Micro 8: Consumer and Producer Surplus and Allocative Efficiency Flashcards
What is consumer surplus?
The difference between the market price for a good or service and the price each respective consumer would have been willing to pay for it.
Can be viewed as welfare or utility gained by consumers that they didn’t pay for, or the surplus welfare that’s gained in the market for a good.
What is producer surplus?
The difference between the total amount paid for a good or service (total revenue in the industry) and how much producers would have been willing to receive for production of the good or service. Anything a producer is paid in addition to how much they would have been willing to receive is a surplus reward that can be spent on goods and services that improve the welfare or utility of the producer.
What does the market price mechanism do?
It naturally leads every market to a state where supply meets demand and so a position which is allocatively efficient. Therefore, a free market economy is the most effective means of distributing resources to maximise social welfare.
What happens when output is at a level higher than or lower than the market equilibrium?
There is a deadweight loss to society.
What is net welfare gain?
Utility or welfare that is gained when output moves towards the socially optimal level of output (where total net welfare is maximised).
What is deadweight loss?
The deficiency in total surplus welfare when the market is not operating at the socially optimal level of output. This is net utility or welfare that could be enjoyed by producers and consumers but is being ‘lost’ underconsumption or the net cost of overconsumption.
What is the socially optimal level of output?
The level of output for an industry that maximises net welfare for society.
What is allocative efficiency?
Allocative efficiency occurs when the value that consumers place on a good or service (reflected in the price they are willing and able to pay) equals the marginal cost of the scarce factor resources used up in production.
The main condition required for allocative efficiency in a market is that market price = marginal cost of supply.
What is dynamic efficiency?
Re-investment of supernormal profit back into the business in the form of new capital etc.
Happens if supernormal profit lasts in the long run.
What is static efficiency?
Consists of allocative, productive and X efficiency, all occur at one specific production point.
