Problem 2. Welfare Economics.

Consider the market shown in Figure 1.

GRAPH ATTACHED BELOW

1. Assume the economy reached the competitive equilibrium, with equilibrium quantity Q* and equilibrium price

P*Identify the following areas in the figure

(a) Consumer surplus.

(b) Producer Surplus.

(c) Value to buyers of consuming Q* units.

(d) Cost to sellers of producing Q* units.

(e) Total surplus.

2. Now assume there is a benevolent social planner interested in maximizing total surplus. The planner is

considering increasing quantity from Q*

to Q¹ so that more consumers receive the benefit of consuming the

good.

(a) Identify the area corresponding to the cost of producing the additional Q¹ ? Q* units.

(b) Identify the area corresponding to the value to buyers of consuming the additional Q¹? Q* units.

(c) Is the idea of increasing the quantity from Q*

to Q¹ a good idea from the point of view of market

efficiency?