Topic: Welfare Properties of the Competitive Market Solution & of Government Interventions
A. Consumer and Producer Surplus
If a consumer demands and purchases q΄ units at the price p΄, then the consumer surplus is the area
between his/her demand curve and the price line for p΄ out to the quantity q΄. This area is interpreted as
the difference between the value of q΄ units of the good and the amount that the individual pays for the
good.
Producer surplus for a firm selling q΄ units at price p΄ is the difference between the firm’s revenue and
the minimum payment for which the firm would sell q΄ units. Geometrically, the surplus for a firm that
sells q΄ units at the price p΄ is the revenue (p΄ q΄) minus the area below the marginal cost curve (which
is also the supply curve).
B. Total Surplus
One measure of the welfare to society from a market is the total surplus which is
C. Competitive Market Outcome
and Total Surplus
$/unit
S
pc
D
qc
quantity
D. Surplus for Other Output Levels 1. Total Surplus for a Quantity Less than the Comp. Eq Quantity
Case 1: The consumers who value the product the
most receive the limited number of units and the
firms who can produce at lowest cost provide the
limited number of units
$/unit
S
pc
D
qc
Case 2 CS : Among consumers who purchased the
product at the comp. eq, those who value the
product least receive the good
quantity
$/unit
S
pc
D
qc
Case 2 PS : and among the firms who produced at
the competitive equilibrium those who produce at
the highest marginal cost provide the limited
number of units
quantity
$/unit
S
pc
D
qc
quantity
2. Total Surplus for a Quantity Greater than the Comp. Eq Quantity
Suppose that more than the comp. eq. quantity is produced. The price is set so that consumers
purchase this quantity and firms are ‘forced’ to produce the total quantity at this price.
CS
$/unit
$/unit
S
S
A
pc
pc
B
pa
D
qc
qa
pa F
E
G
D
J
qc
quantity
PS
I
qa
quantity
Total Surplus
$/unit
$/unit
S
S
A
A
pc
pc
H
B
pa F
E
B
I
G
D
J
qc
qa
quantity
Competitive Eq.
CS
PS
Total Surplus
Difference in Total Surplus:
H
pa F
E
I
G
D
J
qc
qa
quantity
More than the Comp. Eq.
Quantity Produced
3. Intuitive Explanation for Why Total Surplus is Highest at the Competitive Eq. Outcome
Firms:
Consumers:
Market Outcome:
E. Discussion of the Finding that Surplus is Highest for the Competitive Equilibrium.

Remarkable that the only information that needs to be conveyed to consumers and producers is
market price!

Compare a social planner…

Equity (Normative Issues)
o Market consumer surplus is the sum of consumer surplus for each consumer
o

Does accepting total surplus as a welfare measure mean that we must place the same weight
on additional surplus for all individuals?
Issues that we have not yet considered
F.
1.
5.
6.
Applications
Per Unit Tax 2. Per Unit Subsidy 3. Support Programs 4. Output Restrictions
Import Quotas (for a small country for which restrictions by the country do not affect the world price)
Import Tariffs (for a small country for which restrictions by the country do not affect the world price)