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##### Economic surplus

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**Economic surplus**Gains and losses with international trade: Economic Welfare**Consumer surplus**• Consumer surplus is the net gain to consumers being able to buy a product through a market • Consumer surplus is the difference between the highest price someone is willing to pay for a product and the actual market price that is paid, then summed over all units that are demanded and consumed**The highest price that someone is willing to pay for a unit**of a product indicates the value that the buyer attaches to that unit • In order to measure consumer surplus, one has to have: • Market price, quantity demanded, and slope or shape of the demand curve**Consumer surplus can then be measured as the area below the**demand curve and above the market-price line CONSUMER SURPLUS IS THE AREA GIVEN BY THE TRIANGE, C PRICE a a = the intercept of the inverse demand function, while P = market price, and Q = the quantity consumed at the price P C C P Price in the market DEMAND Q QUANTITY**AS DEMAND SHIFTS OUTWARD TO THE RIGHT, GIVEN THE SAME MARKET**PRICE, THEN CONSUMER SURPLUS INCREASES CONSUMER SURPLUS IS THE AREA GIVEN BY THE TRIANGE, C a PRICE C ALSO RECALL THAT THE AREA OF A TRAINGLE IS ½ TIMES BASE TIMES HEIGHT C DEMAND P Price in the market Q QUANTITY SO CONSUMER SURPLUS IS THEREFORE, ½(a – p)Q**Now we impose an actual supply function and derive the price**as the equilibrium price from the condition that demand = supply in the market A PERFECTLY COMPETITIVE MARKET IS ASSUMED HERE CONSUMER SURPLUS TRIANGLE PRICE NOW, WE HAVE ANOTHER SURPLUS CALLED PRODUCERS SURPLUS --- THE DIFFERENCE BETWEEN MARKET PRICE AND THE SUPPLY CURVE a SUPPLY E P DEMAND g Q QUANTITY g IS THE INTERCEPT OF THE INVERSE SUPPLY FUNCTION**LET’S USE AN ACTUAL DEMAND FUNCTION AND AN ACTUAL SUPPLY**FUNCTION, BUT WITHOUT ANY INCOME EFFECT (IN DEMAND) AND WITHOUT ANY PRICE OF INPUTS (IN SUPPLY) • SUPPOSE THE DEMAND FUNCTION IS THEN GIVEN AS • QD = 18 – 1.2P, FOR QD = QUANTITY AND P = PRICE • LET THE SUPPLY FUNCTION BE GIVEN BY • QS = -2 + 0.6P, FOR QS = QUANTITY AND P = PRICE • WE NOW NEED THE EQUILIBRIUM PRICE AND QUANTITY IN THE MARKET • SET QD = QS, OR 18 – 1.2P = -2 + 0.6P • SOLVE FOR P BY REARRANGING AS 1.8P = 16, OR • P = 16/1.8 = 8.89 • THEN SUBSTITUTE P=8.89 INTO THE DEMAND FUNCTION TO GET Q = 18 – 1.2(8.89) = 7.33**SO EQUILIBRIUM PRICE IS 8.89 AND EQUILIBRIUM QUANTITY IN THE**MARKET IS 7.33 • WE NOW WANT TO CALCULATE THE CONSUMER AND PRODUCER SURPLUS VALUES • INVERSE DEMAND FROM THE DEMAND FUNCTION Q = 18 – 1.2P IS GIVEN BY P = 18/1.2 – Q/1.2 • WHICH IS EQUAL TO P = 15 – 0.83Q • SO OUR INTERCEPT, a, IS NOW a = 15 • INVERSE SUPPLY FROM THE SUPPLY FUNCTION Q = -2 + 0.6P IS GIVEN BY P = 2/0.6 + Q/0.6 • WHICH IS EQUAL TO P = 3.33 + 1.67Q • SO OUR INVERSE SUPPLY INTERCEPT, g, IS NOW g = 3.33**NOW ON TO CONSUMER SURPLUS AND PRODUCER SURPLUS GIVEN**EQUILIBRIUM PRICE IS P = 8.89; EQUILIBRIUM QUANTITY IS Q = 7.33; a = 15, AND g = 3.33 • CONSUMER SURPLUS = ½(15 – 8.89)(7.33) • WHICH IS APPROXIMATELY EQUAL TO 22.39 • PRODUCER SURPLUS = ½(8.89 – 3.33)(7.33) • WHICH IS APPROXIMATELY 20.38 CONSUMER SURPLUS = 22.39 PRICE, P a Actually Inverse supply Equilibrium price, P Actually inverse demand PRODUCER SURPLUS = 20.38 g Equilibrium quantity Q QUANTITY, Q**THE AREA UNDER THE SUPPLY CURVE AND UP TO A QUANTITY**SUPPLIED OF Q IS THE PAYMENT TO VARIABLE INPUTS (VARIABLE COSTS) --- SO THE PRODUCER RECEIVES A SURPLUS OVER VARIABLE COSTS --- PRODUCERS SURPLUS CONSUMER SURPLUS = AREA aEP PRICE a SUPPLY P IS EQUILIBRIUM PRICE E P SUPPLY = DEMAND AT POINT E DEMAND g PRODUCERS SURPLUS = AREA gPE Q QUANTITY Q IS EQUILIBRIUM QUANTITY