Welfare Economics
Chapter 7:
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…)
S1
-------------- E1
-------------
P1
Q1
S = Marginal Cost (MC)
MB = MC so Total Welfare is maximized
D = Marginal Benefit (MB)
D1
Qty
• 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)
-------------- E1
-------------
P1
S1
Q1
D1
Qty
• 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
John’s willingness to pay
$100
Paul’s willingness to pay
80
George’s willingness to pay
70
Ringo’s willingness to pay
50
Demand or Marginal Benefit
0
1
2
3
4
Quantity of
Albums
Equilibrium Price = $70
Price of
Album
$100
John’s consumer surplus ($30)
The area below the demand curve &
above the price measures the
consumer surplus in the market.
80
Paul’s consumer
surplus ($10)
70
As Price ↓ =>
Consumer Surplus ↑
Total
50
consumer
surplus ($40)
Demand
0
1
2
3
4 Quantity of
Albums
Equilibrium Price & Consumer Surplus
Price
200
A
This triangle represents the
“welfare” of all consumers at a market price of $100
Consumer
Surplus
100
B
Total Consumer Surplus = $10
C
½ * 1 * 20 = $10
D1 = MB1
0
20
Quantity
[½ b * h]
Consumer Surplus Handout
• Please complete Consumer Surplus worksheet
Sample Problem
1) Calculate the initial consumer surplus at equilibrium price of $300
Price
500
A
2) Calculate the change in consumer surplus when price falls to $100
3) After the price decreases from $300 to $100
a) what gain is for old consumers (people who also bought when price = $300)
b) what gain in consumer surplus is for new consumers
-----------------
-----
0
E1
--------------------
30
50
100
----------------------------------
100
0
E2
D1
Quantity