Welfare can be differentiated according to social and economic aspects. Social welfare is based on the fact that a person has enough means available to shape their own life as independently as possible. Welfare in the economic sense examines the question of how the scarce resources in an economy can be divided up in such a way that everyone is supplied. To determine welfare, the consumer surplus and the producer surplus are calculated.
In this lesson, welfare is treated from an economic point of view. You will learn the importance of economic welfare and the factors that must be known to determine it. Finally, we will show you how welfare is influenced by different market conditions. To deepen your knowledge, you can answer a few exercise questions after the text.
English: economic welfare
What is the importance of welfare for the economy?
According to definitionexplorer.com, economic welfare shows what benefits the economy brings to the individual and to all citizens of a state.
The focus is on these two factors in particular:
- Consumer surplus
- Producer surplus
Welfare: consumer and producer surplus
The consumer surplus
The welfare of an economy is determined by the supply and demand for goods. In the best case scenario, the provider sets a price that all buyers accept. If the provider can sell his product in full, the equilibrium price prevails on the market.
In reality, supply and demand rarely match. As a rule, consumers act at low prices. This means that the provider has to lower its price. However, some buyers accept the price and show their willingness to pay a higher price.
What is the consumer surplus?
The willingness of some buyers to pay creates a gap in the equilibrium price, which is known in the national economy as consumer surplus. The amount of this pension depends on the price offered. If this is low, a high consumer surplus can be determined. If the selling price is high, the pension is lower.
How is the consumer surplus determined?
Example
A fashion house brings a new pair of trousers onto the market. The sales price is set at € 40. The demand corresponds to the expectations of the provider. Some customers are so enthusiastic about the pants that they would buy the pants for € 50.
The equilibrium price is € 40. At this price, the provider can generate sufficient demand. The difference between the equilibrium price and the customer’s willingness to pay is known as the “reservation price “. An enthusiastic customer would also buy three pairs of pants at this price.
The producer surplus
Economic welfare does not only depend on the demand side. The producer surplus must also be known so that economic welfare can be determined.
The producer surplus documents the vendor’s willingness to sell. It is important that he at least set a price that covers the total cost of production. If the seller does not pay attention, he will make a loss.
How is the producer surplus determined? (Formula)
Example
The fashion house from the previous example set a retail price of € 40. This price covers all manufacturing costs. Since the trousers can also be sold at a price of € 50, the provider receives € 10 more than he calculated in his calculation.
The company profit is not determined with the producer surplus. When calculating the producer surplus, only the variable costs play a role. If the entrepreneur wants to know what is left for him in the end, the fixed costs must also be taken into account.
How is economic welfare determined?
Economic welfare is calculated from the sum of producer surplus and consumer surplus.
Example
Economic welfare is determined for the sale of trousers by adding consumer surplus and producer surplus.
Economic welfare and the market
If suppliers and buyers meet in a market, the following market structures can be distinguished:
- monopoly
- Oligopoly
- Polypol
In monopoly
In a monopoly, one supplier meets many buyers. Its position allows the monopolist to set the price for its product. A monopoly does not compete and does not have to fear competition.
In the oligopoly
In the case of an oligopoly, a distinction must be made between the supply oligopoly and the demand oligopoly. In the demand oligopoly, the suppliers are predominantly represented. Your products are in demand by a small number of consumers. In the supply oligopoly it is exactly the opposite.
In the Polypol
The Polypol is characterized by the fact that many suppliers meet many customers. There is strong competition among the providers. The consumers do not have enough power to influence the price.
Welfare only works in a monopoly. By fixing the price, the monopoly determines the rules of the market. Since he does not have to deal with any competition, he can also charge a maximum price for his product. The monopolist also takes into account that his product will not be in demand by all consumers.
The higher the price is above the equilibrium price, the fewer consumers are interested in the goods on offer. The buyers’ reduced willingness to pay leads to a decrease in consumer surplus. The result is an economic loss of welfare.