ECON 205 1st Edition Lecture 4 Outline of Last Lecture Effects of Taxes on Buyers and Sellers Outline of Current Lecture Market Allocation of Resources Customer s Willingness to Pay Free Market vs Government Intervention Costs of Taxation Current Lecture Welfare Economics Allocation of resources is o How much is produced o Who the producer is o Who the consumer is Willingness to Pay WTP and the Demand Curve Each point on demand curve is a consumer represents consumer s WTP WTP is the consumer s value for the good Consumer surplus amount buyer is willing to pay minus the amount the buyer actually pays o CS WTP P CS is the area between the Price and Demand curve from zero to Q And increase in price causes a decrease in consumer surplus Cost and the Supply Curve Cost is all resources including the value of the seller s time that go into producing a good Producer Surplus PS the amount a seller is paid for a good minus the cost of producing the good o PS P cost o A k a profit Total PS is the area above the supply curve and under the price from zero to Q Total Surplus CS PS o Total gains from trade in a market o Value to buyers minus the cost to sellers Market Allocation of Resources In a market economy allocation is decentralized o Determined by interaction between self interested buyers and sellers Total surplus is a measure of society s well being o Measures the efficiency of market allocation Efficiency maximizes total surplus and occurs when o Goods are purchased by those who value them most highly o Goods are produced by producers with the lowest costs o Efficiency comes with market equilibrium If you force overproduction will create negative surplus Adam Smith and the Invisible Hand When individuals act in their own self interest they end up benefiting the whole of society and are therefore led by an invisible hand Free Market vs Government Intervention Laissez faire government doesn t interfere with the market o allow them to do in French to allocate resources efficiently and maximize total surplus as an outside source would need to know every seller s cost and every buyer s WTP for each good in the entire economy o impossible o this is why Central Planning doesn t work Costs of Taxation Deadweight Loss DWL fall of total surplus resulting from a market distortion such as a tax o Happens because it decreases the quantity sold