What is Consumer Surplus?
- Difference between a buyer’s willingness to pay and the amount they actually pay
- Measures the extra value consumers receive above what they pay for a commodity.
Consumer surplus: benefit -> consumer saves -> income gained by the consumer -> amount that can be saved or spent further on other goods or services
How is Consumer Surplus represented on a graph?
Consumer surplus is the area below the demand curve and above the price level.
y= price
x= quantity
What is Willingness to Pay?
Willingness to pay is the maximum amount a buyer is willing to pay for a good.
What effect does a Price Reduction have on consumer surplus?
- Increases real income
- Allows consumers to buy more goods
- Results in an increase in welfare
I guess one could say it increases consumer surplus?
What is the Paradox of Value?
The paradox of value suggests that the recorded monetary value (P * Q) of a good may not accurately reflect its total economic value.
Example: Price Comparison of Mineral Water and Potable (tap) Water
Eine Flasche Wasser ist viel “wertvoller” als 10 Flaschen Wasser. Darum so teuer
What is Producer Surplus?
- Amount a seller is paid (willingness to sell) minus the seller’s cost.
- Includes rents and economic profits (extra-profits) for firms and owners of specialised inputs.
Producer surplus decreases as price decreases!
How is Producer Surplus represented on a graph?
Producer surplus is the area above the supply curve and below the price level.
Define Total Surplus.
- Total Surplus (TS) = Consumer Surplus + Producer Surplus.
- Represents the total value to buyers minus the cost to sellers.
What are the causes of Market Failure?
(5)
- Market power
- Externalities
- Public goods
- Asymmetric information
- Behavioural anomalies: bounded rationality, willpower, and selfishness
In the presence of market failures, we don’t achieve efficiency in resource use.
Use of Consumer and Producer Surplus
Consumer and producer surpluses are used to measure the change in welfare due to a change of a market condition.
- impact of an economic policy or a public investment (cost-benefit analysis is a technique which is based on welfare economics)
Consumer Surplus: Measure of Benefits in the Evaluation of a Public
Investment
Consumer surplus is useful in the evaluation of the benefits of many
government decisions:
Building a new highway
Building a new tunnel for a railroad
Increasing the capacity of a railroad system
Preserving a recreation site
Improving the quality of a public good
Example: Cost-Benefit Analysis of the Construction of a Tunnel for a Railroad
Travel cost (y-axis) = ticket + opportunity cost of time
Number of trips (x-axis) -> nimmt zu wenn travel costs sinken
-> benefit measured using
the change in the Consumer surplus
Welfare analysis of gasoline market with negative externality
supply (social marginal cost) = Equlibrium 1
supply (private marginal cost) = Equilibrium 2
1: keine erxternalities
2: externalities = Fläche zwischen den beiden supply fct. bis zum equilibrium 2
Total surplus Equlibrium 1 - Externality welche nach rechts nach dem schnittpunkt kommt
Total surplus Equlibrium 2 - Externality
There are at least seven reasons for the imperfect functioning of the market
Efficiency:
1. Public goods and common resources
2. Externalities
3. Imperfect competition
4. Incomplete information
Equity:
5. Income and wealth inequalities
Efficiency Equity/Macro-economics:
6. Unemployment and inflation
—
7. Behavioral anomalies
