Welfare Economics Flashcards
Welfare economics
the economics of well-being
Compensating variation
Compensating variation is the amount of money one would need to be paid to accept some change. Compensating variation lets us quantify differences in an individual’s wellbeing in dollar terms.
Consumer surplus
The area under the demand curve and above the price since the demand curve represents the marginal willingness to pay for a good
The benefit a consumer gets from consuming a good, less the price paid.
Producer surplus
The area above the supply curve and below the price, since the supply curve represents the marginal
cost of producing the good
aka = profit (in LR); the difference between costs and revenues
Total social welfare
the addition of consumer and producer surplus; it is maximized under perfect competition when demand = supply
Deadweight loss
The loss in welfare that is a result of moving away from the perfectly competitive equilibrium; transactions that would have made both parties better off that are not happening (reducing in welfare from trades not made)
Can be caused by monopolies, government taxation, etc.
Explain how consumer surplus depends on the elasticity of the demand curve (with respect to price)
Price elasticity of demand determines the slope of this curve
As the curve gets more inelastic, the demand curve steepens & the consumer surplus will be larger. For a good with perfectly inelastic demand, consumer surplus will be infinite. (you’ll pay anything for it).
As the curve gets more elastic, the demand curve flattens & consumer surplus will be smaller. If consumer demand was perfectly elastic, then consumer surplus would be zero. People are totally indifferent between goods, and they’re always willing to just substitute for another good.
Surplus is inversely related to the elasticity of demand. As the elasticity of demand goes up, the surplus is going down.
Explain what deadweight loss is intuitively
By shifting surplus between consumer and producer, certain transactions that would be made under perfect competition are not happening & therefore inefficiencies are created in the market and overall surplus is lowered.
Explain why competition maximizes total surplus
Social welfare is a measure of the well-being of a society. Professor Gruber defines this as the sum of consumer and producer surplus. The first fundamental theorem of welfare economics asserts that social welfare is maximized by competition.
If the elasticity of demand with respect to price is zero, then consumer surplus…
..is infinite. If the elasticity of demand with respect to price is zero, then it is perfectly inelastic. This means consumers will pay anything for the good, so consumer surplus will be infinite.
If the elasticity of demand with respect to price is zero, then consumer surplus…
..is infinite. If the elasticity of demand with respect to price is zero, then it is perfectly inelastic. This means consumers will pay anything for the good, so consumer surplus will be infinite.
If the government institutes a price ceiling below the market price in a previously perfectly competitive market, what will happen?
Producer surplus decreases, because fewer transactions occur and the remaining transactions occur at a lower price. Deadweight loss arises because some trades that produced welfare gains will no longer occur. The increase of deadweight loss will decrease social welfare.
