Evaluating the Market Equilibrium

Consumer and producer surplus when a market reaches the equilibrium pf supply and demand. Recall that consumer surplus equals the area above the price and under the demand curve and producer surplus equals the area below the price and above the supply curve. Thus the total area between the supply and demand curves up to the point of equilibrium represents the total surplus in this market.

Equilibrium allocation of resources? Does it maximize total surplus? To answer these question keep in mind that when a market is in equilibrium the price determines which buyers and sellers participate in the market. Those buyers who value the good more than the price represented by the segment AE on the demand curve choose to buy the good buyers who value it less than the price (represented by the segment EB) do not. Similarly those sellers whose costs are less than price (represented by the segment CE on the supply curve) choose to produce and sell the good sellers whose costs are greater than the price (represented by the segment ED) do not.

Thus given the quantity produced and sold in a market equilibrium the social planner connot increase economic well-being by changing the allocation of consumption among buyers or the allocation of production among sellers.

But can the social planner raise total economic well-being by increasing or decreasing the quantity of the good? The answer is no as stated in this third insight about market outcomes.

To interpret this keep in mind that the demand curve reflects the value buyers and the supply curve reflects the cost to sellers. At any quantity below the equilibrium level such as the value to the marginal buyer exceeds the cost to the marginal seller. As a result increasing the quantity produced and consumed raises total surplus. This continues to be true until the quantity reaches the equilibrium level. Similarly at any quantity above the equilibrium level such the value to the marginal buyer is less than the cost to the marginal seller. In this case decreasing the quantity raises total surplus and this continues to be true until quantity falls to the equilibrium level. To maximize total surplus the social planner would choose the quantity where the supply and demand curves intersect.

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