Summary: Main Points on

Economic Efficiency and the Gains from Trade

selected answers from chapter 9

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Consumer Surplus

The height of the demand curve for a good, at each quantity, shows the benefit of that unit to buyers, measured by some buyer's willingness to pay for that unit of the good.  (See the discussion of reservation prices in Chapter 6, pages 132-3.)

Consumer surplus is the benefit to a consumer of being able to buy a good at the equilibrium price.  The shaded blue area in the graph shows consumer surplus in equilibrium.  The shaded green area shows consumer spending on the good.

 [BECAUSE]        [EXAMPLE]
 
 
 

Producer Surplus

Producer surplus is the benefit to a producer/seller of being able to sell a good at the equilibrium price.

The height of the supply curve for a good, at each quantity, shows the lowest price at which some seller is willing to produce and sell that unit of the good.  So the height of the supply curve for a good, at each quantity, shows the opportunity cost (to sellers) of producing and selling that unit of the good.  (See page 212.)
 
 
 

Gains from Trade

In equilibrium, buyers share the gains from trade.  The total gain from trade equals the consumer surplus plus the producer surplus from the trade.

With competition between price-taking firms, the equilibrium quantity is economically efficient.
 

Economic Efficiency

A change in the economy is a Pareto improvement if at least one person gains and no one loses.

A change is economically efficient if the winners (from that change) could compensate the losers by enough to make the change a Pareto improvement.

An economically efficient situation means that there are no additional economically-efficient changes to be made.
EXAMPLE -- The equilibrium of supply and demand illustrated above.

An economically inefficient situation means that some economically-efficient changes have not yet been made.
EXAMPLE -- when the two students (in the Chapter-3 example) do not trade.
 

The deadweight social loss from an economically inefficient situation equals the consumer and producer surplus that people could gain by eliminating that inefficiency.

The shaded area in the figure shows the deadweight social loss from keeping output below its equilibrium.
 

The deadweight social loss from limiting output to 10 units equals the gains from trade that people would have had if they had traded the 11th, 12th, 13th, 14th, and 15th units. In this case, the deadweight social loss is $10.
 
 

APPLICATION TO DEADWEIGHT SOCIAL LOSSES FROM TAXES

With no tax, the equilibrium price and quantity are P1 and Q1, consumer surplus is A + B + C, and producer surplus is D + E + F.   With a per-unit tax, T, buyers pay PB , sellers keep PS, and Q2 units are traded.  Consumer surplus is A, producer surplus is F, government tax revenue is B + D, and the deadweight social loss is C + E.
 
 

APPLICATION TO DEADWEIGHT SOCIAL LOSSES FROM SUBSIDIES

Without a subsidy, consumer surplus is area A + B
and producer surplus is area F + G.
With a subsidy, consumer surplus is area A + B + E + F,
producer surplus is area B + C + F + G,
the government pays area B + C + D + E + F,
and the deadweight social loss is area D.
 
 

APPLICATION TO THE GAINS FROM INTERNATIONAL TRADE

Algebra of Consumer Surplus

Qd = 10 - 2 P                     and                Qs = -5+ 3 P

where Qd and Qs are the quantities demanded and supplied, P is the price of the good, and a, b, c, and d are numbers.

The equilibrium price is P = 3.

And the equilibrium quantity is Q  =  4

Look at Figure A1 on page 230 of the text -- consumer surplus is the area of a right triangle.  The formula for the area of a triangle is half the area of the corresponding rectangle -- in this case, Q=4, so the rectangle has base = 4 (because that is the quantity demanded) and height = 2.   [BECAUSE]

So consumer surplus = (1/2) (4) (2) = 4.