Welfare Analysis

1
Welfare Analysis

• Consumer Surplus Producer Surplus
• Welfare Analysis of Tax Welfare Analysis of
  Price Control

2
Economic Efficiency

• A situation is economically inefficient if there
  is some way to change it so that so that someone
  gains while no one else loses.
• A change is a Pareto improvement if at least one
  person gains and no one loses
• A change is economically efficient if the winners
  could compensate the losers by enough to make the
  change a Pareto improvement.

3
Assessing Benefits

• Consumer Sovereignty
• Willingness to Pay Consumer Benefit
• Consumer Surplus
• Willingness to Sell Opportunity Cost
• Producer Surplus

4
Consumer Surplus -- Difference between
Willingness to Pay and Price Paid by Buyer
r1
r2
r3
r4
3
5
1
2
4
5
Consumer Surplus Is Triangle Below Demand, Above
Market Price.
Price
Consumer Surplus
P0
Demand
Quantity
5
Total Expenditure
6
Producer Surplus- Difference Between Opportunity
Cost and Selling Price
Price
t5
t4
t3
t2
t1
Quantity
7
Producer Surplus
Price
Supply
P0t5
Producer Surplus
Quantity
8
Consumer and Producer Surplus - Market Equilibrium
Price
Consumer Surplus
Supply
P0
Demand
Producer Surplus
Q0
Quantity
9
Reduce Output Winners can not compensate losers.
Price
A - New CS ABE - Old CS CDF - Old PS BCD -
New PS
Supply
A
P1
B
E
P0
C
F
D
Demand
Quantity
Q0
Q1
Suppliers gain B-F, but consumers lose BE.
10
Analyze the Following

• Impact of Price Ceiling on Efficiency
• Impact of Price Floor on Efficiency
• Impact of Sales Tax on Efficiency
• Impact of a Subsidy on Efficiency

11
Impact of Price Ceiling on Efficiency
ABC -- New CS ABE -- Old CS D -- New PS CDF
-- Old PS
Demand
A
Supply
B
E
Market Clearing Price
C
F
Price Ceiling
D
EF is the Deadweight Loss Associated with Price
Ceiling
12
Impact of Price Floor on Efficiency
A -- New CS ABE -- Old CS BCD -- New PS CFD
-- Old PS
Supply
A
Price Floor
B
E
Market clearing price
C
F
D
Demand
Q1
Q0
EF is deadweight loss associated with the price
floor.
13
SUMMARY

• Market Equilibrium is Efficient. No Deadweight
  Loss.
• Price controls create a deadweight loss
• Also, there are costs associated with rationing
  mechanisms, black markets etc.