Lecture Principles of Microeconomics: Chapter 6 - James D. Miller

Lecture Principles of Microeconomics: Chapter 6 - Wealth creation and destruction. After reading this chapter, you should be able to answer the following questions: What is wealth? What creates wealth? How is wealth destroyed? What is consumers’ surplus? What is producers’ surplus? When is total surplus to society maximized? What is deadweight loss? How do government set prices, taxes and subsidies create deadweight loss? How do innovations affect a market economy?

Chapter 6

Wealth Creation And Destruction

Learning Objectives

• What is wealth?

• What creates wealth?

• How is wealth destroyed?

• What is consumers’ surplus?

• What is producers’ surplus?

• When is total surplus to society maximized?

• What is deadweight loss?

• How do government set prices, taxes and

subsidies create deadweight loss?

• How do innovations affect a market economy?

• The total wealth of society is the sum of

each individual's wealth.

• Money transfers have no effect on the

wealth of society.

Wealth Creation

• Voluntary trade increases wealth of

society since it moves goods to someone who places higher value on them.

• Production as well as trade can increase wealth.

• Trade allows the manufacturer to produce goods A manufacturer will only sell a

good for more than it costs to increase

wealth and buyer will only pay an amount less than what the good is worth to her.

Wealth Creation

• The growth rate of wealth creation over

the long run is the most important force

shaping a society

Destruction Of Wealth By Governments

• Taxes reduce trade by eliminating incentives of some

buyers as well as sellers as a tax raises consumer’s

price and lowers producer’s price

Subsidies:

• Subsidies destroy wealth by encouraging wastage and misallocation of resources

Destruction Of Wealth By Governments

Forced sharing:

Theft:

someone who places higher value on them

Eminent domain

= Power of a government to take private property

abuse the power of eminent domain for their own use

Willingness To Pay And Demand

• The maximum

amount consumers

are willing to pay for

goods determine the

height of demand

curves.

Consumer’s Surplus

• The difference between

the most that consumers

are willing to pay for a

good and its price

= Net benefit that

consumers receive after

buying a good

• The greater the

consumer’s surplus, the

better off the consumers

are

Most willing to pay

Consumer’s surplus if price =$2

Consumer’s Surplus

• Total consumer’s

surplus

= The area between the

demand curve and

surplus to old consumers Consumers’

surplus to new consumers

Demand Equilibrium

Production Cost And Supply

• The cost of producing

goods determines the

height of supply

curves.

Producer’s Surplus

• The difference between

the price and the cost of

producing a good

= Net benefit that producers

receive after selling a

good

• The greater the

producer’s surplus, the

better off producers are

Producer’s Surplus

• Total producer’s

surplus

= The area between the

supply curve and

price.

Market price Price

Quantity Supply Equilibrium

= Loss of wealth because of

some lost trades

= Net loss of resources to

= Loss of wealth because of

some lost trades.

• Additional deadweight loss of

government created shortage

because of the opportunity

cost of time for waiting

9,000 3,000

Consumers’

surplus

Deadweight Loss

Producers’ surplus

Government set price

Supply

Demand

$6

Wealth Maximizing Equilibrium

Y X

Supply

Demand

• To maximize the wealth

of society, the goods

must be produced only if

the demand curve is

above the supply curve

• Producing too much of a

good means that the

resources used to make

the good could be better

used elsewhere

Supply, Demand And Taxes

• Raises tax revenue

for the government.

Price consumers pay

Price producers receive Deadweight Loss

Deadweight Loss of Tax

• The deadweight loss of the tax is caused by

consumers no longer buying some goods that they value more than it costs to produce.

• By causing market to under produce, tax

destroys society’s wealth.

• Any tax is shared by both consumers and

producers regardless of on whom it is imposed.

Supply, Demand and Subsidies

Deadweight Loss

• Increases quantity of goods

where supply curve is above

the demand curve

• Creates deadweight loss to

society by overproducing

goods and wasting resources

Innovation

• Economic growth is driven by innovations Innovations create wealth.

• Markets do an extraordinary job of

promoting wealth and creating

innovations.

• Marketplace innovations include small

improvements to existing products along with major innovations in development of new products.

Innovation

• Markets ration resources to only those

potential innovations that will appeal to

consumers.

• Markets send signals to innovators

allowing them to correct their errors.

• Innovations in production can eliminate

some jobs, yet society as a whole gains

wealth from these job-destroying

technologies by freeing up resources.

Freedom and Wealth Creation

• Markets make magnificent coordinators of economic activities.

• History shows that free market economies produced vastly more wealth than

centrally planned economies.

• Central planners can never match the

wealth creating abilities of a free economy.

Do You Know?

• How can one person giving a good to another increase the total wealth of society?

Voluntary trade increases the wealth of society The

person buying a good places higher value on it than the person selling it Thus both people have net gains

increasing society's wealth

• What is total surplus?

Total surplus is the sum total of the net benefits all

consumers and all producers gain from trade and the

value society gets from production and consumption of a good

• Why does the marketplace promote innovations?

Innovations create wealth, improve welfare of people and promote economic growth

Summary

• Value of a good is the most its owner

would pay for it.

• An individual’s wealth is the value of all his possessions.

• Trade, production and innovation create

wealth.

• Wealth can be destroyed by various

government controls and interference

• Consumer’s surplus = The maximum price consumer

would have paid – Actual price

• Producer’s surplus = The good’s price – The cost to the seller of making the good

• Total surplus = Consumer’s surplus + Producer’s surplus

• Total surplus is maximized at the supply and demand

Coming Up

Why do we trade?