Consumer Surplus

Marginal Willingness to Pay Curve leads naturally to the concept of consumer surplus. Follow the following line of logic:

  1. The area under the MWTP curve is the Total Willingness to Pay (TWTP)—the amount the consumer was willing to pay to get amount of goods.
  2. Since they didn’t have to actually pay that amount (they only paid ), they’re better off.
  3. The quantitative amount that they’re better off is the Consumer Surplus

Deadweight Loss due to Taxation, Analyzed with MWTP Curves

Consier a distortionary tax on housing prices, per square feet. The blue line shows the price per sqft of housing. The red line shows the post-tax budget line, and is the optimal point.

  • → What if instead the government took away a lump sum instead of a distortionary tax? The amount taken away is and the green line shows the new budget. In this hypothetical, ideal case, the optimal is .
  • → In this case, the distortionary tax collected for bundle is vertial distance . As , the vertical distance shows the Deadweight Loss for the taxation. (The lump sum was better.)

Alternatively, consider graphing the MWTP for utility , using points .

  • → With the distortionary tax—optimal bundle: , . Govn’t revenue is
  • → With the lump sum tax—optimal bundle: ,

How come the consumer has more surplus as in the bottom graph? Aren’t they indifferent in MWTP?

  • → The consumer instead lost the collected lump sum tax, ;
  • → ∴