Consumer Surplus in Welfare Economics

Consumer Surplus

• Welfare economics studies how resource allocation affects economic well-being. Resource allocation refers to how much of each good is produced, which producers produce it, and which consumers consume it.
• Willingness to Pay (WTP) is the maximum amount a buyer will pay for a good. It represents the value a buyer places on a good.
• Example: Willingness to pay for a textbook varied based on the buyer (Beanie-$200, Mitch-$150, Frank-$100). If the price is $150, only Beanie and Mitch would buy it.

Consumer Surplus (CS)

• Consumer Surplus (CS) calculates the difference between the value a buyer places on a good and the price they pay.
• Mathematically, CS is the area between the demand curve and the price.
• Example (from graphic): The area under the demand curve, but above the price, represents consumer surplus.

Producer Surplus

• Cost is the value of everything a seller gives up to produce a good, including opportunity cost.
• Willingness to Sell (WTS) is the minimum price a seller is willing to accept for a good; this may be considered the seller's cost.
• Example: Willingness to sell tutoring services varied across individuals (Beanie-$30/hr, Mitch-$20/hr, Frank-$10/hr). If the price is $25, Beanie and Mitch will provide tutoring services.
• Producer Surplus measures the difference between the price a seller receives and their willingness to sell. This is represented on a graph by the area between the price and the supply curve.

Market Efficiency

• In a market economy, resource allocation is decentralized and determined by buyers and sellers interacting.
• The market's allocation of resources may not always be desirable. Another allocation may be better for society.
• Total surplus is a measure of society's well-being, used to evaluate whether the market allocation is efficient. Efficiency refers to maximum total surplus. Goods are consumed by buyers who value them most, and are produced by producers with the lowest costs. Making a small change to the production or consumption of a good, would not increase total surplus.
• Social Planner is a theoretical entity that aims for maximum total surplus in society.

Price Controls

• Price controls, including price floors and ceilings, change how the market allocates resources and can negatively affect the market when used in the wrong circumstances.

Evaluating Price Controls

• Markets often allocate resources effectively through prices (invisible hand).
• Price controls, while intending to help the poor, can often cause negative outcomes, such as misallocation of resources, shortages, or surpluses. Key concepts of consumer and producer surplus, total surplus, price ceilings, deadweight loss, and market failure are critical for evaluating the impact of these controls.