2 Describe the choices that consumers make and explain why consumers are efficient on the market demand curve. We can use what you have learned about the decisions made by consumers and competitive firms and market equilibrium to describe an efficient use of resources.

Choices Consumers allocate their budgets to get the most value possible out of them. We derive a consumer’s demand curve by finding how the best budget allocation changes as the price of a good changes. So consumers get the most value out of their resources at all points along their demand curves. If the people who consume a good or service are the only ones who benefit from it, then the market demand curve measures the benefit to the entire society and is the marginal social benefit curve.

Competitive firms produce the quantity that maximises profit. We derive the firm’s supply curve by finding the profit-maximising quantity at each price. So firms get the most value out of their resources at all points along their supply curves. If the firms that produce a good or service bear all the costs of producing it, then the market supply curve measures the marginal cost to the entire society, and the market supply curve is the marginal social cost curve.

Equilibrium and Efficiency Resources are used efficiently when marginal social benefit equals marginal social cost. Competitive equilibrium achieves this efficient outcome because, with no externalities, price equals marginal social benefit for consumers, and price equals marginal social cost for producers.

The gains from trade are the consumer surplus plus the producer surplus. The gains from trade for consumers are measured by consumer surplus, which is the area below the demand curve and above the price paid (see Chapter 5, p. 107). The gains from trade for producers are measured by producer surplus, which is the area above the supply curve and below the price received (see Chapter 5, p. 109). The total gains from trade are the sum of consumer surplus and producer surplus. When the market for a good or service is in equilibrium, the gains from trade are maximised.