Welfare

calculations
 Consumer & Producer Surplus
Consumer Surplus
Highest price consumers are prepared to pay for a good
minus the amount actually paid
is the difference between what you are willing to pay
and what you actually pay.

Producer surplus
Price received by firms for selling a good minus the lowest
price they are willing to accept to produce the good
is the difference between the price the seller received
and how much they were willing to sell it for.
Consumer & Producer Surplus

P
Area below Consumer Surplus S = MSC
Demand curve
& above price line
P1 Consumer Surplus + Producer Surplus
= Social Surplus (Social Welfare)
Pe
Note: Social Surplus is at its maximum
Area above the when market is in equilibrium.
Supply curve
& below price line P2
Producer Surplus
D = MSB

Q
Q1 Qe

Allocative efficiency at Pe & Qe - Marginal Benefit to Society (D=MSB) is equal to the

Marginal Cost to Society of supplying the production (S = MSC)
Consumer and Producer’s Surplus
P Calculate the area of:
1. Consumer Surplus
2. Producer Surplus
$10
3. Total Surplus S
8 Area of a
triangle is
6 CS 1/2bh:
$5 1. CS= $25
4 2. PS= $20
PS
3. Total= $45
2

1 D
2 4 6 8 10 Q 4
 Review
P Calculate the area of:
1. Consumer Surplus
2. Producer Surplus
$16 3. Total Surplus
S
14
CS
12 1. CS= $20
PS
2. PS= $5
3. Total= $25
11

10
D
2 4 6 8 10 Q 5
Government
Intervention
Government intervention in Markets

A. Tax and Subsidy

B. Price Floor and Price Ceiling
C. Tariffs and Quotas
Taxes (Indirect/Excise/Specific Tax)
Tax on goods and services
it’s a $ amount per unit produced of a good or service
Shifts supply curve left (because paid by producers. Consumers pay producers
when buying a good, the producer that goes ahead and pays the government. You only swipe
your credit card once to the store (not twice one to the government one to the store)
 Scenario without a Tax
Supply
Schedule
P
P Qs $5 S

$5 140
4

$4 120
3
$3 100
2
$2 80
$1 60 1
D

40 60 80 100 120 140 Q 9

 Tax STAX
Supply Government sets a $2 per
Schedule unit tax on Cigarettes
P
P Qs $5 S

$5 $7 140
4

$4 $6 120 Tax is the vertical

3 distance between
$3 $5 100 supply curves
2
$2 $4 80
$1 $3 60 1
D

40 60 80 100 120 140 Q 10

 Identify the Excise Taxes STAX
following:
1. Price before tax
2. Price P
consumers pay $5 S
after tax
3. Price producers
4
get after tax
4. Total tax
revenue for the 3
government
before tax 2
5. Total tax
revenue for the 1
D
government
after tax
40 60 80 100 120 140 Q 11
 Excise Tax Calculate
P
Stax 1. Tax Per Unit
2. Total Tax
S Revenue
3. Amount of
Tax paid by
Pc$14 consumers
4. Amount of
12 Tax paid by
Pp 11 producers
5. Total
Expenditures
6. Total
8 D Revenue for
firms
10 12 Q
13
Why Gov impose a tax?
Source of Revenue
Excise taxes often imposed on goods with inelastic
PED (alcohol, cigarettes)
Discourage consumption of goods the
government deems unhealthy or desirable
Degree to which this is successful depends on PED

Redistribute Income
Excise taxes on “luxury” goods (e.g. expensive cars)
Tax revenue spent on services for poor people
Correct Negative Externalities
e.g. pollution
Tax - Evaluate stakeholder impact
‘Stakeholders’ affected by it

● Consumers (- worse off) pay higher prices AND

consume less. Receive less and pay more.
● Producers (- worse off) receive a lower price (as must
pay tax to govt) AND sell less. Revenue falls.
● The government (+ better) - gains revenue (tax x Q)
Taxes Welfare calculations
Some Consumer and Producer
Surplus (Social Surplus) becomes
Government Revenue

Welfare loss (deadweight loss, a+b))

represents benefits that are lost to
society because resources are not
allocated efficiently.

Tax has caused underproduction of

the good relative to what is socially
desirable (Qt < Qe)

Results in loss of allocative

efficiency & Welfare Loss
 Taxes and Welfare Loss
● Consumer Surplus (after tax) = ● Producer surplus = area below
area above price paid by price received by firms (Pp) and
consumers (Pc) and below Demand above Supply curve up to Quantity
curve up to Quantity consumed produced (Qt)
after tax (Qt)
● Welfare Loss (Deadweight loss) -
● Government Revenue some after-tax social surplus (a +
○ (Pc=Pp) x Qt b) is completely lost.
● Some Consumer and Producer ● Tax has caused underproduction of
Surplus becomes Government Tax the good relative to what is socially
Revenue desirable (Qt < Qe)
● BUT this will come back to society ● This underallocation of resources
in the form of government spending means loss of allocative
- so not a welfare loss (more a efficiency
“welfare transfer”)
Excise Tax Calculate
1. CS Before Tax
2. Total Expenditures
Before Tax
3. Tax Per Unit
4. Total Tax Revenue that
goes to Government
5. Amount of Tax paid by
consumers
6. Amount of Tax paid by
producers
7. Total Expenditures after
tax
8. Total Revenue for firms
after tax
9. CS After Tax
10. DWL
 Subsidies
Subsidy is dollar amount per unit produced payed by the
government to producers.
Increases price received by producers, causing them to produce more.
Decreases price payed by consumers, causing them to consume more.

Governments can use subsidies to:

• Encourage production of a good or service
• Make certain goods affordable to poor
• Support growth of particular industries
• Increase producer revenues like farmers

You can think of subsidies like an “anti-tax” (opposite effect)

Examples
 Impact: Subsidies
S1
P

Pp S2 = S1 - Subsidy
Government
P* spending on Pp = Price paid to Producers
Subsidy
Pc = Price paid by Consumers
Pc P* / Q* = Without subsidy
Qsb = Quantity supplied with
subsidy

Cost of Subsidy to Govt.=

D Qsb * (Pp - Pc)

Q* Qsb Q
Subsidies: stakeholders
● Consumers (+ better) – pay lower price AND consume more.

● Producers (+ better) – receive higher price (because receives

price consumers pay PLUS subsidy) AND sell more. Revenues
increase.

● The government (- worse off) pays for the subsidy

○ Opportunity Cost - Not able to spend on other programmes
○ May need to raise taxes or increase borrowing to pay for subsidies
○ Taxpayers worse off!
Arguments against Subsidies
1.Opportunity cost - Government money
used up in subsidy payments be better
spent elsewhere?
2.May encourage inefficient production
3.Who decides who gets assitance?
4.Taxpayers and consumers ultimately pays
the costs of subsidies
Subsidy welfare calculations part 1
Subsidy reduces unit cost
of supply. Supply curves
shifts to right (S1 to
S2+subsidy).
Subsidy is vertical distance
between supply curves
Price paid by consumers falls
from Pe to Pc
Quantity supplied by firms
increases from Qe to Qs
Firms receive a higher price
(Pf) = the new market
price (Pc) plus the subsidy
Government Spending =
subsidy per unit x Output
Subsidy welfare calculations part 2
Before the subsidy, social
(consumer plus producer) surplus
is maximum
Marginal Benefit = Marginal Cost
(MB = MC)
Allocative efficiency
After the granting of the subsidy,
both consumer surplus and
producer surplus increase
Government expenditure, the
cost of subsidy =
Qsb x (Pp - Pc)
So Government (social) losses
are greater than gains to
social surplus
Welfare Loss (Deadweight loss)
is equal to area a
 PRICE CONTROLS
Sometimes Government sets minimum or maximum prices and prices are
unable to adjust to their equilibrium level determined by demand and supply.
Price controls result in market disequilibrium - shortages (Qd>Qs) or surpluses (Qs>Qd).

Price Ceiling – governemnt sets a maximum price for a particular good.

● Price ceiling is always set below the equilibrium price otherwise would
have no effect on the market.
● An effort to keep prices below equilibrium. Leads to a shortage.
● E.g. Rent controls
Price Floor – government sets a minimum price for a particular good.
● Price floor is always set above the equilibrium price otherwise would have
no effect on the market.
● An effort to keep prices high. Leads to surpluses.
● e.g. Price Support for agricultural products - Govt buys surplus production
● e.g. Minimum wage
Price Ceiling & Price Floor
P/
Price Floor:
S
Wages ● Demand = Q1
Surplus ● Supply = Q2
National
Minimum Price Floor ● Surplus = (Q2-Q1)
Wage
Price Ceiling
Pe ● Demand = Q2
● Supply = Q1
Rent ● Shortage = Q2-Q1
Price Ceiling
Controls
Shortage
D
Q
Q1 Qe Q2

Government intervention in markets (products or resources) can create

shortages and surpluses by preventing the price mechanism to adjust itself
 Price Ceiling
Maximum legal price a seller can charge for a product.
Goal: Make affordable by keeping price from reaching Eq.

Price Gasoline
$8 S
Does this
policy help 6
consumers? To be “binding”,
Result: 4
BLACK
a price ceiling must Price Ceiling

MARKETS be 2below equilibrium

Shortag
1 e D
(Qd>Qs)
10 20 30 40 50 60 70 80 Q 28
 Price Floor
Minimum legal price a seller can sell a product.
Goal: Keep price high by keeping price from falling to Eq.

P Corn
$ S
Surplus
(Qd<Qs) Price Floor
4
To have an effect,
a price floor must be
3

Does this
above equilibrium
policy help
2

corn
1
producers? D

10 20 30 40 50 60 70 80 Q 29
 Practice Questions
1. Which of the following will occur if a legal price floor is
placed on a good below its free market equilibrium?
A. Surpluses will develop
B. Shortages will develop
C. Underground markets will develop
D. The equilibrium price and quantity will remain the same
E. The quantity sold will increase
2. Which of the following statements about price control is true
A. A price ceiling causes a shortage if the ceiling price
is above the equilibrium price
B. A price floor causes a surplus if the price floor is
below the equilibrium price
C. Price ceilings and price floors result in a
misallocation of resources
D. Price floors above equilibrium cause a shortage 30
2012 Question 17
Price Ceilings: stakeholders
● Consumers (mixed) –
(+ better) those consumers who were able to buy the good at that
low price before it ran out are happy
(- worse off) those consumers who really wanted the product but
weren’t able to get it because ran out (shortage)

● Producers (- worse off) They receive a lower price and also

produce/sell less (because they are not willing to produce more at
that low price). Revenue decreases.
● The government (neutral) – doesn’t receive or spend money
 Price Ceiling example
e.g. Rent Controls (New York)
Impact on Market Outcomes
Disequilibrium - cannot clear - creates shortage (Qd>Qs)

Consequences for Economy

Shortage (much more Qd than there is supplied)
Housing conditions deteriorate (no incentive to invest money in property
maintenance or improvement)
Black markets develop - buy at subsidized price, sell at market price. Price ceilings
create incentives for people to resell goods on a black market, allowing real prices to be higher anyway.

Non-price rationing (resource allocation) via: queuing; vouchers; corruption

Inefficiency - loss of social welfare
Price Ceiling Welfare calculations
Consumer Surplus + Producer Surplus
P = Social Surplus (Social Welfare)
Area below Consumer Surplus S = MSC
Demand curve
& above price line

Welfare loss - loss of social

surplus because of artificial price
Pe ceiling. Loss of producer surplus
(loss of allocative & productive
Area above the efficiency
Supply curve
& below price line P2 Price ceiling
D = MSB
Producer Surplus

Q
Q1 Qe

Allocative efficiency at Pe & Qe - Marginal Benefit to society (D=MSB) is equal to the

Marginal Cost to society of supplying the production (S = MSC)
 Price Ceilings
Consumer surplus was
P/ S = MC (a+b) and is now (a+c)
Wages
Producer Surplus was (c+d)
and is only (e) with price
ceiling.
a
b Welfare Loss triangle (b+d)
Pe Welfare Loss = b + d
shows loss of social welfare
d or social surplus (consumer
c
plus producer surplus) due to
Pc Price Ceiling Price Ceiling.
Shortage Before= (a b)+(c d e)
e
(Qs - Qd) After = (a c)+(e)
D = MB Loss = (b d)
Q
Qs Qe Qd

Government intervention in markets (products or

resources) can create shortages and surpluses by
preventing the price mechanism correcting imbalances.
Welfare loss shows under-allocation of resources.
Price Floors: stakeholders
● Consumers (- worse off) They pay a higher price and buy less.
● Producers (mixed)
(+ better) those firms who were able to sell for the higher price
and got the customers
(- worse off) those firms who were willing to produce/sell but no
on one bought (surplus Qs>Qd) from them because of high prices.
● The government (neutral) – doesn’t receive or spend money
-------------------------------------------------------------------------------------------
However, in case of Minimum Wage, keep in mind that Consumers of
workers is the Firms and Suppliers of workers is the people. Therefore,
with Minimum Wages, the companies are always worse off as pay
higher wages, and the workers are mixed as some get hired at the
higher wage and some don’t get a job because firms don’t hire many.
Price Floor Welfare calculations
Consumer Surplus + Producer
Surplus = Social Surplus
P Consumer Surplus
Area below (Social Welfare)
S = MSC
Demand curve
& above price line
P1 Price floor
Welfare loss - loss of social surplus
Pe because of artificial price floor creating
disequilibrium in market. Loss of
Area above the consumer surplus (loss of allocative &
Supply curve productive efficiency)
& below price line
D = MSB
Producer Surplus
Q
Q1 Qe

Allocative efficiency at Pe & Qe - Marginal Benefit to society (D=MSB) is equal to the

Marginal Cost to society of supplying the production (S = MSC)
Price Floors (min. wage): stakeholders
● Producers (- worse off) as they have to pay salary to
be able to hire and produce therefore higher costs of
production and they’ll also hire less people. So they pay
more and get less workers.

● Workers (mixed) - Those with jobs gain, those made

unemployed (Qe-Qd) lose.

● Consumers (- worse off) – Minimum Wage increase

production costs for product. Supply curve shifts to left.
Price rise, quantity demanded falls.
Minimum Wage (price floor) consq
Excess labour supply = unemployment (Qs-Qd)
Higher wages increase supply of labour and reduce demand
“Illegal employment” below the Min Wage
Incentive as at that high wage many can’t find work.
Often with little or no employment rights (since working illegally)
Higher prices for consumers
Firms have to pay more for workers which means higher costs of
production for them which will lead to higher prices of their goods
Negative Welfare Impacts
Note: Government doesn’t ‘buy’ surplus labour!
2010 Question 3
2010 Question 4
 Tariffs & Quotas
World Price- Countries can buy products at their own
domestic price or they can buy the products at a
cheaper world price
Tariff- Tax on imports that increases the world price
1. Tariffs - Government tax on imports (per unit), paid by importers
Protective - protect domestic industry & employment from competition
Revenue - raise revenue for government (esp. poor countries)

Quota- a limit on number of imports.

1. Quotas - Legal limit on quantity of goods that can be imported
Similar effect to Tariff but Do not create government revenues

Purpose of tariffs and quotas:

•To protect domestic producers from a cheaper world price.
•To prevent domestic unemployment 42
 International Trade Graph
When we have Trade we now have TWO possible supply curves for the
domestic market: a World (Global) Supply Curve; and a Domestic
Supply curve.
• World supply curve (Sw) is perfectly elastic at the World Price (Wp) as
global suppliers have sufficient capacity to meet any level of demand in the
domestic economy. Too small compared to world.
Imports & Exports
• If world market price (Pw) is above the domestic price (Pd), domestic
producers will prefer to export rather than sell at home.
• If the world price is below the domestic price then consumers will
want to buy imports instead.
Graph with Free Trad (country importing)
World Price lower than Domestic price Pw = World Price (determined by
World Supply Sw)
Q1 = domestic supply
Q2 = domestic demand
Q2-Q1 = imports

When the World Supply

Curve Sw (and so World
Price Pw) is below the
domestic price (Pd), then
goods will be imported.

Domestic demand at Pw =
Qd
Domestic Supply at Pw = Qs.

So domestic suppliers are

willing only to supply up to
Qs. That means imports will
make up the rest of the
Graph with theTariff
After Tariff:
Pw+t = World price plus tariff. Paid
by consumers, received by
producers
Q3 = domestic supply
Q4 = domestic demand
Q4-Q3 = imports
Price rises; quantity demanded
falls; domestic production
increases.
Tariff: Welfare Loss
Consumer surplus:
• Before tariff = (abcdef)
• After tariff = (ab)
• Loss = (cdef)
Producer surplus:
• Before tariff = (g)
• After tariff = (gc)
Government Revenue
• Tariff revenue = (e) =
(Q3xQ4) x tariff
• Not welfare loss, since will
redistributed via govt.
Welfare Loss (d+f)
• Loss of allocative and
productive efficiency
• Less produced at higher
price, by less efficient
domestic producers
(instead of foreign
producers)
 Tariffs: Winners & Losers
• Winners:
– Domestic producers - higher Price & Quantity produced
– Domestic workers - higher employment
– Government gains tariff (tax) revenue (Q imported x Tariff)

• Losers:
– Domestic consumers - higher price, lower consumption
– Foreign producers - receive the world price - lose sales
– Domestic income distribution worsens - tariffs are a regressive tax
(rich pay same percentage tariff as poor people)
– Increased inefficiency in production - Global misallocation of
resources. Domestic firms are less efficient than foreign.
 Quotas:
Legal limit on quantity of a good than can be imported
Who gets the revenue? The company that owns the quota licence effectively
receives the “quota revenue” from higher domestic prices.
• Winners:
– Domestic producers - higher prices and higher quantities
– Domestic workers - Domestic employment increases
• Losers:
– Domestic consumers - higher price, lower consumption
– Domestic income distribution worsens - Quotas lead to price rises - so
have “regressive effect” as tariffs
– Increased inefficiency in production - Misallocation of resources.
– Foreign Workers - Reduced production & employment
• Undecided - depends on how quotas allocated
– Government - does it get revenue from Quota sales (box e)?
– Foreign Producers - depends if get Quota revenues (e)?
 International Trade and Quotas
Identify the following:
1. CS with no trade
2. PS with no trade
3. Amount we import at
world price (PW)
4. PS if we trade at world
price (PW)
5. CS if we trade at
world price (PW)
6. If government tariff
leads to a world price
This graphs show the of PT, how much is
imported and what is
domestic supply and
the CS and PS?
demand for grain. The letters
represent area.