Understanding Economics

6th edition
by Mark Lovewell, Khoa Nguyen and Brennan Thompson

Chapter 7
Economic Welfare and Income
Distribution
Learning Objectives

⚪ This chapter will:

1. Describe the concepts of consumer
surplus, producers surplus and
deadweight loss
2. Distinguish between spillover costs and
benefits, and identify the ways that govt.
addresses these issues
3. Identify the causes of poverty and the
way poverty is measured
4. Evaluate the effectiveness of govt.
intervention to change the distribution of
income
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Consumer and Producer Surplus

⚪ Alfred Marshall
• was the first to establish the use of
demand and supply curves
• devised the notion of consumer surplus
which is the difference between marginal
benefit and price for each unit of a
product
⚪ The concept of consumer surplus
applies both to individual consumer
and market demand curves

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Consumer and Producer Surplus
⚪ Consumer Surplus
• The net benefit, expressed in dollar terms
from buying a product at its market price

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Consumer and Producer Surplus
⚪ Producer Surplus
• The difference between the price received
from selling each unit of a product and
the marginal cost of producing it

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Consumer and Producer Surplus
(The case of perfect competition)
⚪ At quantities below 100,000 pizzas, MB
exceeds MC, which means economic
welfare can be increased by raising
quantity

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Consumer and Producer Surplus
(When a market becomes uncompetitive)
⚪ Deadweight Loss is the net loss in economic
welfare that results from a government policy

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 Spillover Costs
⚪ Spillover effects are the external effects of
economic activities which have an impact on
outsiders who are not producing or consuming a
product
⚪ Spillover costs are the negative external effects
of producing or consuming a product
• adding these costs to private costs raises the supply
curve & the preferred outcome is at a lower quantity
than in a perfectly competitive market
• government intervention (e.g. an excise tax) can
produce the preferred outcome
• Carbon Tax: Excise tax levied on a wide range of
products to counteract spillover costs associated with
carbon emissions
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 Spillover Costs

Market Demand Curve for Strawberries

Demand and Supply D S S
Schedules for Gasoline 2.5 0 1

Price Quantity Quantity 0 a Spillover

2.0 Costs,
($ per Demanded Supplied Excise
(D (S0 (S1 0

Price ($ per
litre) Tax
) (millions )of litres)) 1.5 b

litre)
0
$2.50 4 8 6 1.0
2.00 5 7 5 0
1.50 6 6 4 0.5
0
1.00 7 5 3
0.05 8 4 2 0 1 2 3 4 5 6 7 8

Millions of
Litres

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 Spillover Benefits
⚪ Spillover benefits are the positive
external effects of producing or
consuming a product
• adding these benefits to private benefits
raises the demand curve
• the preferred outcome is at a higher
quantity than occurs in a perfectly
competitive market
• government intervention (e.g. a consumer
subsidy) can produce the preferred outcome
⚪ Public good is a product whose
benefits cannot be restricted to certain
individuals
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 Spillover Benefits
Figure 3.14, page 69

Demand and Supply Curves for an

Demand and Supply Schedules Engineering Education
for an Engineering Education 600
0 b
Tuition Enrollment Quantity 500
($ per Demanded Supplied 0 Spillover
year) (D0) (D1) (S Benefits,
400 a
(thousands of students) Student
)

Tuition ($ per
0 Subsidy
$6000 8 10 12 300

year)
5000 9 11 11 0
200
4000 10 12 10 S D D
0
3000 11 13 9 100 0
1

2000 12 14 8 0

1 1 1 1 1
0 8 9
0 1 2 3 4
Thousands of
Students

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 The distribution of Income
(Income Shares)
⚪ Lorenz Curve: A curve showing the
cumulative distribution of income among a
country’s households
⚪ Two hypothetical economies: Perfectly
equal and Perfectly unequal
⚪ Gini coefficient: A single numerical
measure of income distribution
(https://en.wikipedia.org/wiki/Gini_coefficie
nt)
⚪ https://en.wikipedia.org/wiki/List_of_countri
es_by_income_equality

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 The Lorenz Curve

e
100
Distribution of Cumulative Distribution of

Cumulative Share of
Household Income Household Income 80
Share of Cumulative Share Perfect

Income (%)
Income in of Income Equality d
60
2000 (%) in 2000 (%)
40 c
Lowest 4.5 Lowest 20% 4.5
Second 10.1 (a) 20 b
Perfect
Third 16.1 Lowest 40% 14.6 = 4.5 a
Inequality
Fourth 24.2 + 10.1 (b)
Highest 45.2 Lowest 60% 30.7 = 14.6 0 20 40 60 80 100
+ 16.1 (c)
Lowest 80% 54.9 = 30.7 Households (%)
+ 24.2 (d)
100% 100.0 = 54.9
+ 45.2 (e)

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Gini Index of Bangladesh

Source: BBS
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 Gini Index of Different Sectors of
Employment

Source:
Zubayer et
al., 2018

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Reasons for Income Inequality

⚪ There are three main reasons for

income inequality (in addition to
wage determinants):
• risk-taking
• ability
• wealth
⚪ Wealth is more unequally distributed
than income.

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 Wage Determinants (a)

⚪ There are seven main wage determinants

• labour productivity
• education
• experience
• job conditions
• regional disparities
• market power
• discrimination

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Education

⚪ Education
• usually adds to a worker’s pay but has
opportunity costs as well
• serves two main purposes (consumption
and investment in human capital)
⚪ A student will undertake an educational
program if its benefits (both monetary
and nonmonetary) exceed its
opportunity costs

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Labour Unions

⚪ There are two main types of labour

unions
• industrial unions include all workers in a
certain industry
• craft unions include workers in a
particular occupation and restrict who can
be members

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Job Discrimination

⚪ Some person or group benefits at the

expense of another person or group
⚪ Not based on differences in human capital

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Job Discrimination Cont.

⚪ Job discrimination can take two main forms

• direct job discrimination is the payment of
different amounts for substantially the same
work
• a discriminatory division of jobs (e.g.
secretaries and warehouse clerks)
• Mixed across these two is gender, age, racial,
ethnic and physical ability discrimination.
• Some grouped helped and another group’s
expense

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