ECON 1B03 Lecture Notes - Lecture 3: Economic Surplus, Competitive Equilibrium

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10 Jun 2018

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Economic Welfare: Total Surplus and Deadweight Loss

Total Surplus = Consumer Surplus + Producer Surplus

Consumer Surplus = Value to Buyer – Amount buyer pays

Producer Surplus = Amount Sellers receive – Cost to sellers

In equilibrium, Since Amount buyer pays = Amount sellers receive

Total Surplus = Value to Buyers – Cost to Sellers

In summary, free markets do 3 things:

1. Allocate the supply of goods to the buyers who value them most highly (have the highest

willingness to pay)

2. Allocate the demand for goods to the producer who can produce them at least cost

3. Produce the quantity of goods that maximizes the sum of consumer and producer surplus

(equilibrium quantity)

- The total suplus tiagle a’t e ay igge tha it is he the aket is at euiliium

- Total surplus is maximized at equilibrium

- The equilibrium outcome is the efficient outcome

Deadweight Losses

- Whenever the market outcome is in equilibrium, total surplus is maximized

- But it’s ot alays the ase that the aket is i a opetitie euilibrium

- A loss in total surplus happens when the quantity tradde is less than what would be

traded when the market is in competitive equilibrium (less than eqilbrium quantity)

Example: Consider the Price of P1

- Consumers only want to buy Q1 (short side dominates, only Q1 will be sold)

- Q1< QE

- Total surplus is now only the yellow triangle and blue trapezoid

- At P1 only Q1 is traded in the market

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Total surplus = consumer surplus + producer surplus. Consumer surplus = value to buyer amount buyer pays. Producer surplus = amount sellers receive cost to sellers. In equilibrium, since amount buyer pays = amount sellers receive. Total surplus = value to buyers cost to sellers. The total su(cid:396)plus t(cid:396)ia(cid:374)gle (cid:272)a(cid:374)"t (cid:271)e a(cid:374)y (cid:271)igge(cid:396) tha(cid:374) it is (cid:449)he(cid:374) the (cid:373)a(cid:396)ket is at e(cid:395)uili(cid:271)(cid:396)ium. Whenever the market outcome is in equilibrium, total surplus is maximized. But it"s (cid:374)ot al(cid:449)ays the (cid:272)ase that the (cid:373)a(cid:396)ket is i(cid:374) a (cid:272)o(cid:373)petiti(cid:448)e e(cid:395)uilibrium. A loss in total surplus happens when the quantity tradde is less than what would be traded when the market is in competitive equilibrium (less than eqilbrium quantity) Consumers only want to buy q1 (short side dominates, only q1 will be sold) Total surplus is now only the yellow triangle and blue trapezoid. At p1 only q1 is traded in the market.