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CHAPTER 2 THEORETICAL TOOLS OF PUBLIC FINANCE 49

Social Efficiency
Armed with the analysis thus far, we are now ready to take the final step: to
measure social efficiency, or the size of the pie. Social efficiency represents the
net gains to society from all trades that are made in a particular market, and it
consists of two components: consumer and producer surplus.
Consumer Surplus The gain to consumers from trades in a market for con-
sumer goods is consumer surplus, the benefit that consumers derive from consumer surplus The benefit
consuming a good above and beyond what they paid for the good. Once we that consumers derive from
consuming a good, above and
know the demand curve, consumer surplus is easy to measure, because each point beyond the price they paid for
on a demand curve represents the consumers willingness to pay for that quantity. It is the good.
important to always keep in mind that willingness to pay is dependent on the
consumers resources; willingness to pay is shorthand for willingness to pay
given available resources.
Panel (a) of Figure 2-14 shows a graphical representation of consumer sur-
plus in the movie market: the shaded area below the demand curve and above
the equilibrium price PE (area WZX). This area is consumer surplus because
these are units where the willingness to pay (represented by the demand curve)
is higher than the amount actually paid, PE. Consumer surplus is largest on the
very first unit, since this represents the consumer who most wanted the good.
(He is willing to buy the good at a very high price.) For that first unit, con-
sumer surplus is equal to the distance WX on the vertical axis. Consumer surplus

FIGURE 2-14

(a) (b) (c)


Price, P P P
W

W Consumer
surplus S S S
W
Z Z Z
PE PE PE
X X X D
D
D

Y Y Y

Q E Quantity, Q QE Q QE Q

Consumer Surplus The consumer surplus is the area below the demand curve and above the equilibrium
market price, the shaded area WZX in all three panels of this graph. This represents the value to consumers
of consuming goods above and beyond the price paid for those goods. As demand becomes more inelastic,
consumer surplus rises; as demand becomes more elastic, consumer surplus falls.