1. Consumer Surplus and Economic Welfare

2. Consumer and Producer Surplus Consumer Surplus consumer surplus The difference between the maximum amount a person is willing to pay for a good and its current market price.

3. Consumer and Producer Surplus Consumer Surplus Market Demand and Consumer Surplus As illustrated in diagram (a) some consumers (see point A) are willing to pay as much as £5.00 each for hamburgers. Since the market price is just £2.50, they receive a consumer surplus of £2.50 for each hamburger that they consume. Others (see point B) are willing to pay something less than £5.00 and receive a slightly smaller surplus. Since the market price of hamburgers is just £2.50, the area of the shaded triangle in diagram (b) is equal to total consumer surplus. 2.5 0

4. Consumer and Producer Surplus Producer Surplus producer surplus The difference between the current market price and the full cost of production for the firm.

5.  Consumer and Producer Surplus Producer Surplus Market Supply and Producer Surplus As illustrated in diagram (a), some producers are willing to produce hamburgers for a price of £0.75 each. Since they are paid £2.50, they earn a producer surplus equal to £1.75. Other producers are willing to supply hamburgers at a price of £1.00; they receive a producer surplus equal to £1.50. Since the market price of hamburgers is £2.50, the area of the shaded triangle in diagram (b) is equal to total producer surplus. 2. 50

6.  Consumer and Producer Surplus Competitive Markets Maximize the Sum of Producer and Consumer Surplus Total Producer and Consumer Surplus Total producer and consumer surplus is greatest where supply and demand curves intersect at equilibrium.

7.  Supply and Demand and Market Efficiency Competitive Markets Maximize the Sum of Producer and Consumer Surplus deadweight loss The net loss of producer and consumer surplus from underproduction or overproduction.

8.  Supply and Demand and Market Efficiency Deadweight Loss Diagram (a) shows the consequences of producing 4 million hamburgers per month instead of 7 million hamburgers per month. Total producer and consumer surplus is reduced by the area of triangle ABC shaded in yellow. This is called the deadweight loss from underproduction. Diagram (b) shows the consequences of producing 10 million hamburgers per month instead of 7 million hamburgers per month. As production increases from 7 million to 10 million hamburgers, the full cost of production rises above consumers’ willingness to pay, resulting in a deadweight loss equal to the area of triangle ABC.

9. Supply and Demand and Market Efficiency Potential Causes of Deadweight Loss From Under- and Overproduction When supply and demand interact freely, competitive markets produce what people want at least cost. We say they are productively efficient. There are a number of naturally occurring sources of market failure. Monopoly power gives firms the incentive to underproduce and overprice, taxes and subsidies may distort consumer choices, external costs such as pollution and congestion may lead to over- or underproduction of some goods, and artificial price floors and price ceilings may have the same effects.

10.  Key terms • allocative efficiency • consumer surplus • deadweight loss • producer surplus • productive efficiency • price rationing • welfare