5b. Competition Maximizes Welfare Flashcards
What is “Consumer Welfare”?
“Consumer welfare from a good is the benefit a consumer gets from consuming that goods MINUS what the consumer paid to buy the good.”
What is “Consumer Surplus”?
The monetary difference between what a consumer is willing to pay for the quantity of the good purchased and what the good actually costs is called consumer surplus (CS).
How is “consumer surplus” shown on a DIG?
Below Demand curve, above equilibrium price
What is “Producer Surplus”?
“the difference between the amount for which a good sells and the minimum amount necessary for the seller to be willing to produce the good”
How is “producer surplus” shown on a DIG?
Above the supply curve, below the price
What is the equation of “welfare”?
Define Welfare as W= PS+CS
-> SUM of consumer surplus and produces surplus
What does the perfect competition equilibrium do to welfare?
Perfect Competition equilibrium q* (where Demand=Supply) maximizes W
What is the “deadweight loss”?
net reduction in welfare from the loss of surplus by one group that is not offset by a gain to another group.
What is the “deadweight loss” in this example?
area C + E
What is pareto efficiency?
“When no one can be made better off without making someone else worse off.”
Why are too many trades bad for welfare?
Bad for welfare…
The cost of producing the extra unit of output exceeds the value consumers place on it
What are some examples of government policies to move an economy away from the competitive equilibrium?
- Restricting the number of firms or quota on production/consumption
- Raising entry and exit costs
- Introducing Sales Taxes
- Price Floor and Price Ceiling
- Tariff/Quotas
How does a “sales tax” affect welfare?
DWL is created (area C + E),
Tax lowers output from the competitive level where welfare is MAXIMISED.
The subsidy is on a DIG the opposite of?
The opposite of a sales tax!
Instead of shifting demand inwards, a subsidy will shift demand outwards.
What is a “price floor”?
In some markets, the government sets a price floor , or minimum price, which is the lowest price a consumer can pay legally for the good.
What are the impacts of a price floor?
If the market price is above p, the support program is irrelevant.
If the market price would be below p , however, the government buys as much output as necessary to drive the price up to p.
What is a “price ceiling”?
In some markets, the government sets a price ceiling : the highest price that a firm can legally charge.
Impact of price ceiling
As a result of the price ceiling, consumers buy the good at a lower price but are limited by sellers as to how much they can buy. Because less is sold than at the precontrol equilibrium, society suffers a deadweight loss: Consumers value the good more than the marginal cost of producing extra units.
