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: real vs nominal gross domestic product

Nominal GDP:   A nominal GDP measures the value of a nation's output produced in a year, given the prices charged for that year. However, if prices increase while the output level stays constant in a given year, the nominal GDP will drastically increase, even though the level of production is equal to that of the previous year. Estimating real GDP: To determine the actual change in output from one year to the next, we must adjust the nominal value of a country's output in a year based on changes in the average price level during that year.  Inflation is when the price level increases, whereas deflation is when the price level is decreasing. To determine whether the nominal GDP overestimates or underestimates the output of a country, one must know whether the average price level has increased or decreased. In order to achieve this task can use a price index known as the GDP deflator. The GDP deflator: Real GDP is calculated by replacing the prices for that current year with tho...
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: the money market and loanable funds market

  The money market: The money market combines the supply of money and the demand for money for a country. The supply curve (Sm) is inelastic and is determined by the central bank. The demand curve (Dm) is the horizontal summation of the asset and transaction demand curves and is sloping downward. The intersection between the Sm and Dm is the equilibrium interest rate for a country. A change in the nominal interest rate implies that either or both curves (i.e Sm and Dm) have shifted to the right or left. An increase in nominal GDP (P*Y) will lead to an increase in the transaction demand for money which will shift the total demand (Dm) to the right. The nominal interest rate goes up. A decrease in the level of output (Y) will shift the Dm curve to the left. The Sm curve will shift whenever the central bank decides to change the money supply due to a monetary policy decision. The Fed expands the supply of excess reserves in commercial banks, by purchasing bonds from banks, Sm shi...
Post a Comment
Read more