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Welfare Analysis

Now that we know the basic principals that affect the market supply and demand curves, we can turn our attention to the welfare analysis of the market and see how the economic value  is divided between the producers and the consumers.
  • Consumer surplus is the difference between the price a consumer is willing to pay and the current market price. The consumer surplus is equal to the area bounded from above by the demand curve and bounded from below by the equilibrium price.
  • Producer Surplus is the difference between the price a producer is willing to sell and the current market price. This is equal to the area bounded from above by the equilibrium market price and bounded from below by the supply curve.
  • Total economic surplus is the sum of consumer and producer surpluses. It is maximized at the equilibrium price and quantity point.
  • Dead-weight loss is the sum producer and consumer surplus that could have been achieved had the equilibrium price and quantity prevailed in the market. Therefore, if the current price is the market clearing price, there is no dead-weight loss in the market.

Example: 

In this first example, the total economic surplus is maximized. The quantity and price are determined by the intersection of the supply and demand curve.

In the second graph, we see that due to a per unit tax, the supply curve shifts to the left.  A dead-weight loss is created (the triangle area between Qt and QE) and part of the consumer and producer surplus now goes to government. The area is denoted as "Government Surplus", and represents the total revenue created by the tax. Due to the dead-weight loss,  the total economic surplus is smaller than before.


 Reference: Mayer,David. AP Microeconomics Crash Course. Research & Education Association (2014). p 65-66.

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