Econ Notes: Chapter 7 Welfare Economics- Recall, the allocation of recourse refers to:o How much of each good is producedo Which producers produce ito Which consumers consumes it- Welfare economics studies how the allocation of resources affects economicwell being.Willingness to Pay (WTP)A buyer’s willingness to pay for a good is the maximum amount the buyer will pay for that good. WTP measures how much the buyer values the good. ** see notes for chart, looks like a staircase- If there were a huge #of buyers as in a competivie market, there would be a huge # of very tiny steps.- At any Q, the height of the D curve is the WTP of the marginal buyer, the buyerwho would leave the market if P were any higher. Consumer Surplus- Consumer Surplus it the amount a buyer is a willing to pay minus the amountthe buyer actually pays:o CS= WTP-Po Suppose P=260 Flea’s CS=300-260=40 The others get no CS because they do not buy an iPod at this price.At Q=5(thousand), the marginal buyer is willing to pay 50 for a pair of shoes.Suppose P=30CS=50-30=20CS is the area above P and below the D curve, from 0 to QRecall area of the triangle .5bh- Height= 60-30=30- CS= .5x15x30= 225How a Higher Price Reduces CSIf P rises to 40$, Q=10CS=.5x10x20=100Two reasons for the fall in SC1. Fall in CS due to buyers leaving the market (little triangle)2. Fall in SC due to reaming buyers paying higher P ( rectangle)Cost and the Supply Curve- Cost is the value of everything a seller must give up to produce a good (i.e. opportunity cost).- Includes coast of all resources used to produce good, including value of the seller’s time.- Ex. Cost of 3 sellers in the lawn-cutting business.o A seller will produce the g/s if the prices exceeds of her cost.o Hence, cost is a measure of willingness to sell.o Name o Costo Jack o $10o Janet o $20o Chrissy o $35o Jack is most efficient o See noteso At each Q, the height of the S curve is the cost of the marginal seller, the seller who would leave the market if the price were any lower. Producer Surplus- PS=P-cost- Producer Surplus (PS): the amount a seller is paid for a good minus the seller’s cost. o Suppse P=$25 Jacks’s PS= $15 Janet’s PS= $5 Chrissy’s PS= $0 Total PS= $20- PS with Lots of Sellers and A Smooth S curve- PS is the area b/w P and the S curve from 0 to Q- CS and PS are monetary Two reason for the fall in PS1. Fall in PS due to sellers leaving the market (small triangle)2. Fall in PS due to remaining sellers getting lower P (rectangle)CS, PS and Total Surplus- CS= values to buyers- amount by buyerso = Buyers’ gains from participating in the market- PS= amount received by the sellers- cost to sellerso = Sellers gains from participating in the market- Total surplus= CS+PCo = total gains from trade in a markero = value to buyers- cost to sellersEfficiency Total Surplus = value to buyers- cost to sellers.An allocation of resources is efficient if it maximizes total surplus. Efficiency means:- The goods are consumed by the buyers who value them most highly- The goods are produced by the producers with the lowest costs.- Raising or lowering the quantity of a good would not increase total surplus. Which Buyers Consume the Good?Every buyer whose WTP is > 30 will buyThe buyers who value the good most highly are the ones who consume it. Whick Sellers Produce the Good?Every seller whose cost is < 30 will produce the good.Every seller whose cost is >30 will not. The seller with the lowest cost produce the goodDoes Eq’m Q Maximize Total Surplus?Producing to much: Can Increase total surplus by reducing QProducing to little: Can increase total surplus by increasing QThe Market eq’m maximizes total surplus: At other quantity, can increase totalsurplus by moving toward the market eq’m