Principles of Microeconomics Chapter 6 Welfare Economics the study of how the allocation of resources Equilibrium price maximizes total benefits received by both buyers affects economic well being and sellers Willingness to Pay the maximum amount that a buyer will pay for a Consumer Surplus the amount a buyer is willing to pay for a good minus the amount the buyer actually pays for it E g Willing to pay 100 for a dress buy it for 50 Consumer surplus Market consumer surplus is the sum of each individual consumer Using the Demand Curve to Measure CS 1 Use Willingness to Pay to find demand schedule At any quantity the price given by the demand curve shows the willingness to pay of the marginal buyer buyer who would leave the market first if there was any increase in price 2 Area under the demand curve and above the price CS This holds true for straight demand curves as well the steps of good is 50 surplus marginal buyers are so small they more or less form a straight line But when a price drops and the CS increases it is in two parts Firstly buyers who were already buying Q1 at higher price of P1 are better off because they are paying less Increase in CS of existing buyers is equal to the reduction in the amount they pay Second new buyers enter the market because they are willing to buy the good at a lower price qD increases and the CS they receive is equal to the area of the triangle created by the demand curve the change in price and the change in qD Consumer surplus measures the benefit that buyers receive from a good as the buyers themselves perceive it Producer Surplus Cost the value of everything a seller must give up to produce a good cost is the lowest price a seller will accept to sell Producer surplus the amount a seller is paid for a good minus the cost of providing it measures the benefit sellers receive from participating in a market Using the Supply Curve to Measure PS 1 At any quantity the price given by the supply curve shows the cost of the marginal seller the seller who would leave the market if the price were any lower 2 Area above the supply curve and under the price PS Applies for straight supply curves as well When the price rises from P1 to P2 producer surplus will increase firstly for the initial sellers who now have an increased PS and as new sellers enter the market they will supply more shifting Q1 to Q2 Market Efficiency The Benevolent Social Planner all knowing all powerful well intentioned dictator that wants to maximize the economic well being of everyone in society Potential measures of economic well being total surplus sum of producer and consumer surpluses Value to buyers Cost to sellers If an allocation of resources maximizes total surplus the allocation exhibits efficiency Moving production from a high cost producer to a low cost producer lowers total cost to sellers and increases total surplus moving consumption of a good from a buyer with a low valuation to a buyer with high valuation raises total surplus Equality the property of distributing economic prosperity uniformly among the members of society Efficiency vs Equality Efficiency is making the pie as big as possible equality is making the pie as evenly distributed as possible Evaluating the Market Equilibrium The total area between the demand and supply curves up to the equilibrium point is total market surplus is this efficient When a market is in equilibrium those buyers who value the good more than the price choose to buy the good buyers who value it less than the price do not those sellers whose costs are less than the price choose to produce and sell the good sellers whose costs are greater than the price do not ERGO 1 Free markets allocate the supply of goods to the buyers who value them most highly as measured by their willingness to pay 2 Free markets allocate the demand for goods to the sellers who can produce them at the lowest cost 3 Free markets produce the quantity of goods that maximizes the sum of consumer and producer surplus Thus social planner cannot allocate resources to be any more beneficial NOR can she increase well being by increasing decreasing quantity of the good Any quantity below the equilibrium price the value to the marginal buyer exceeds the cost to the marginal seller As a result increasing Q will increase total surplus Any quantity above the equilibrium price the value to the marginal buyer is less than the cost to the marginal seller As a result decreasing Q will increase total surplus The policy of leaving the market to efficiently allocate resources is called laissez faire Social planners would need to know the value of a particular good to every potential consumer in the market and the cost of every potential producer IN EVERY MARKET This is almost impossible
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