If you're seeing this message, it means we're having trouble loading external resources on our website.

If you're behind a web filter, please make sure that the domains *.kastatic.org and *.kasandbox.org are unblocked.

Main content
Current time:0:00Total duration:11:29
MKT‑4 (EU)
MKT‑4.A.4 (EK)
MKT‑4.A.5 (EK)

Video transcript

what we're going to do in this video is think about the market for chocolate and we're gonna think about supply and demand curves but we're gonna get an intuition for them in a slightly different way in particular for the demand curve we will think about the idea of marginal marginal benefit now marginal benefit when we talk about margin it's really thinking about what 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 if you imagine if there was no chocolate but there's people in the market who craved 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 because they get that much benefit or if they paid less than $50 let's say they paid ten dollars for it well then they're getting 40 dollars of extra benefit of kind of surplus benefit from being able to get it at a price lower than their marginal benefit but then let's say the 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 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 is well what's just the 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 they're saying oh well the chocolates 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 chocolate it out and they give 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 thought about it in terms of marginal benefit now on the supply side there's a related idea we're gonna think about marginal cost marginal cost so let's say at first there's no chocolate being produced in this market and 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 gonna 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 that the first units of chocolate it's at the marginal cost to produce it is actually quite low but once you utilize those folks you utilize that darling factory utilize those free cocoa bushes or whatever cocoa trees well then you got to plant new ones you got to train new employees you got to build a new factory and so to produce that next increment well that's gonna cost a little bit more and then a little bit more and then a little bit more which is the general trend in most in most markets initially that first amount you produce in this cheap away using the low-hanging fruit as possible but then you gotta go up the tree find higher and higher fruit I'm 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 hey Sal that's a marginal cost curve but once again this is 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 we 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 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 gonna say hey wow I can produce this cheaply people have a people get a lot of benefit for they'd be definitely willing to pay $10 a pound wherever I am if people are getting this much benefit they're definitely going be willing to pay $10 for it so I'm gonna produce some or actually I'm gonna 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 when we talked about just supply and demand we talked 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 gonna have this cost you're gonna have this cost 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 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 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 the society would be incurring more incremental cost per unit than they would be getting a 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 sub zero this is this quantity is considered allocative Li efficient allocative Li efficient which is a very fancy word allocative Li 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 q1 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 it could have had but it does not get this is called a deadweight loss dead weight loss and we talked about it in other videos remember in the allocated Li 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 allocated Li efficient quantity your marginal benefit is higher than your marginal cost and you are leaving you're leaving all of this total surplus on the table regardless of how you would have actually allocated it or distributed it between the consumers and the producers and what if you produced a quantity larger than the allocated Li efficient quantity once again very fancy word so let's say that's q2 what happens over here well here you you are able to take advantage of all of this surplus right over here this 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 a net negative benefit or a net I guess I would 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 and not just our suppliers are pressing this 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 two would be considered this two would be considered a dead let me write that in a color you can see a dead weight loss deadweight loss we often assume it was hey we're leaving some total surplus on the table but we also have deadly 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 marginal benefit we are going to produce deadweight loss in either situation and a properly functioning market should be producing the quantity that is allocated li efficient in an ideal world and of course all of our models assume a lot of assumptions to make the things a little bit cleaner so we can do lines to describe market behavior
AP® is a registered trademark of the College Board, which has not reviewed this resource.