welfare economics and the gains from trade. a consumer buys chickens from a farm. we want to measure...
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Welfare Economics and the Gains from Trade
A consumer buys chickens from a farm.
We want to measure the gains from trade.
We need to measure the gains of the consumer and the gains of the farm.
Total & Marginal Value Gains of consumer
3 38 10
4 45 7
5 50 5
6 52 2
Quantity Total Value
Marginal Value
1 $15 $15
2 28 13
Price Quantity
$15 1
13 2
10 3
7 4
5 5
2 6
Total Value as an Area
$
15
1 2 3 4 5 6
13
10
7
5
2
Q
The total value is the area under the demand function
Consumer’s SurplusPrice is 7
$
15
1 2 3 4 5 6
13
10
7
5
2
Q
A
BD=MV
Consumer’s Surplus
Total Value=A+B=$45
Expenditure=B(P times Q)=$28
Consumer’s Surplus=A=$17
Marginal Cost and the Supply Function
Quantity Marginal Cost Total Cost
Price
1 1 1 (FC=0) 1
2 3 4 3
3 5 8 5
4 7 15 7
Price required to produce the second unit is $3 because producing a second unit increases the cost in $3.
Total Cost as an Area
$
1 2 3 4 5 6
7
53
1Q
S=MC
Total Cost as an Area
P
1 2 3 4 5 6
7
53
1Q
S=MC
C
D
Producer’s Surplus
Total Revenue (P times Q)=C+D=$28
Production Costs=D=$16
Producer’s Surplus=C=$12
Total Surplus
P
15
1 2 3 4 5 6
13
10
7
5
2
Q
Consumer’s Surplus
D
Producer’s Surplus
S
Consumers’ Value in the Market
P
15
1 2 3 4 5 6
13
11
8
7
3
Q
C1C3
C2 C2 C1 C3
Marginal Value
Q C1 C2 C3
1 15 13 7
2 8 11 3
Total Costs in the Market
P
1 2 3 4 5 6
653
1Q
S=MC
Marginal Cost
Q F1 F2 F3
1 1 5 6
2 3 11 7
F1F1
F2F3
7
11
F3F2
Effect of a Tax on Welfare
P
AB
E
H
C
F
Q
D
S
I
D
G
D’
Pc
P
QQ’
Pf
tax
Welfare ComputationBefore Sales Tax After Sales Tax
Consumers’ surplus
A+B+C+D+E A+B
Tax Revenue - C+D+F+G
Social Gain A+B+C+D+E+F+G+H+I
A+B+C+D+F+G+I
Deadweight Loss
_ E+H
Producers’ surplus
F+G+H+I I
Effect of a Subsidy on Welfare
P
A
E
H
C
F
Q
D
S
D
GD’
Ps
P
Q Q’
Pd
B
Subsidy
Welfare ComputationBefore Subsidy After Subsidy
Consumers’ surplus
A+C A+C+F+G
Tax Revenue - -(C+D+E+F+G)
Social Gain A+C+F+H A+C+F+H-E
Deadweight Loss
_ E
Producers’ surplus
F+H C+D+F+H
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