic while supply is inelastic, consumer surplus is
small while producer surplus is large. If demand is relatively
inelastic while supply is very elastic, consumer surplus is large
while producer surplus is small.
Changes in preferences are reflected quickly—through the operation of demand
and supply curves—in changes in prices. These changes are then translated by firms
into changes in production. Assume that the economy is initially producing at point
E along the production possibilities curve in Figure 10.4. Consumers decide that
they like SUVs more and sedans less. The increased demand for SUVs will result in
the price of SUVs increasing, and this price rise will lead to an increased output of
SUVs; at the same time, the decrease in demand for sedans will result in the price
of sedans falling, and this change in turn will lead to a decreased output of sedans.
The economy will move from E to a point such as E 1 , where there are more SUVs
and fewer sedans produced; the mix of goods produced in the economy will have
changed to reflect the changed preferences of consumers.
Wrap-Up
THREE CONDITIONS FOR PARETO EFFICIENCY
1. Exchange efficiency: Goods must be distributed among individuals in a way
that leaves no scope for gains from further trade.
2. Production efficiency: The economy must be on its production possibilities
curve.
3. Product-mix efficiency: The economy must produce a mix of goods reflecting
the preferences of consumers.
224 ∂ CHAPTER 10 THE EFFICIENCY OF COMPETITIVE MARKETS