Skip to main content

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.

Labels:

Comments

Post a Comment

Popular posts from this blog

Macroeconomics: equilibrium in the AD/AS model

Real output and price level in the AD/AS model: The short run equilibrium in the AD/AS model, is when the  intersection between the short run aggregate supply curve and the aggregate demand curve determines the level of output and price level.          This short equilibrium output can be compared to the full-employment (i.e long run equilibrium) output by adding the long run aggregate supply curve in the graph.  If the difference between the short run equilibrium output and full employment output is negative than we have a recessionary gap. This could be caused by a decrease in households' consumption, a fall in private investments, or a decrease in government spending. If the difference is positive, we have an inflationary gap, where the short run equilibrium output is bigger than its full employment output. This can be caused by an increase in households expenditures, expansionary fiscal policy, etc... If the gap is zero, this means that t...
Post a Comment
Read more

Microeconomics: Firms and cost in the short run

In Economics, the term short run refers to a time period where at least one variable of interest does not change . In our case, the short run for a firm is when at least one input  (labor, land, capital) stays fixed. Usually land and capital are considered fixed in the short run.  If an input is fixed during a period time, no matter how much the total product a firm produces, its cost stays the same. This cost is commonly known as fixed cost (FC). Examples of fixed costs: rent, property taxes, loan payments. Labor is often considered to be a part of the  variable cost (VC) . Variable cost can be defined as the cost a firm has control over during the short run. Unlike fixed cost, variable cost increases (decreases) as a firm's total product increases (decreases). Examples of variable costs include: utility bills, wages, raw materials A firm's total cost (TC) is the sum of its variable and fixed costs. As you can see, the fixed cost...
Post a Comment
Read more

Macroeconomics: balance of payments accounts

Balance of payment is the sum of three separate accounts and must always be equal to 0 (given no statistical error): Current account: the net flow of funds exchanged for goods and services, and monetary gifts  that flow in and out of a country. This is often used as an indicator for net export. Financial account: also known as the capital account, is the net flow of funds for investment in real assets (direct investments) or financial assets (stocks or bonds) into a nation. Official reserves: in order to balance the two accounts above, a country must have a reserve of foreign money. It measures the net effect of all money flows from the other accounts. If the current account is positive, it must be the case that the sum of the financial account and official reserves is negative. Current account (CA) components: Balance of trade in goods: spending by consumers and firms on imported and exported goods. Exported goods have a positive effect on the current account, whereas importe...
Post a Comment
Read more