Consumer Surplus, Producer Surplus, and Market Efficiency

1
Consumer Surplus, Producer Surplus, and Market
Efficiency
2
Welfare Economics

• Welfare economics the study of how the
  allocation of resources affects economic
  well-being
• Transition from positive analysis to normative
  analysis

3
Consumer Surplus

• Consumer surplus (CS) the area below the demand
  curve and above the price line
• CS Total WTP total expenditure
• A measure of consumer(s) well-being

4
Producer Surplus

• Producer surplus (PS) the area above the supply
  curve and below the price line
• PS Total revenue (TR) variable costs (VC)
• A measure of producer(s) well-being
• Relationship between profit and PS?
• Profit TR TC TR (FC VC)
• Not the same if FC 0

5
Efficiency

• Total surplus TS CS PS
• Measure of consumer(s) and producer(s) well-being
• Efficiency the property of a resource allocation
  of maximizing the TS received by all members of
  society
• Efficiency is the normative criteria of economics

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Perfectly Competitive Markets are Efficient

• The equilibrium price and quantity (P,Q)
  maximize total surplus
• Proof by contradiction
• If Q TS is lower
• If Q Q, there is a DWL and TS is lower
• Must be true that Q and therefore P maximize TS
• This is Adam Smiths Invisible Hand at work

7
Concepts Relating Efficiency and Equity

• Pareto efficiency a situation where no one can
  be made better-off without making someone else
  worse-off
• Pareto improvement a change that makes at least
  one individual better-off without making anyone
  else worse-off
• Potential Pareto improvement a change that makes
  some people better-off by enough that they could
  compensate any losers so that no one is made
  worse-off