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Notes for Chapter 3 ECON 2390 Benefit-Cost Analysis Benefits to the consumer The key to a benefit that anything of value will be acquired by giving something up. Typically measured as consumer surplus. Willingness to pay is the key idea and equals the difference between the maximum the consumer would be willing to pay and the actual purchase price. 2 Consumer demand Consumer demand depends on price or the produce, price of complements and substitutes, income, wealth,…. Typical relationships focus on quantity demanded and the “own” price. QD = a – BP P = a/B – (1/B)QD 3 Willingness to pay Price B Pe A Qe The demand curve represents the willingness to pay Pe is the equilibrium price Consumer surplus is the triangle PeAB Quantity Supplied 4 Producer Surplus Price Pe A B Qe The supply curve represents the willingness to offer This is an idealized relationship (see notes page) Pe is the equilibrium price Producer surplus is the triangle PeAB Quantity Supplied 5 Derivation of marginal cost Total supply QS1 = 3p-4 QS2 = p-2 QS1 + QS2 =QT = (3p-4) + +p-2) = 4P-6 Marginal cost MC1 = 4/3 +1/3QS1 MC2 = 2 + QS2 MCT = 3.2 + 1/4QT 6 Social welfare The sum of producer and consumer surplus equals social welfare If a change, such an environmental regulation increases social welfare, then that policy should be adopted. Benefit cost analysis is the study of investments and policy that are designed to increase social welfare. Environmental goods are and increasingly important element of social welfare. Ability to pay is an important limit to willingness to pay. 7 Consumer + producer surplus = social surplus Perfect competition maximizes social surplus The point X* is allocatively efficient Any deviation, such as rationing, reduces the social surplus 8