Consumers, Producers and The Efficiency of Markets.
To begin the study of welfare economics we must look at the benefits buyers receive from
participating in the market.
Welfare Economics: The study of how the allocation of resources affects economic well being.
Willingness to Pay
Willingness to pay: the maximum amount that a buyer will pay for a good
This determines the buyer’s consumer surplus for the good.
Consumer Surplus: A buyer’s willingness to pay minus the amount the buyer actually pays.
The greater the gap between the actual price and the price the buyer is willing to pay, the greater
the consumer surplus is and the more beneficial it is to participate in the market.
Using the Demand Curve to Measure Consumer Surplus
For an individuals consumer surplus:
You subtract the price of the good from the buyer’s willingness to pay
For the entire market’s consumer surplus:
The area below the demand curve and above the price measures the consumer surplus.
How a Lower Price Raises Consumer Surplus
When the price goes down the consumer surplus goes up
How much can be calculated by calculating the difference in area between the original triangle
and the new triangle.
(See Page 150, Figure 7.3 for clearer example)
What Does Consumer Surplus Measure?
The goal in developing the concept of consumer surplus is to be able to make normative
judgments about the desirability of market outcomes. If policy makers choose to favor the best interest of the buyer’s they will wish to create a higher
In most markets, consumer surplus does reflect the economic wellbeing.
The benefits sellers receive from participating in a market
Cost and Willingness to Sell
The sellers willingness to sell depends on the cost it is to do the job or produce the good.
Cost: the value of everything a seller must give up to produce the good.
The seller will take no less than the cost of everything they gave up to produce the good.
The seller would be happy to take more (increasing their producer surplus)
Producer Surplus: the amount a seller is paid for a good minus the seller’s cost
Using the Supply Curve to Measure Producer Surplus
To create the graph you use the cost of the sellers
The area above t