Question

Welfare economics provides a framework for evaluating the impact of normative statement or government policies. Explain the framework of welfare economics. What are consumer and producer surplus? Explain why there are differences in willingness to pay along the demand market curve. Explain why there are difference in costs along the market supply curve.

Answer 1

ANSWER:

GIVEN THAT:

THE WELFARE ECONOMICS PROVIDES A FRAME WORK FOR EVALUATING THE IMPACT OF A NORMATIVE:

1. Welfare Economics is the branch of economics that tends to study the welfare of all the individuals in an economy at an aggregate level.

2. The welfare economics is the derivation of the social welfare functions of the individuals which denotes the utility that is being achieved by whole society with the allocation of resources.

3. Government aims to maximize the social welfare meaning that with the distribution of resources it tends to increase the utility of the whole society.

4. The field of welfare Economics is supported by two welfare theorems.

5.The first welfare theorem states that at a competitive equilibrium, the allocation of resources is efficient or pareto optimal which says that utility of all the individuals is maximized.

6. In other words,the economy is operating at its optimal level with the given resources.

7. The second welfare theorem states that the pareto optimal allocation can be stated as a competitive equilibrium meaning that if the allocation is efficient, the the given price level is competitive.

8. Consumer Surplus is the difference between the amount that the consumer is willing to pay and the amount that he actually ends up paying.

9. For example if a consumer is willing to pay $4 unit of good and the price of the good is $2, the consumer surplus equals $2.($4 -$2).

10. Producer Surplus is the difference between the amount that the producer is willing to charge and the amount that he actually ends up receiving.

11. For example if a producer is willing to $2 unit of good and the price of the good is $4, the producer surplus equals $2.($4 -$2).

12. The demand curve of an individual shows the quantity demanded by an individual at different price levels.

13. It is downward sloping meaning that as the price of good is reduced , the quantity demanded by an individual increases.

14. This is based on the principle of diminishing marginal rate of substitution meaning that as more and more of a good is consumed by an individual , its marginal utility decreases and thus willing to pay less price for every successive unit of a good.

15. The marginal cost of the producer is upward sloping which means that as the quanity of goods produced increases,.

16. The marginal cost also increases and there could various reasons such as (i) Improper allocation of resources (ii) Poor technology (iii) Inefficient labor.

17. In the long run, the cost could decline as well with the changes in the production technique, resource allocation etc.So, its never on the same trajectory and keeps varying based on the given production constraints.