Question

3. Markets and wellbeing: Why we want markets that make consumer and producer surplus bigger? Explain the concept of surplus and the relationship between price and consumer surplus. Please, build your argument trough an example (it can be fictitious).

Answer must contain a brief introduction to concepts and facts, a part of analysis and critical evaluation and final conclusions.

Answer 1

Consumer surplus represents the area of the difference between price consumer is willing to pay for the product and the price they pay multiplied by quantity sold while producer surplus is the area showing the price at which producer is willing to sell goods and the price at which they sell.

Higher consumer and producer surplus represents that market is opertaing without any hindrance or any government interference or the market is perfectly competitive. Any government interference such as prce ceiling and price floor result in fall in producer surplus and consumer surplus respectively. Any market form other than perfectly competitive result in deadweight loss because they tends to produce at less than socially optimum level where consumer surplus falls.

Example of Price Ceiling: There is deadweight loss of area C + E.

Example of Price Floor: There is deadweight loss of triangle DCE.

Monopoly: There is deadweight loss of area A + B.

In short we expect free market to maximize consumer and producer surplus.