Equilibrium, allocative efficiency and total surplus

Summary

This video explores the market for chocolate through the lens of supply and demand, focusing on marginal benefit and marginal cost. It illustrates how the initial high marginal benefit of chocolate decreases as more becomes available, forming the demand curve. Similarly, the video shows how marginal cost increases with production, shaping the supply curve. The intersection of these curves represents an allocatively efficient market outcome, maximizing surplus benefit without deadweight loss.

Takeaways

• 🍫 Marginal benefit reflects the additional benefit a consumer gets from purchasing one more unit of a product, such as chocolate.
• 📉 As the quantity of chocolate increases, the marginal benefit tends to decrease since initial cravings or needs are satisfied.
• 💵 Consumer surplus occurs when buyers pay less than their marginal benefit, receiving extra value.
• 🏭 Marginal cost represents the additional cost of producing one more unit, and tends to increase as cheaper resources are exhausted.
• 📊 The supply curve can be viewed as the marginal cost curve in a market, reflecting rising costs as more chocolate is produced.
• 📈 Total surplus is the area between the marginal benefit and marginal cost curves, showing the benefit the market gets from consumption.
• ⚖️ Allocative efficiency occurs when marginal benefit equals marginal cost, indicating no more benefit can be derived from additional production.
• 🚫 Producing less than the allocatively efficient quantity results in deadweight loss, leaving surplus unachieved.
• ❌ Producing more than the efficient quantity also causes deadweight loss, with costs outweighing the benefits.
• 🔄 A properly functioning market aims to produce the allocatively efficient quantity to maximize total surplus and minimize deadweight loss.

Q & A

What is the concept of marginal benefit as discussed in the video?

Marginal benefit refers to the additional benefit a consumer receives from consuming one more unit of a good, such as chocolate. In the video, it's explained that the marginal benefit for the first unit of chocolate could be very high, like $50 per pound, because of the intense craving for it.

How does the marginal benefit change as more chocolate becomes available?

As more chocolate becomes available, the marginal benefit decreases because the initial intense craving or need for chocolate is satiated. People are still willing to consume more, but they are not as excited about each additional unit as they were about the first one.

Can you explain the concept of surplus benefit as it relates to the chocolate market?

Surplus benefit refers to the difference between the total benefit consumers receive from consuming chocolate and the total cost producers incur to produce it. When the marginal benefit is greater than the marginal cost, there is surplus benefit, indicating that producing more chocolate would be beneficial.

What is the relationship between marginal benefit and the demand curve?

The marginal benefit curve is essentially the same as the demand curve. It shows the maximum price consumers are willing to pay for each additional unit of a good, which is a reflection of their marginal benefit.

What is meant by allocative efficiency in the context of the chocolate market?

Allocative efficiency occurs when the quantity of chocolate produced is such that the marginal benefit equals the marginal cost. This is the point where no surplus benefit is left on the table, and no deadweight loss is incurred, making the allocation of resources efficient.

How does the marginal cost of producing chocolate change as more chocolate is produced?

As more chocolate is produced, the marginal cost increases. Initially, production might be cheap using existing resources like a derelict factory or wild cocoa bushes. However, as these resources are used up, new investments like planting new trees or training new employees become necessary, increasing the cost.

What is the significance of the intersection point of the marginal benefit and marginal cost curves?

The intersection point of the marginal benefit and marginal cost curves represents the allocatively efficient quantity of chocolate production. At this point, the market maximizes surplus benefit, and no additional production would increase overall welfare.

What is a deadweight loss in the context of the chocolate market?

A deadweight loss occurs when the quantity of chocolate produced is either less than or more than the allocatively efficient quantity. If less, the market is leaving surplus benefit on the table. If more, the market is incurring a net negative total surplus, as the marginal cost exceeds the marginal benefit.

Why is it not efficient to produce more chocolate once the marginal cost exceeds the marginal benefit?

Producing more chocolate when the marginal cost exceeds the marginal benefit results in a deadweight loss. This is because the cost of producing each additional unit is greater than the benefit consumers receive from it, leading to a net loss for society.

How does the video script illustrate the concept of consumer surplus?

The script illustrates consumer surplus by explaining that if consumers pay less than their marginal benefit for chocolate, they receive extra benefit, or surplus benefit, from the transaction. This surplus is the area between the demand curve (marginal benefit) and the price they actually pay.

What role does the supply curve play in determining the allocatively efficient quantity of chocolate?

The supply curve, which is based on marginal cost, plays a crucial role in determining the allocatively efficient quantity. It shows the cost of producing each additional unit of chocolate. The allocatively efficient quantity is found where the supply curve (marginal cost) intersects with the demand curve (marginal benefit).

Outlines

00:00

🍫 Understanding the Chocolate Market's Demand Curve

The first paragraph introduces the concept of the market for chocolate using supply and demand curves with a focus on marginal benefit. It explains how the marginal benefit, or the benefit received from consuming an additional unit of chocolate, decreases as more chocolate becomes available. Initially, the benefit is high, as those who crave chocolate are willing to pay a premium for it, but as the market becomes saturated, the marginal benefit diminishes. The area under the marginal benefit curve represents the total benefit the market receives from consuming chocolate. This curve is equivalent to the demand curve in the chocolate market, with price plotted against quantity.

05:00

📈 The Relationship Between Marginal Benefit, Cost, and Surplus

The second paragraph delves into the concept of surplus benefit, which is the difference between the total benefit to the market (represented by the area under the marginal benefit curve) and the cost of production (represented by the area under the marginal cost curve). It discusses how suppliers will continue to produce as long as there is surplus benefit, meaning the marginal benefit exceeds the marginal cost. The point at which the marginal benefit equals the marginal cost is considered allocatively efficient, where no surplus benefit remains, and it's not economically efficient to produce more. Beyond this point, producing additional units results in a net negative benefit, known as a deadweight loss, because the cost of production exceeds the benefit received.

10:00

📉 Deadweight Loss and Allocative Efficiency

The third paragraph further explores the implications of producing at quantities that are not allocatively efficient. It explains that if production is less than the allocatively efficient quantity, there is a deadweight loss because the market is leaving potential surplus benefit on the table. Conversely, if production exceeds the allocatively efficient quantity, the market incurs a net negative total surplus, also a deadweight loss, because the marginal cost of production is higher than the marginal benefit. The paragraph concludes by emphasizing the importance of a properly functioning market in achieving allocative efficiency, which is an ideal state where resources are allocated optimally.

Keywords

💡Marginal Benefit

Marginal Benefit refers to the additional satisfaction or utility a consumer gains from consuming one more unit of a good or service. In the context of the video, it's used to explain how the first units of chocolate are highly valued, with the example given that someone might be willing to pay $50 for the first pound due to their intense craving for it. As more chocolate becomes available, this marginal benefit decreases because the initial strong desire is satisfied.

💡Demand Curve

A Demand Curve illustrates the relationship between the price of a good and the quantity demanded by consumers at various price levels. The video describes the demand curve for chocolate by relating it to the concept of marginal benefit, suggesting that as the price decreases (or as the quantity increases), the marginal benefit per pound of chocolate also decreases.

💡Quantity

In the script, 'quantity' refers to the amount of a product, such as chocolate, that is available in the market. The concept is integral to understanding how the marginal benefit changes with different quantities. For instance, a small quantity of chocolate might have a high marginal benefit due to scarcity, whereas an abundant quantity would have a lower marginal benefit.

💡Marginal Cost

Marginal Cost is the cost of producing one additional unit of a good. The video uses the example of a chocolate factory to explain how the marginal cost starts low when utilizing existing resources like a derelict factory and wild cocoa bushes but increases as new resources must be developed, such as planting new trees and training new employees.

💡Supply Curve

The Supply Curve shows the amount of a good that producers are willing to supply at various prices. The video equates the supply curve to the marginal cost curve, indicating that producers will supply more chocolate as long as the marginal cost is less than the marginal benefit, thus maximizing profit.

💡Surplus Benefit

Surplus Benefit is the difference between the value consumers place on a good (marginal benefit) and the cost of production (marginal cost). The video suggests that as long as there is surplus benefit, it's profitable for suppliers to produce more chocolate. This surplus is represented by the area between the marginal benefit and marginal cost curves.

💡Allocative Efficiency

Allocative Efficiency occurs when the quantity of a good produced and sold in a market equals the quantity that maximizes the difference between consumers' marginal benefits and producers' marginal costs. The video points out that at the intersection of the marginal benefit and marginal cost curves, the market achieves allocative efficiency, which is the optimal level of production for societal welfare.

💡Deadweight Loss

Deadweight Loss is the decrease in economic efficiency that occurs when the quantity of a good or service produced is not the allocatively efficient quantity. The video explains two scenarios for deadweight loss: when the quantity produced is less than the allocatively efficient quantity (leaving surplus benefit on the table) and when it's more (incurring a net negative benefit).

💡Market Equilibrium

Market Equilibrium is the state where the quantity demanded by consumers equals the quantity supplied by producers at a given price. The video implies that market equilibrium is achieved when marginal benefit equals marginal cost, which is the point where no surplus benefit remains to incentivize further production.

💡Price

Price in the video refers to the cost at which consumers can purchase a good, such as chocolate. It's a key determinant of the quantity demanded and supplied. The video discusses how price interacts with marginal benefit and marginal cost to influence the quantity of chocolate that is produced and consumed.

💡Consumer Surplus

Consumer Surplus is the difference between what consumers are willing to pay for a good and what they actually pay. The video suggests that consumers receive a surplus when they can purchase chocolate at a price lower than their marginal benefit, indicating they receive more value than they pay for.

Highlights

Introduction to the concept of marginal benefit in the context of the chocolate market.

Explanation of how marginal benefit is quantified in terms of willingness to pay.

Description of how marginal benefit decreases as more of a product becomes available.

Illustration of the relationship between marginal benefit and quantity using a rectangle analogy.

Introduction of the demand curve as a representation of marginal benefit.

Discussion on the supply side and the concept of marginal cost.

Explanation of how marginal cost increases as production scales up.

Construction of a marginal cost curve as a representation of the supply curve.

Analysis of surplus benefit as the area between the marginal benefit and marginal cost curves.

Identification of the efficient price and quantity in the market.

Explanation of how production continues as long as marginal benefit exceeds marginal cost.

Identification of the point of intersection between marginal benefit and marginal cost as allocatively efficient.

Discussion of deadweight loss when production is less or more than the allocatively efficient quantity.

Explanation of the concept of deadweight loss in both underproduction and overproduction scenarios.

Emphasis on the importance of a properly functioning market in achieving allocative efficiency.

Caution about the assumptions underlying economic models and their simplifications.

Transcripts

- [Instructor] What we're going to do in this video

is think about the market for chocolate

and we're going to think about supply and demand curves,

but we're going to get an intuition

for them in a slightly different way.

In particular for the demand curve

we will think about the idea of marginal benefit.

Now marginal benefit, when we're talking about margin

it's really thinking about, well,

what happens on the increment?

What happens for each little extra that you do?

So this is saying, what is the benefit that I get

if I get a little bit more of, in this case, chocolate?

Well, from the market's point of view,

imagine if there was no chocolate,

but there's people in the market who

crave chocolate, who dream of chocolate.

If all of a sudden they were able to

get their hands on some chocolate,

they would get a huge benefit for

that incremental amount of chocolate.

Maybe for these folks, their benefit,

which we could quantify as, in terms of dollars,

maybe their benefit is 50 dollars per pound.

One way to think about it, they'd be willing

to pay 50 dollars because they get that much benefit,

or if they paid less than 50 dollars,

let's say they paid 10 dollars for it,

well then they're getting 40 dollars of extra benefit

a kind of surplus of benefit from being able to get it

at a price lower than their marginal benefit.

But then let's say more chocolate becomes available.

People still like it but some of that really deep need,

that deep addiction for chocolate has been satiated,

and so the marginal benefit tends for, in most markets,

the marginal benefit tends to go down as quantity increases.

One way to think about it, that first initial amount

of quantity if you, so we have some small amount

of quantity right over here, I'll say delta quantity.

That first quantity, if you multiply it times

the marginal benefit, well that gives you an area

roughly of a rectangle like this, it's not quite

rectangular at the top, it's more of a trapezoid

if this is downward sloping, but you could

approximate it as a rectangle.

But either way, the area right over here,

the area under the marginal benefit curve,

you could think about this as, well,

that's just the benefit that the market is getting

from consuming this chocolate in this case.

And so let's just continue on this trend.

If there's more and more chocolate

the market will get benefit from it,

but people aren't as excited about it anymore.

They're saying, oh, well, the chocolate's around,

yeah, it'd be nice to have a little bit more,

but I don't need so much more.

And at some point people might be

all chocolated out, and they have maybe

even zero marginal benefit from

that incremental amount of chocolate,

chocolate has filled up the town,

there's nowhere to actually put it.

Now that won't always be the case,

you might go someplace like that,

but either way you think about it

we would view this as our marginal benefit curve.

And notice, this is exactly the same as

a demand curve in the market for chocolate.

We have plotted price versus quantity

in the market for chocolate, but we've thought

about it in terms of marginal benefit.

Now on the supply side there's a related idea,

we're going to think about marginal cost, marginal cost.

So let's say at first there's no chocolate

being produced in this market.

And a savvy entrepreneur says, hey,

I know some folks who are addicted to chocolate,

they would get a lot of benefit from it,

so I'm going to try to produce some chocolate.

And they look around and they find out,

hey, there's actually a derelict chocolate factory

in town that no one is using and it's surrounded

by these wild cocoa bushes that are perfect for chocolate.

And there are some people in town

who are actually unemployed, but they are

amazing at producing chocolate.

And so the first units of chocolate,

the marginal cost to produce it is actually quite low.

But once you utilize those folks,

you utilize that derelict factory,

you utilize those free cocoa bushes or whatever,

cocoa trees, well then you've got to plant new ones,

you've got to train new employees,

you've got to build a new factory.

And so to produce that next increment,

well that's going to cost a little bit more and then

a little bit more and then a little bit more,

which is the general trend in most markets.

Initially that first amount you produce in as cheap a way,

using the low hanging fruit, as possible,

but then you've got to go up the tree,

find higher and higher fruit, maybe I'm mixing metaphors.

But your cost, your marginal cost per unit

goes higher and higher and higher.

Now, what have we constructed here?

Well you might say, hey, Sal, that's a marginal cost curve.

But once again, this also could be viewed as

the supply curve for this particular market.

Now what is happening at these

low quantities right over here?

Well, the cost of production is,

let's say they produce this delta Q amount,

the cost of production would be the area

right over here under the marginal cost curve,

that would be the cost of production.

But they're able to sell it,

the benefit to the market I should say,

would be the total area under this red curve,

would be the benefit to the market,

the total area under this curve.

So if you have the total benefit to the market,

you take out the cost, then what you have

in between these curves, you could view this

as a surplus, you could view this as

a surplus of benefit right over here.

So let me write this down, this is surplus,

and you won't hear this term but I like to use it,

because it makes it intuitive on what

we're talking about, this is surplus benefit.

So as long as there's surplus benefit

the suppliers are going to say, hey, wow,

I can produce this cheaply, people have a,

people get a lot of benefit for it,

they'd be definitely willing to pay

10 dollars a pound wherever I am.

If people are getting this much benefit,

they're definitely going to be willing

to pay 10 dollars for it.

So I'm going to produce some, or actually

I'm going to produce some and I could even charge,

I could charge anywhere in between these areas.

Maybe I could charge right over here

and I get some of the benefit and then

the consumers get some of the benefit.

But then another maybe entrepreneur realizes, hey,

well, there's more benefit to be had

in this market, so they keep producing,

they keep producing as long as there is benefit here,

as long as the marginal benefit is

higher than the marginal cost, all the way until

we get to that point right over here.

Now what happens, what happens right over here?

Well we talked about just supply and demand,

we talk about that's an efficient price

and efficient quantity, but let's just think about,

we said up until this point it makes sense

to produce more and more and more.

Even this increment, if we're already at this quantity,

it makes sense to produce even a little bit more

because you're going to have this cost,

you're going to have this cost to incur,

but then the market could have all of this,

the market could have all of this benefit,

which is larger than the cost.

And so you say, well, as long as I sell it

for something in between we can split

that surplus benefit, so to speak.

But once these two lines intersect

and we have the situation where our marginal benefit,

marginal benefit, is equal to our marginal cost,

well at that point there is no surplus benefit

now to be had, there's no really

incentive to produce more than this.

Beyond this point, your incremental cost of production,

your marginal cost is higher than your marginal benefit.

So, if you actually wanted to give it to someone

for their benefit, you would be taking a loss.

Or even if you just think about the market itself,

the society would be incurring more

incremental cost per unit than they would

be getting of benefit, so why even do it?

And so this point right over here

where these two lines, these two curves intersect

and we've talked about this with just supply and demand,

but when we think about it in terms of marginal benefit

and marginal cost, we think about this quantity

right over here, let's just call it Q subzero,

this quantity is considered allocatively

efficient, allocatively efficient.

Which is a very fancy word, allocatively efficient.

Why is that the case?

Well, any other quantity would not be efficient.

For example, let's say for some reason we were at

this quantity right over here, let's say Q, Q one.

Well what happens at this quantity right over here?

Well, at this quantity, at this quantity right over here,

the marginal benefit is higher than the marginal cost.

Marginal benefit is greater than the marginal cost.

And so we're leaving a bunch of stuff on the table,

the market is leaving a bunch of surplus benefit,

you could say total surplus, on the table.

And so this benefit that the market could have had,

but it does not get, this is called a deadweight loss,

deadweight loss, and we talk about it in other videos.

Remember, in the allocatively efficient quantity

we have this huge total surplus,

which is the area under the marginal benefit curve

and above the marginal cost curve

up until the point of intersection.

But if you do a quantity less than that

allocatively efficient quantity,

your marginal benefit is higher than

your marginal cost, and you are leaving,

you are leaving all of this total surplus on the table,

regardless of how you would have actually allocated it

or distributed it between the consumers or the producers.

And what if you produced a quantity larger

than the allocatively efficient quantity?

Once again, very fancy word, so let's say

that's Q two, what happens over here?

Well, here you're able to take advantage

of all of this surplus right over here,

this total surplus right over here,

but now you're creating negative surplus.

So, in this part, now all of this area shows

a net negative benefit, or a net I guess I should say

a net cost that our market is incurring.

And so this here it was a deadweight loss because

we were leaving stuff on the table that we could have had.

Here we're producing at a cost that our market,

not just our suppliers are producing at a cost,

the benefit our market is getting

is less for each incremental unit,

is less than, or is far less than the cost

and so we are incurring a net negative total surplus.

And so this, too, would be considered,

this, too, would be considered a dead, let me write that

in a color you can see, a deadweight loss.

Deadweight loss we often assume it was, hey,

we're leaving some total surplus on the table,

but we also have deadweight loss in the case

where we are producing unnecessarily

because the benefit is less than the actual cost.

And so whether our marginal benefit is greater

than our marginal cost, or in this case

our marginal cost is greater than our marginal benefit,

we are going to produce deadweight loss in either situation.

And a properly functioning market should be

producing the quantity that is allocatively efficient.

In an ideal world and of course all of our models assume

a lot of assumptions to make things a little bit cleaner,

so we can do lines to describe market behavior.