Consumer and producer surplus
- Consumer surplus = the maximum amount a buyer is willing to pay − the amount actually paid. On a diagram: the area below the demand curve and above the price.
- Producer surplus = the amount received − the minimum amount a seller is willing to accept. On a diagram: the area above the supply curve and below the price.
- Total (social) surplus = consumer surplus + producer surplus.
Efficiency and deadweight loss
Resource allocation is efficient when total surplus is maximised. In a competitive market without externalities this happens at the equilibrium quantity, where marginal benefit equals marginal cost.
Deadweight loss is the loss in total surplus when the quantity transacted differs from the efficient quantity. Effective price ceilings and floors, quotas and unit taxes all create deadweight losses.
Externalities
An externality is a cost or benefit that falls on third parties and is not reflected in the price.
- External cost (e.g. pollution): marginal social cost > marginal private cost, so the market over-produces.
- External benefit (e.g. vaccination): marginal social benefit > marginal private benefit, so the market under-produces.
Government responses include taxes or charges (e.g. the plastic shopping bag charge), subsidies, regulations, and better-defined property rights.
Public goods
A public good is non-rivalrous in consumption: one person's consumption does not reduce the amount available to others (e.g. street lights, free online course materials).
When people cannot be excluded from consuming it, they can free ride, so the good is under-provided by the market and is often provided by the government.
Equity
- Equality of outcome: a more even distribution of income.
- Equality of opportunity: the same chance to compete, e.g. free education.
The Gini coefficient measures income inequality, from 0 (perfect equality) to 1 (perfect inequality). A higher value means a more unequal distribution of income.
Policies to reduce inequality: progressive taxes, transfer payments (e.g. CSSA), free education and medical services, a minimum wage. They may weaken incentives, so there is often a trade-off between efficiency and equity.
Common mistake: "efficient" does not mean "fair". A market can be efficient even if income is very unequally distributed.