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Welfare economics
The maximum amount that a buyer will pay for a good.
Willingness to pay
The maximum amount that a buyer will pay for a good.
Consumer surplus
The amount a buyer is willing to pay for a good minus the amount the buyer actually pays for it. It can be measured as the area below the demand curve and above the price, and it measures the benefit that consumers receive from the good as the buyers themselves perceive it.
How do lower prices help consumer surplus?
Existing buyers gain extra consumer surplus because they pay less for the product than before (area A), and new buyers enter the market, gaining consumer surplus on additional units purchased (area B).
Cost
The value of everything a seller must give up to produce a good
Producer surplus
The amount a seller is paid for a good minus the seller's cost. It can be measured as the area above the supply curve and below the price and is used to measure the economic well-being of producers.
How do higher prices help producer surplus?
Existing sellers gain extra producer surplus because they receive more for the product than before (area C), and new sellers enter the market, gaining producer surplus on additional units sold (area D).
Total surplus
Consumer Surplus + Producer Surplus (Value to Buyers - Amount Paid by Buyers) + (Amount Received by Sellers - Costs of Sellers
Efficiency
The property of a resource allocation of maximizing the total surplus received by all members of society.
Equity
The fairness of the distribution of well-being among the members of society.
At the market equilibrium price,
goods are allocated to buyers who value them most, and demand is met by sellers who produce at the lowest cost, in a free market. This ensures efficient distribution based on willingness to pay and production costs. Total surplus is maximized.
At any quantity of output smaller than the equilibrium quantity,
the value of the product to buyers is greater than the cost to sellers so total surplus would rise if output increases.
At any quantity of output greater than the equilibrium quantity,
the value of the product to buyers is less than the cost to sellers so total surplus would rise if output decreases.
