Welfare Economics
Consumer Surplus
Welfare Economics
Welfare Economics is the study of whether a market allocation is socially desirable
•Market equilibrium maximizes total welfare for society unless there is a market failure (i.e. externalities, price fixing, etc…)
S = Marginal Cost (MC)
D = Marginal Benefit (MB)
MB = MC so Total Welfare is maximized
• Consumer surplus- measures welfare for the buyer
• Producer surplus- measures welfare for the seller
• Total Welfare = Consumer Surplus + Producer Surplus
CONSUMER SURPLUS
• Willingness to pay- the maximum price a consumer would pay – how much a consumer values a good/service
– called the marginal benefit (MB)
• Consumer Surplus- buyer’s willingness to pay minus price paid
– CS = MB – Price Paid
Demand Schedule & the Demand Curve
The market demand curve depicts the quantity buyers are willing to pay at each price
Consumers value goods differently
The demand curve is essentially a marginal benefit curve
Demand Curve
Price of Album
0 Quantity of
Albums Demand or Marginal Benefit
1 2 3 4
$100 John’s willingness to pay
80 Paul’s willingness to pay
70 George’s willingness to pay
50 Ringo’s willingness to pay
Equilibrium Price = $70
Price of Album
50 70 80
0
$100
Demand
1 2 3 4
Total
consumer surplus ($40)
Quantity of Albums John’s consumer surplus ($30)
Paul’s consumer surplus ($10)
The area below the demand curve &
above the price measures the consumer surplus in the market.
As Price ↓
=>Consumer Surplus ↑
Equilibrium Price & Consumer Surplus
Consumer Surplus
Quantity Price
0
D
1= MB
1100
20 B
A
C
This triangle represents the
“welfare” of all consumers at a market price of $100
200
Total Consumer Surplus = $10
½ * 1 * 20 = $10 [½ b * h]
Consumer Surplus Handout
• Please complete Consumer Surplus worksheet
Sample Problem
Quantity Price
0
500 A
1)
Calculate the initial consumer surplus at equilibrium price of $3002)
Calculate the change in consumer surplus when price falls to $100300
100
3)
After the price decreases from $300 to $100a) what gain is for old consumers (people who also bought when price = $300) b) what gain in consumer surplus is for new consumers
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50 100
