Question

What is “willingness to pay” and “willingness to sell”? How is willingness to pay/sell related to consumer and producer surplus? Under what conditions can it be said that economic welfare is maximized? What is meant by an “efficient allocation of resources”?

 

Answer 1

Willingness to pay (WTP) is the maximum amount an individual is willing to sacrifice to procure a good or avoid something undesirable.

Willingness to sell is the opportunity cost of producing that unit of output, since sellers would not sell that unit below the cost of producing it, but would sell if the price was greater than the cost of producing it.

The price of any goods transaction will thus be any point between a buyer's willingness to pay and a seller's willingness to accept.

Consumer Surplus is the area under the demand curve that represents the difference between what a consumer is willing and able to pay for a product and what the consumer actually ends up paying.

The Producer Surplus is the area under the supply curve that represents the difference between what a producer is willing and able to accept for selling a product and what the producer sells it for.

Welfare is maximized when the utility of those society members that have the least is the greatest. No economic activity will increase social welfare unless it improves the position of the society member that is the worst off.

All the points on the grand social utility frontier are Pareto efficient but only one point, the point of bliss, identifies where social welfare is maximized. This point is where the social utility frontier is tangent to the highest possible social indifference curve.

An efficient allocation of resources is: That combination of inputs, outputs and distribution of inputs, outputs such that any change in the economy can make someone better off (as measured by indifference curve map) only by making someone worse off (pareto efficiency).