Consumer Surplus and Producer Surplus

The additional benefits enjoyed by consumers pay less than they are willing to pay and by producers who sell for a price higher than they are willing to sell for are known as consumer and producer surplus. Together they make up the “total welfare” of a market. This lesson introduces and explains these concepts, important for understanding what makes the market system effective at meeting society’s wants and needs.

 

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Why does Supply slope upwards? (The law of increasing opportunity cost and supply)

In a previous lesson we introduced the law of supply and the determinants of supply, but we never clearly explained WHY there is a direct relationship between price and quantity supplied. In this lesson we will connect the law of supply to a law introduced in an earlier lesson on the PPC and the Law of Increasing Opportunity Costs.

The concept of increasing marginal costs of production will be explained and the link between firms’ marginal costs and supply will be established in this lesson.

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The Law of Demand (NEW 2016)

Our study of market economies requires us to examine both the demand-side and the supply-side of product and resources markets. Buyers and sellers interact with one another to engage in mutually beneficial exchanges in a market economy, and prices are set based on the demand and supply for a particular good, service or resource. This video lesson presents the law of demand, and explains how the demand curve can illustrate this fundamental economic concept.

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The Law of Increasing Opportunity Cost and the PPC Model

In a previous lesson we introduced the basic economic concepts of scarcity, opportunity cost, and the production possibilities curve (PPC). In that lesson, we examined the tradeoffs an individual faces in the use of her time between “work” and “play”. We showed that the opportunity cost of one hour of work is always the one hour of play that the individual could have enjoyed instead.

The constant opportunitiy cost between work and play is illustrated in the PPC model as a straight line production possibilities curve. In this lesson, we will expand our understanding of the PPC and opportunity costs by examining the tradeoff a nation faces between the production of two goods using its scarce resources. Cars and pizzas require very different resources to produce, and therefore, as the production of one good increases, the opportunity cost of its production in terms of the other good increases.

The result is a PPC that is bowed outwards from the origin. When choosing between the production of two goods, the more similar the resources needed to produce each good, the straighter the PPC will be. The less similar the resources needed to produce each good, the further the PPC will be bowed out from the origin.

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The Circular Flow Model of a Market Economy

By this point in your course you may have learned the definition of a market: A place where buyers and sellers meet to engage in mutually beneficial exchanges. But what is a market economy? Two basic types of markets exist in any market economy: resource markets and product markets. The exchanges that take place in these markets benefit both the households and the firms that engage in exchanges.

This lesson will introduce the circular flow of money, resources and goods and services in a market economy. We will examine how resources flow from households to firms, and goods and services from firms to households. We will also seek to explain why individuals are willing to engage in the exchanges that characterize the market system.

To order practice activities on this and other lessons from the Econ Classroom, click here.

For student revision guides and teacher PowerPoints, click here.

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Scarcity, Opportunity Cost and the Production Possibilities Curve

The basic economic problem is one rooted in both the natural world and in human greed. We live in a world of limited resources, but we seem to have unlimited wants. This results in scarcity, which gives rise to the very field of Economics, which deals with how to allocate scarce resources between the competing wants and needs of society.

This lesson will introduce these basic economic concepts, along with the first (and perhaps the most useful) graph an Economics student will learn, the Production Possibilities Curve.

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The Tragedy of the Commons as a Market Failure

One notable form of market failure arises due to a phenomenon first articulated by American ecologist Garrett Hardin, who warned of the Tragedy of the Commons. In his 1968 essay, Hardin explained that when there exist common resources, for which there is no private owner, the incentive among rational users of that resources is to exploit it to the fullest potential in order to maximize their own self gain before the resource is depleted. The tragedy of the commons, therefore, is that common resources will inevitably be depleted due to humans’ self-interested behavior, leaving us with shortages in key resources essential to human survival.

In this video lesson the market failure of common access resources is explained and applied to three such resources being depleted in an unsustainable manner by the world’s people today: fish in the seas, trees from the forests and air in our atmosphere.

After watching this video, you may find the following blog posts particularly useful in learning and understanding what makes common resources a market failure:

 

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Negative Externalities of Consumption as a Market Failure

Sometimes a good’s consumption imposes costs on third parties not involved in the market. Such situations are evidence of a type of market failure known as negative consumption externalities. This lesson introduces the key terms and diagrams required to analyze such market failures and provides several examples and potential solutions.

Part 1:

Part 2:

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Calculating the Effects of Price Controls

This lesson applies linear equations for demand and supply to our analysis of the effects of price controls. We can determine the precise surplus that will result from a price floor or the shortage that results from a price ceiling by applying the government set prices to the equations for supply and demand.

Before watching this video students should view the lesson that introduces price controls, Determining the Effects of Price Ceilings nad Price Floors.

 

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Determining the Effects of Price Ceilings and Price Floors

This video lesson examines the effect of two types of government interventions in the markets for particular goods. Price ceilings and price controls consist of maximum or minimum prices imposed by government, intended to help either the consumers or the producers of particular goods. Like many forms of government intervention, price controls have unintended consequences that usually make them inefficient, and reduce total welfare in affected markets.

In this lesson we will look at two real world examples of price controls: the market for butter in Europe, in which European governments enforce a price floor intended to help butter producers, and the market for petrol in China, in which the Chinese government enforces a price ceilings meant to help consumers. Once you have watched the videos, follow the links below two blog posts about these two examples, and respond to the discussion questions at the end of the posts.

 

Price controls on the blog:

  1. The problem with price controls in Europe’s agricultural markets
  2. Price controls in the Chinese Petrol market – or why you may have to wait in line to fill your gas tank!

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Calculating the Effects of a Subsidy

This lesson explains how to calculate the effects of a per unit subsidy in a commodity market (in this case corn) using linear demand and supply equations. By employing demand and supply equations, we can determine how a per unit subsidy will effect supply, and then we can calculate the new equilibrium price and quantity. To extend our analysis, we can calculate the increase in consumer and producer surplus, the total cost to taxpayers of the subsidy, and thereby the net cost of the subsidy to society as a whole.

 

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The Effects of a Subsidy on Market Equilibrium

This video lesson illustrates and explains the effects that a per unit subsidy will have on the market for a commodity, in this case, corn. The payment to producers from government lowers the marginal cost of production, increases supply and leads to lower prices for consumers and greater revenues for producers. However, subsidies are not always economically efficient, since as we will see, the cost to taxpayers may outweigh the benefit to producers and consumers, meaning a subsidy may result in a net loss of societal welfare.

 

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Examining the effect of an excise tax on an inelastic good – Cigarettes

This video lesson explains how a specific excise tax will affect the equilibrium price and quantity in the market for cigarettes, which is used to represents a good for which demand is relatively inelastic. We will also explain how the tax burden is shared by both producers and consumers, and the portion of the tax born by consumers depends on the elasticity of demand for the product.

 

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