- Welfare economics studies whether market allocations are socially desirable. Market equilibrium maximizes total welfare unless there are market failures like externalities or price fixing. - Consumer surplus measures welfare for buyers and is the difference between what consumers are willing to pay and the actual price paid. It represents the benefit consumers receive from purchasing goods or services. - The demand curve shows consumers' willingness to pay at different prices and is essentially a marginal benefit curve. The area under the demand curve and above the price measures total consumer surplus in the market. Lower prices increase consumer surplus.

1. Welfare Economics
Chapter 7: Consumer Surplus

2. Welfare Economics
Welfare Economics is the study of whether a market
allocation is socially desirable
•Market equilibrium maximizes total welfare for society unless there is
a market failure (i.e. externalities, price fixing, etc…)
Qty
D1
S1
-------------
P1
Q1
E1
--------------
S = Marginal Cost (MC)
D = Marginal Benefit (MB)
MB = MC so Total Welfare is maximized

3. • Consumer surplus- measures welfare for the buyer
• Producer surplus- measures welfare for the seller
• Total Welfare = Consumer Surplus + Producer Surplus

4. CONSUMER SURPLUS
• Willingness to pay- the maximum price a consumer would pay
– how much a consumer values a good/service
– called the marginal benefit (MB)
• Consumer Surplus- buyer’s willingness to pay minus price
paid
– CS = MB – Price Paid
Qty
D1
S1
-------------
P1
Q1
E1
--------------

5. Demand Schedule & the Demand Curve
The market demand curve depicts the quantity
buyers are willing to pay at each price
Consumers value goods differently
The demand curve is essentially a marginal benefit curve

6. Demand Curve
Price of
Album
0 Quantity of
Albums
Demand or Marginal Benefit
1 2 3 4
$100 John’s willingness to pay
80 Paul’s willingness to pay
70 George’s willingness to pay
50 Ringo’s willingness to pay

7. Equilibrium Price = $70
Price of
Album
50
70
80
0
$100
Demand
1 2 3 4
Total
consumer
surplus ($40)
Quantity of
Albums
John’s consumer surplus ($30)
Paul’s consumer
surplus ($10)
The area below the demand curve &
above the price measures the
consumer surplus in the market.
As Price ↓ =>
Consumer Surplus ↑

8. Equilibrium Price & Consumer Surplus
Consumer
Surplus
Quantity
Price
0
D1 = MB1
100
20
B
A
C
This triangle represents the
“welfare” of all consumers at a market price of $100
200
Total Consumer Surplus = $10
½ * 1 * 20 = $10 [½ b * h]

9. Consumer Surplus Handout
• Please complete Consumer Surplus worksheet

10. Sample Problem
Quantity
Price
0
A
500
1) Calculate the initial consumer surplus at equilibrium price of $300
2) Calculate the change in consumer surplus when price falls to $100
300
100
3) After the price decreases from $300
to $100
a) what gain is for old consumers (people who also bought when price = $300
)
b) what gain in consumer surplus is for new consumers
--------------------
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-----------------
50 100
D1
E1
E2