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POE Week10 PDF
POE Week10 PDF
POE Week10 PDF
Consumer surplus
It is the area under the demand curve & above the price.
P*
D
Q*
Producer surplus
difference between what the producer receives for the good
and the amount the producer is willing to receive to provide
the good.
It is the area above the supply curve & below the price.
P*
D
Q*
Social Welfare
Social welfare = consumer surplus + producer surplus.
P
P1
D
Q1
P2
D
Q2
and increases,
P3
D
Q3
P*
D
Q*
Implication:
social welfare (i.e. total surplus) = CS+ PS
is maximized at the perfectly competitive
equilibrium.
Change in welfare
W2 W1 = (CS2 + PS2) (CS1 + PS1)
An alternative equivalent way is the following.
1. Calculate the change in consumer surplus:
CS = CS2 CS1 .
2. Calculate the change in producer surplus:
PS = PS2 PS1 .
3. Add to get the total gain or loss in social welfare:
CS + PS = (CS2 CS1) + (PS2 PS1)
Why useful?
Examine the welfare effects of some government
policies.
Calculate the benefits and costs of various
economic policies
Price Ceiling
Without the ceiling what is CS+PS ?
Suppose the Govt. considers the price P* to be too high
P*
D
Q*
Pc
D
Qc
S
V
Pc
D
Qc
The consumers who gain are those who get the product
at a lower price.
The consumers who lose are those who are no longer
able to buy the product because there is less supplied.
S
V
Pc
D
Qc
S
V
Pc
D
Qc
Pc
D
Qc
Pc
V
W
D
Qc
Pc
S
V
W
V+ W= deadweight
loss to society that
results from the policy.
D
Qc
S
8K
D
0
S
8K
7K
D
0
1.8
S
9K
8K
7K
D
0
1.8
2.0
S
9K
8K
7K
V
W
D
0
1.8
2.0
Consumers gain
U V = 1,800 million - 100 million = 1,700 million.
Producers lose
U + W = 1,800 million + 100 million = 1,900 million
S
9
8
7
V
W
D
0
1.8
2.0
S
9
8
7
V
W
D
0
1.8
2.0
Price Floor
Without the floor, market clears at P*
P*
D
Q*
Pf
D
Qf
S
U
D
Qf
S
U
W
D
Qf
Pf
V
W
D
Qf