Welfare Analysis Consumer Surplus; Producer Surplus Welfare Analysis of Tax; Welfare Analysis of Price Control

Economic Efficiency A situation is economically inefficient if there is some way to change it so that so that someone gains while no one else loses. A change is a Pareto improvement if at least one person gains and no one loses A change is economically efficient if the winners could compensate the losers by enough to make the change a Pareto improvement.

Assessing Benefits Consumer Sovereignty “Willingness to Pay” = Consumer Benefit Consumer Surplus “Willingness to Sell” =Opportunity Cost Producer Surplus

Consumer Surplus -- Difference between Willingness to Pay and Price Paid by Buyer Quantity P0 Demand r1 r2 r3 r4 3 5 1 2 4

Consumer Surplus Is Triangle Below Demand, Above Market Price. 5 Quantity Total Expenditure

Producer Surplus- Difference Between Opportunity Cost and Selling Price 1 2 3 4 5 P0=t5 t5 t4 t3 t2 t1 Quantity

Producer Surplus Price Supply P0=t5 Producer Surplus Quantity

Consumer and Producer Surplus - Market Equilibrium Price Consumer Surplus Supply P0 Demand Producer Surplus Q0 Quantity

Reduce Output: Winners can not compensate losers. Price A - New CS A+B+E - Old CS C+D+F - Old PS B+C+D - New PS Supply A P1 B E P0 C F D Demand Quantity Q1 Q0 Suppliers gain B-F, but consumers lose B+E.

Analyze the Following Impact of Price Ceiling on Efficiency Impact of Price Floor on Efficiency Impact of Sales Tax on Efficiency Impact of a Subsidy on Efficiency

Impact of Price Ceiling on Efficiency A+B+C -- New CS A+B+E -- Old CS D -- New PS C+D+F -- Old PS Demand A Supply B E Market Clearing Price C F Price Ceiling D E+F is the Deadweight Loss Associated with Price Ceiling

Impact of Price Floor on Efficiency A -- New CS A+B+E -- Old CS B+C+D -- New PS C+F+D -- Old PS Supply A Price Floor B E Market clearing price C F D Demand Q1 Q0 E+F is deadweight loss associated with the price floor.

SUMMARY Market Equilibrium is Efficient. No Deadweight Loss. Price controls create a deadweight loss Also, there are costs associated with rationing mechanisms, black markets etc.