Chapter 7: Welfare Economics

welfare economics
the study of how the allocation of resources affects economic well-being

examining the benefits that buyers and sellers receive from engaging in market transactions, we then examine how society can make these benefits as large as possible

insight (welfare economics)
in any market, the equilibrium of supply and demand maximizes the total benefits received by all buyers and sellers combined

equilibrium price
the best price because it maximizes the total welfare of consumers and producers

willingness to pay
the maximum amount that a buyer will pay for a good

measures how much the buyer values the good

if the price is below/equal to willingness to pay
buyer will buy

if the price is above the willingness to pay
buyer will not buy

consumer surplus
the amount a buyer is willing to pay for a good minus the amount the buyer actually pays for it

measures the benefit buyers receive from participating in a markets

a good measure of economic well-being if policymakers want to respect the preferences of buyers

using the demand curve to measure consumer surplus
at any quantity, the price given by the demand curve shows the willingness to pay of the marginal buyer, the buyer who would leave the market first if the price were any higher

consumer surplus (graph)
the area below the demand curve and above the price measures the consumer surplus in a market

relationship between price and consumer surplus
a lower price raises consumer surplus

the value of everything a seller must give up to produce a good

only do the work/provide the

is a measure of her willingness to sell her services

producer surplus
the amount a seller is paid for a good minus the seller’s cost of producing it

producer surplus and the supply curve
a higher price raises producer surplus

producer surplus (graph)
the area below the price and above the supply curve measures the producer surplus in a market

total surplus
it is natural to use total surplus as a measure of society’s economic well-being

= (value to buyers) – (cost to sellers)

the property of a resource allocation of maximizing the total surplus received by all members of society

if an allocation of resources maximizes the total surplus, we say that the allocation exhibits efficiency

the property of distributing economic prosperity uniformly among the members of society

inefficient allocation
if a good is not being produced by the sellers with the lowest cost

if a good is not being consumed by the buyers who value it most highly

free markets and allocation
free markets produce the quantity of goods that maximizes the sum of consumer and producer surplus

equilibrium outcome
is an efficient allocation of resources

the invisible hand (even though self-interest)

organ market
binding price ceiling leads to shortage

market power
the ability to influence prices

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

sometimes the decisions of buyers and sellers impact those who are not participants in the market at all

pollution and agricultural pesticides

the welfare implications of market activity depend on more than just the value obtained by the buyers and the cost incurred by the sellers

market failure
caused by market power and externalities

the inability of some unregulated markets to allocate resources efficiently

when markets fail, public policy can potentially remedy the problem and increase economic efficiency