Economics: Surplus and Deadweight Loss

Economic Surplus

• Market surplus is the sum of the surplus of each quantity exchanged
• Consumer surplus is the difference between the maximum price a consumer is willing to pay for a good and the price they actually pay.
• Producer surplus is the difference between the minimum price a producer is willing to accept for a good and the price they actually receive.
• Economic surplus is the sum of consumer surplus and producer surplus.

Deadweight Loss

• Deadweight Loss is the value of economic surplus forgone when the market is not adjusted to its competitive equilibrium.
• When there is underproduction, it could be caused by price controls (ceiling or floor) or taxes.
• When there is overproduction, it could be caused by a subsidy.

Price Controls and Deadweight Loss

• When a price floor is set at 100, consumer surplus decreases, producer surplus increases, and deadweight loss occurs.
• When a price ceiling is set at 40, consumer surplus increases, producer surplus decreases, and deadweight loss occurs.

Tax and Deadweight Loss

• Tax Revenue is part of Economic Surplus.
• Tax Revenue comes from producer and/or consumer surplus.
• Tax revenue is collected by the government when a tax is imposed on a good.
• The government collects tax revenue, but also creates deadweight loss.

Subsidy and Deadweight Loss

• A subsidy is essentially a negative tax, and it is funded by economic surplus in the market for another good.
• Deadweight loss is the area of the triangle to the right of the equilibrium quantity.

Productive vs. Allocative Efficiency

• Productive efficiency is achieved when production is at the lowest average total cost, or when the economy is producing on the production possibilities frontier (PPF).
• Allocative efficiency is achieved when the marginal benefit (MB) of production equals the marginal cost (MC).
• Allocative efficiency is achieved at the competitive equilibrium level of production.