Welfare Analysis Consumer Surplus Producer Surplus Welfare Analysis

Welfare Analysis Consumer Surplus; Producer Surplus Welfare Analysis of Tax; Welfare Analysis of Price Control

Economic Efficiency • A situation is economically inefficient if there is some way to change it so that someone gains while no one else loses. • A change is a Pareto improvement if at least one person gains and no one loses • A change is economically efficient if the winners could compensate the losers by enough to make the change a Pareto improvement.

Assessing Benefits • • • Consumer Sovereignty “Willingness to Pay” = Consumer Benefit Consumer Surplus “Willingness to Sell” =Opportunity Cost Producer Surplus

Consumer Surplus -- Difference between Willingness to Pay and Price Paid by Buyer Price r 1 r 2 r 3 r 4 P 0 Demand 1 2 3 4 5 Quantity

Consumer Surplus Is Triangle Below Demand, Above Market Price Consumer Surplus P 0 Demand 5 Quantity Total Expenditure

Producer Surplus- Difference Between Opportunity Cost and Selling Price t 5 t 4 t 3 t 2 t 1 P 0=t 5 1 2 3 4 5 Quantity

Producer Surplus Price Supply P 0=t 5 Producer Surplus Quantity

Consumer and Producer Surplus - Market Equilibrium Price Consumer Surplus Supply P 0 Producer Surplus Q 0 Demand Quantity

Reduce Output: Winners can not compensate losers. Price Supply A B C D E F P 1 A - New CS A+B+E - Old CS C+D+F - Old PS B+C+D - New PS P 0 Demand Q 1 Q 0 Quantity Suppliers gain B-F, but consumers lose B+E.

Analyze the Following • • Impact of Price Ceiling on Efficiency Impact of Price Floor on Efficiency Impact of Sales Tax on Efficiency Impact of a Subsidy on Efficiency

Impact of Price Ceiling on Efficiency Demand A+B+C -- New CS A+B+E -- Old CS D -- New PS C+D+F -- Old PS Supply A B C D E F Market Clearing Price Ceiling E+F is the Deadweight Loss Associated with Price Ceiling

Impact of Price Floor on Efficiency A -- New CS A+B+E -- Old CS B+C+D -- New PS C+F+D -- Old PS Supply A Price Floor B E F C Market clearing price D Demand Q 1 Q 0 E+F is deadweight loss associated with the price floor.

SUMMARY • Market Equilibrium is Efficient. No Deadweight Loss. • Price controls create a deadweight loss • Also, there are costs associated with rationing mechanisms, black markets etc.