GOVERNMENT INTERVENTION IN THE MARKET

Objective of Government Intervention: Social Welfare

Price Ceiling: Legally established maximum price a seller can charge. To protect the interests of
the buyers.
Price Floor: A legally established minimum price a seller can be paid. To protect the interests of
the sellers.
A Market with a Price Ceiling that is not Binding

A Market with a Price Ceiling that is Binding

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The Market for Gasoline with a Price Ceiling

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A Market with a Price Floor that is Not Binding

A Market with a Price Floor that is Binding

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How the Minimum Wage Affects the Labor Market

How the Minimum Wage Affects the Labor Market

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Producer Surplus
Producer surplus is the amount a seller is paid minus the cost of production.
It measures the benefit sellers receive from participating in a market.
The Costs of Four Possible Sellers

The Supply Schedule and the Supply Curve

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Measuring Producer Surplus with the Supply Curve

Measuring Producer Surplus with the Supply Curve

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How the Price Affects Producer Surplus?

How the Price Affects Producer Surplus?

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Consumer and Producer Surplus in the Market Equilibrium

• Consumer Surplus is the benefit that buyers receive from participating in a market.
• Producer surplus is the benefit that sellers receive.
• Consumer surplus equals the area above the price and under the demand curve.
• Producer surplus equals the area below the price and above the supply curve.
Measuring Economic Welfare using Consumer and Producer Surplus
• Consumer and Producer Surplus are the basic tools that economists use to study the
welfare of the buyers and the sellers.
• These tools can help us address a fundamental economic question. Is the allocation of
resources determined by free market desirable?
Measuring Economic Welfare using Consumer and Producer Surplus
Consumer Surplus = Value to Buyers – Amount Paid by the Buyers
Producer Surplus = Amount Received by Sellers – Cost to sellers
Total Surplus = (Value to Buyers – Amount Paid by the Buyers) + (Amount Received by Sellers
– Cost sellers)
The amount paid by buyers equals the amount received by sellers, so the middle two terms in the
expression cancel each other. As a result, we can write total surplus as
Total Surplus = Value to Buyers – Cost to Sellers

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Total Surplus
Total surplus is the sum of consumer and producer surplus – is the area between the supply and
demand curves up to the equilibrium point.

Efficiency of Free Markets

When the market is in equilibrium the price determines which buyers and sellers participate in
the market. Those buyers who value the good equal to or more than price(Segment AE) on the
demand curve choose to buy the good, buyers who value it less than the price(segment EB) do
not.
Free markets allocate the supply of goods to the buyers who value them most highly, as
measured by their willingness to pay.
Those sellers whose costs are less than the price(segment CE)choose to produce and sell the
goods; sellers whose costs are greater than the price(segment ED)do not.
Free markets allocate the demand for goods to the sellers who can produce them at the lowest
cost.
Deadweight Loss
Definition: It is the loss of economic efficiency in terms of utility for consumers/producers such
that the optimal or allocative efficiency is not achieved. This arises due to reasons like taxes or
subsidies, price ceilings or floors, externalities and monopoly pricing. It is the excess burden
created due to loss of benefit to the participants in trade which are individuals as consumers or
producers.
The area of deadweight loss in the figure can be measured by comparing the total surplus under
free market system with respect to total surplus when there is a price floor

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Under free market system total surplus is equal to the area A, B,D and When a price floor is
imposed, total surplus get reduced to E,C and D and there is a loss in the economic surplus (Area
A and B) known as deadweight loss. Since consumer surplus is the area below the demand
curve and above the price, with the price floor the area of consumer surplus is reduced from
areas B, C, and E to only area E. Producer surplus which is below the price and above the supply
or marginal cost curve changes from area A and D to D and C.

The area of deadweight loss in the figure can be measured by comparing the total surplus under
free market system with respect to total surplus when there is a price ceiling. Under free market
system total surplus is equal to the area A, B,D and When a price ceiling is imposed, total
surplus get reduced to E,C and D and there is a loss in the economic surplus (Area A and B)
known as deadweight loss.The consumer surplus area changes from areas E and B to E and C
and the producer surplus area is reduced from A, C, and D to only D.

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Measuring Total Surplus Numerically

Total Surplus = Consumer surplus + producer surplus

Both consumer and producer surplus can be measured by calculating the area
of the triangles

Consumer surplus
Area of the triangle = .5 (300x600) = $90,000
Producer surplus
Area of the triangle = .5 (300x600) = $90,000
Total Surplus = $90,000 + $90,000 = $180,000

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Measuring Change in Total Surplus due to Govt intervention

Consumer surplus (triangle + rectangle)

Triangle area = .5(200 x400) = $40,000
Rectangle area = 200 x 400 = $80,000
Total Consumer surplus = $ 120,000
Producer surplus
Area of the triangle= .5 (200x400) = $40,000
Total Surplus = $120,000 + $40,000 = $160,000

Due to govt.intervention, there has been a decline of $2000 in total surplus ($180,000 -
$160,000)
Dead weight Loss = area of the triangle DWL in the above diagram = .5(100x 400) = $2000

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