Welfare economics
How the allocation of resources affects economic well-being
Willingness to pay
Maximum amount that a buyer will pay for a good
Consumer surplus
Amount a buyer is willing to pay for a good
Minus amount the buyer actually pays for it
Measures the benefit buyers receive from participating in a market
Closely related to the demand curve
Demand schedule
Derived from the willingness to pay of the possible buyers
Cost
Value of everything a seller must give up to produce a good
Measure of willingness to sell
Producer surplus
Amount a seller is paid for a good minus the seller’s cost of providing it
Market Efficiency
The benevolent social planner
All-knowing, all-powerful, well-intentioned dictator
Wants to maximize the economic well-being of everyone in society
Economic well-being of a society
Total surplus = Sum of consumer and producer surplus
Total surplus = Consumer surplus + Producer surplus
Efficiency
Property of a resource allocation
Maximizing the total surplus received by all members of society
Equality
Property of distributing economic prosperity uniformly among the members of society
Gains from trade in a market
Like a pie to be shared among the market participants
The question of efficiency
Whether the pie is as big as possible
The question of equality
How the pie is sliced
How the portions are distributed among members of society
Market outcomes
Free markets allocate the supply of goods to the buyers who value them most highly
Measured by their willingness to pay
Free markets allocate the demand for goods to the sellers who can produce them at the least cost
Adam Smith’s invisible hand
Takes all the information about buyers and sellers into account
Guides everyone in the market to the best outcome
Economic efficiency
Free markets = best way to organize economic activity