Consumer surplus
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  • 1. 1 Consumer Surplus, Externalities and Deadweight Loss Dadhi Adhikari Kathmandu College of Management
  • 2. 2 Consumers Surplus (CS) • Willingness to Pay (WTP): the maximum amount that a buyer is ready to pay (demand curve represents WTP) • Consumers Surplus = WTP-actual payment
  • 3. 3 Example of CS Buyer of Goat WTP A 10,000 B 8,000 C 7,000 D 5,000 Suppose a seller wants to sell a goat during Dashain festival
  • 4. 4 Example (Cont..) For one Goat Buyer A will buy at 8000 CS of A = 10,000 – 8,000 = 2,000 If there are two goats Price will set at 7,000 CS of A = 10,000 – 7,000 = 3,000 CS of B = 8,000 – 7,000 = 1,000 Total CS = 3,000+1,000 = 4,000
  • 5. 5 Example in figure . No. of Goat Price 1 2 10000 8000 7000 Initial CS of A CS of B Addition to CS for A
  • 6. 6 CS with Demand Curve . Q P Q1 Q2 P1 P2 Initial CS of A CS of B Addition to CS for A P P1 P2 Initial CS of A CS of B Addition to CS for AInitial CS of A Addition to CS for A
  • 7. 7 Producers Surplus (PS) • Producers surplus is the amount that is paid to seller minus the sellers cost. • Cost is the value of everything a seller must give up to produce a good.
  • 8. 8 PS with supply curve . Q Q1 Q2 P P1 P2 CS of B Initial PS of A Addition to PS for A
  • 9. 9 Market Efficiency • Efficiency = Maximization of total surplus • Total surplus = Consumers WTP- Amount paid to seller + Amount received by seller - Cost of seller • Total Surplus = Consumers WTP - Cost of seller
  • 10. 10 Market Equilibrium . Supply Demand Consumers Surplus Producers Surplus P Q
  • 11. 11 Dead Weight Loss . D S P Pmax A B D C E Before Price Ceiling After Price Ceiling Change Consumer Surplus A+C A+B B-C Producer Surplus B+D+E D -B-E Total Surplus A+B+C+D+E A+B+D -C-E
  • 12. 12 Deadweight Loss • Definition: Net loss of total surplus • Read yourself: Deadweight loss in case fo price floor
  • 13. 13 Externality-Definition • Effect of one persons action to wellbeing of another person. • Examples: effect of smoking, effect of waste product of a factory to downstream people • Externalities-Positive and Negative
  • 14. 14 Externality and Market Efficiency . Q P S (private cost) D (Private value) Here market is efficient as there is no externality QMarket
  • 15. 15 Negative Production Externality . Q P S (private cost) D (Private value) QMarketQOptimum Loss of Surplus due to overproduction Social Cost
  • 16. 16 Positive Externality in Production . Q P S (private cost) D (Private value) QoptimumQmarket Loss of Surplus due to underproduction Social Cost
  • 17. 17 Positive externality in consumption . S (Private Cost) Social Value D (Private value) QoptimumQmarket Q P Loss of Surplus due to underproduction
  • 18. 18 Negative Consumption Externality . S (Private Cost) Social Value D (Private value) QoptimumQmarket Loss of Surplus due to overproduction
  • 19. 19 Network Externality • If each individuals preference is affected by the preference of others • Bandwagon effect and Snob effect are the example of network externality
  • 20. 20 Bandwagon Effect • Positive network externality in which individual demand any goods/services because others do so. • In Bandwagon effect demand curve is more flatter (more elastic)
  • 21. 21 Snob Effect • Desire to keep unique commodity • Demand curve for snob effect is relatively steeper (less inelastic)
  • 22. 22 Reference • Mankiw • Pindyck and Rubinfeld