Economic surplus Gains and losses with international trade: Economic Welfare

Consumer surplus Consumer surplus is the net gain to consumers being able to buy a product through a market Consumer surplus is the net gain to consumers being able to buy a product through a market Consumer surplus is the difference between the highest price someone is willing to pay for a product and the actual market price that is paid, then summed over all units that are demanded and consumed Consumer surplus is the difference between the highest price someone is willing to pay for a product and the actual market price that is paid, then summed over all units that are demanded and consumed

The highest price that someone is willing to pay for a unit of a product indicates the value that the buyer attaches to that unit The highest price that someone is willing to pay for a unit of a product indicates the value that the buyer attaches to that unit In order to measure consumer surplus, one has to have: In order to measure consumer surplus, one has to have: Market price, quantity demanded, and slope or shape of the demand curve Market price, quantity demanded, and slope or shape of the demand curve

Consumer surplus can then be measured as the area below the demand curve and above the market-price line PRICE QUANTITY DEMAND Price in the market CONSUMER SURPLUS IS THE AREA GIVEN BY THE TRIANGE, C C a P Q C a = the intercept of the inverse demand function, while P = market price, and Q = the quantity consumed at the price P

AS DEMAND SHIFTS OUTWARD TO THE RIGHT, GIVEN THE SAME MARKET PRICE, THEN CONSUMER SURPLUS INCREASES PRICE QUANTITY DEMAND Price in the market CONSUMER SURPLUS IS THE AREA GIVEN BY THE TRIANGE, C C a P Q C ALSO RECALL THAT THE AREA OF A TRAINGLE IS ½ TIMES BASE TIMES HEIGHT SO CONSUMER SURPLUS IS THEREFORE, ½(a – p)Q

Now we impose an actual supply function and derive the price as the equilibrium price from the condition that demand = supply in the market DEMAND SUPPLY PRICE QUANTITY P Q a g E CONSUMER SURPLUS TRIANGLE NOW, WE HAVE ANOTHER SURPLUS CALLED PRODUCERS SURPLUS --- THE DIFFERENCE BETWEEN MARKET PRICE AND THE SUPPLY CURVE g IS THE INTERCEPT OF THE INVERSE SUPPLY FUNCTION A PERFECTLY COMPETITIVE MARKET IS ASSUMED HERE

LET’S USE AN ACTUAL DEMAND FUNCTION AND AN ACTUAL SUPPLY FUNCTION, BUT WITHOUT ANY INCOME EFFECT (IN DEMAND) AND WITHOUT ANY PRICE OF INPUTS (IN SUPPLY) SUPPOSE THE DEMAND FUNCTION IS THEN GIVEN AS SUPPOSE THE DEMAND FUNCTION IS THEN GIVEN AS Q D = 18 – 1.2P, FOR Q D = QUANTITY AND P = PRICE Q D = 18 – 1.2P, FOR Q D = QUANTITY AND P = PRICE LET THE SUPPLY FUNCTION BE GIVEN BY LET THE SUPPLY FUNCTION BE GIVEN BY Q S = P, FOR Q S = QUANTITY AND P = PRICE Q S = P, FOR Q S = QUANTITY AND P = PRICE WE NOW NEED THE EQUILIBRIUM PRICE AND QUANTITY IN THE MARKET WE NOW NEED THE EQUILIBRIUM PRICE AND QUANTITY IN THE MARKET SET Q D = Q S, OR 18 – 1.2P = P SET Q D = Q S, OR 18 – 1.2P = P SOLVE FOR P BY REARRANGING AS 1.8P = 16, OR SOLVE FOR P BY REARRANGING AS 1.8P = 16, OR P = 16/1.8 = 8.89 P = 16/1.8 = 8.89 THEN SUBSTITUTE P=8.89 INTO THE DEMAND FUNCTION TO GET Q = 18 – 1.2(8.89) = 7.33 THEN SUBSTITUTE P=8.89 INTO THE DEMAND FUNCTION TO GET Q = 18 – 1.2(8.89) = 7.33

SO EQUILIBRIUM PRICE IS 8.89 AND EQUILIBRIUM QUANTITY IN THE MARKET IS 7.33 WE NOW WANT TO CALCULATE THE CONSUMER AND PRODUCER SURPLUS VALUES WE NOW WANT TO CALCULATE THE CONSUMER AND PRODUCER SURPLUS VALUES INVERSE DEMAND FROM THE DEMAND FUNCTION Q = 18 – 1.2P IS GIVEN BY P = 18/1.2 – Q/1.2 INVERSE DEMAND FROM THE DEMAND FUNCTION Q = 18 – 1.2P IS GIVEN BY P = 18/1.2 – Q/1.2 WHICH IS EQUAL TO P = 15 – 0.83Q WHICH IS EQUAL TO P = 15 – 0.83Q SO OUR INTERCEPT, a, IS NOW a = 15 SO OUR INTERCEPT, a, IS NOW a = 15 INVERSE SUPPLY FROM THE SUPPLY FUNCTION Q = P IS GIVEN BY P = 2/0.6 + Q/0.6 INVERSE SUPPLY FROM THE SUPPLY FUNCTION Q = P IS GIVEN BY P = 2/0.6 + Q/0.6 WHICH IS EQUAL TO P = Q WHICH IS EQUAL TO P = Q SO OUR INVERSE SUPPLY INTERCEPT, g, IS NOW g = 3.33 SO OUR INVERSE SUPPLY INTERCEPT, g, IS NOW g = 3.33

NOW ON TO CONSUMER SURPLUS AND PRODUCER SURPLUS GIVEN EQUILIBRIUM PRICE IS P = 8.89; EQUILIBRIUM QUANTITY IS Q = 7.33; a = 15, AND g = 3.33 CONSUMER SURPLUS = ½(15 – 8.89)(7.33) CONSUMER SURPLUS = ½(15 – 8.89)(7.33) WHICH IS APPROXIMATELY EQUAL TO WHICH IS APPROXIMATELY EQUAL TO PRODUCER SURPLUS = ½(8.89 – 3.33)(7.33) PRODUCER SURPLUS = ½(8.89 – 3.33)(7.33) WHICH IS APPROXIMATELY WHICH IS APPROXIMATELY Actually Inverse supply Actually inverse demand PRICE, P QUANTITY, Q Equilibrium price, P Equilibrium quantity Q CONSUMER SURPLUS = PRODUCER SURPLUS = a g

THE AREA UNDER THE SUPPLY CURVE AND UP TO A QUANTITY SUPPLIED OF Q IS THE PAYMENT TO VARIABLE INPUTS (VARIABLE COSTS) --- SO THE PRODUCER RECEIVES A SURPLUS OVER VARIABLE COSTS --- PRODUCERS SURPLUS DEMAND SUPPLY PRICE QUANTITY P Q a g E CONSUMER SURPLUS = AREA aEP PRODUCERS SURPLUS = AREA gPE Q IS EQUILIBRIUM QUANTITY SUPPLY = DEMAND AT POINT E P IS EQUILIBRIUM PRICE