Markets and Welfare
Our analysis assumed that markets are perfectly competitive.
Welfare Economics: the study of how the allocation of resources affects economic well-being.
1. Consumers, Producers, and the Efficiency of Markets
1.1 Consumer Surplus
The amount a buyer is willing to pay for a good minus the amount the buyer actually pays for it.
1.2 Producer Surplus
Cost: the value of everything a seller must give up to produce a good.
Producer Surplus: the amount a seller is paid for a good minus the seller’s cost of providing it.
1.3 Market Efficiency
Total surplus
= (Value to buyers - Amount paid by buyers) + (Amount received by sellers - Cost to sellers)
= Value to buyers - Cost to sellers
If an allocation of resources maximizes total surplus, we say that the allocation exhibits efficiency.
Equality: whether the various buyers and sellers in the market have a similar level of economic well-being.
The market equilibrium maximizes the sum of producer and consumer surplus:
1.4 Market Failure
To conclude that markets are efficient, we made several assumptions about how markets work. When these assumptions do not hold, our conclusion that the market equilibrium is efficient may no longer be true.
- Markets are perfectly competitive.
- Market power can cause markets to be inefficient because it keeps the price and quantity away from the levels determined by the equilibrium of supply and demand.
- The outcome in a market matters only to the buyers and sellers who participate in that market.
- side effects; externalities
2. Application: The Costs of Taxation
The fall in total surplus that results when a tax (or some other policy) distorts a market outcome is called a deadweight loss.
The price elasticities of supply and demand are determinants of the deadweight loss.
The greater the elasticities of supply and demand, the greater the deadweight loss of a tax.
Laffer curve (e):
