Welfare Economics Chapter 7 Consumer Producer Surplus CONSUMER

Welfare Economics Chapter 7: Consumer & Producer Surplus

CONSUMER SURPLUS • Consumer Surplus (CS) = measures the welfare of the buyer • CS = maximum price a buyer is willing to pay minus price paid • Demand Curve = Marginal Benefit Curve – CS = MB – Price Paid

Demand Schedule & the Demand Curve Demand curves depicts the quantity buyers are willing to pay at each price Consumers value goods differently The demand curve is essentially a marginal benefit curve

Individual Consumer Surplus Price of Album @ Equilibrium Price = $70 $100 John’s consumer surplus ($30) 80 Paul’s consumer surplus ($10) P 1 70 Total 50 consumer surplus ($40) Demand 0 1 2 3 4 Quantity of Albums

Total Consumer Surplus Price $200 A The triangle above current market price is the“welfare” of all consumers Total Consumer Surplus @ $100 price = $10 Consumer Surplus $100 B ½ * 1 * 20 = $10 C D 1 = MB 1 0 20 Quantity [½ base * height]

Consumer Surplus Handout • Please complete Consumer Surplus worksheet

Producer Surplus • Producer Surplus (PS) = measures the welfare of the seller • PS = price received minus minimum price firms will sell good/service • Supply = Marginal Cost Curve – PS = Price Received - MC

Rising Prices & Producer Surplus Price Supply = MC Additional producer surplus to initial producers P 2 P 1 D E As Price Producer Surplus F B Initial producer surplus C Producer surplus to new producers A 0 Q 1 Q 2 Quantity

Welfare Economics is the study of whether a market allocation is socially desirable (MB = MC) • equilibrium maximizes total welfare for society unless there is a market failure – (i. e. externalities, price fixing, etc…) S = Marginal Cost (MC) D = Marginal Benefit (MB)

EFFICIENCY vs. EQUITY • Efficiency = an allocation which maximizes the Total Surplus – Total Surplus = Consumer Surplus + Producer Surplus • Equity = the fairness of the distribution of well-being among the various buyers and sellers – Equity is not addressed in free markets • Market equilibrium quantity maximizes *Total Welfare – * assuming no market failures such as externalities, price collusion, fraud, etc….

Producer Surplus & Total Welfare & Surplus are interchangeable terms ( i. e. Total Welfare is same as Total Surplus)