Welfare Economics Economicsis the study of how the allocation Welfare of resources affects economic well being Buyers and sellers receive from taking part in the market in the market results in maximum benefits and therefore maximum total welfare for both the consumers and the producers of the product Welfare Economics measures economic welfare from the buyer s side measures economic welfare from the seller s side Demand Curve and Willingness to Pay Price 3 00 2 50 2 00 1 50 1 00 0 50 0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity 1 CONSUMER SURPLUS willingness to pay is the maximum amount that a buyer is willing to pay for a good that buyer values the good It measures how much or service CONSUMER SURPLUS Surplus is the buyer s willingness to pay Consumer for a good minus the amount the buyer actually pays for it The area below and above measures the consumer surplus in the market How the Price Affects Consumer Surplus a Consumer Surplus at Price P Price A Consumer surplus P1 B C Demand 0 Q1 Quantity 2 How the Price Affects Consumer Surplus b Consumer Surplus at Price P Price A Initial consumer surplus P1 C Consumer surplus to new consumers B F P2 D E Additional consumer surplus to initial consumers 0 Demand Q1 Q2 Quantity PRODUCER SURPLUS Producer Surplus is the amount a seller is paid for seller s cost a good minus sellers It measures the benefit to participating in a market Supply Curve Marginal Cost Curve Price 3 00 2 50 2 00 1 50 1 00 0 50 0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity 3 Using the Supply Curve to Measure Producer Surplus below The area below and above supply curve measures the producer surplus in a market How the Price Affects Producer Surplus a Producer Surplus at Price P Price Supply P1 B C Producer surplus A 0 Q1 Quantity How the Price Affects Producer Surplus b Producer Surplus at Price P Price Supply Additional producer surplus to initial producers P2 P1 D E F B Initial producer surplus C Producer surplus to new producers A 0 Q1 Q2 Quantity 4 MARKET EFFICIENCY Total Surplus Consumer surplus Producer surplus or Value to Total surplus sellers Cost to buyers Consumer and Producer Surplus in the Market Equilibrium Price A D Supply Consumer surplus Equilibrium price E Producer surplus B Demand C 0 Equilibrium quantity Quantity MARKET EFFICIENCY Three Insights Concerning Market Outcomes Free markets allocate the supply of goods to the most highly as measured by buyers who value them willingness to pay their Free markets allocate the demand for goods to the least cost sellers who can produce them at Free markets produce the quantity of goods that consumer and producer surplus maximizes the sum of 5 The Efficiency of the Equilibrium Quantity Price Supply Value to buyers Cost to sellers Cost to sellers 0 Value to buyers Equilibrium quantity Value to buyers is greater than cost to sellers Demand Quantity Value to buyers is less than cost to sellers Evaluating the Market Equilibrium Because the equilibrium outcome is an efficient allocation of resources the social planner can leave the market outcome as he she finds it This policy of leaving well enough alone goes by the French expression laissez faire 6