We've now discussed the value that consumers get from their purchases, consumer surplus, and the value that producers get from their sales, producer surplus, and together these make up economic surplus. The demand curve shows us what consumers are willing to pay, their marginal benefit. The supply curve in a competitive market shows us what producers are willing to sell for, their marginal cost. Every transaction where the benefit to consumers exceeds the cost to producers is a valuable transaction. If the marginal benefit is greater than the marginal cost, make those tacos.
The thing that consumers are getting is worth more to them than it was to the producer. Those are gains from trade. The equilibrium of supply and demand gives us the surplus maximizing quantity.
The equilibrium amount will be the one that gives us the greatest economic surplus. This is an efficient allocation. We can take it further. Markets will not have wasteful transactions. Ones where it costs more to produce the good than consumers value it, like over here.
Where the marginal cost of an additional taco is more than the marginal benefit to the consumer. That unit shouldn't be made. Those are wasted resources. And this is called deadweight loss. Sounds so dramatic.
We're not maximizing economic surplus if we produce over here. Deadweight loss from overproduction. So if we're overproducing, I'm going to draw this in a different color. This right here would be deadweight loss. These are wasteful transactions.
We can use that same term, deadweight loss, to refer to the lost economic surplus from underproduction. Let's say we're producing this much. These are voluntary exchanges that would benefit both consumers and producers.
But if they didn't happen, those gains never happen. That's also deadweight loss because we are not at the surplus maximizing quantity. But there's more we can learn from this.
Who gets the tacos? An efficient allocation creates the largest possible economic surplus. That means that the goods go to those with the greatest marginal benefit as measured by willingness to pay.
Suppose we have two people looking to buy tacos, Marquis and Nicole. M and N. Marquis is willing to pay $6 for his first taco, $4 for his second taco, and $1 for his third taco. Nicole is willing to pay $5 for her first taco, just $2 for the second one, and $0 for her third taco. She just doesn't want it.
At an equilibrium price of $3, Marquis buys two tacos which he values at $10 total. So at a price of $3, the value to Marquis, I'm going to say value M, is $6 plus $4. At that price of $3, Nicole buys one taco.
And the value to her is the value of that one taco, $5. So the value to them together is $15. The $10 that Marquise values his tacos and the $5 that Nicole values hers. In a market, that's the allocation that maximizes surplus and is efficient. But we can tell that Marquise values tacos more than Nicole does.
Suppose we took Marquis's second taco away and gave it to Nicole. What would happen? Well, that second taco was worth $4 to Marquis, but it's only worth $2 to Nicole.
If we take that taco from Marquis and give it to Nicole, Marquis now only gets $6 of value from his one taco, while Nicole gets $7 of value. $5 from the first taco, $2 from the second. Total value is 6 plus 5 plus 2 which is $13, less than the $15 in the market allocation. That taco was worth more to Marquis than it was to Nicole.
Okay, so let's take Nicole's taco away from her and give it to Marquis. Now his total value is $11, 6 plus 4 plus 1, while hers is $0. Total value is $11 versus $15 in the market or efficient allocation. If the price is $3, Marquis will make a rational decision and buy two tacos.
Nicole will make a rational decision and buy one taco. And that will maximize economic surplus and lead to an efficient allocation. No one's planning this.
They're just making their own decisions. following their own self-interest, behaving rationally, comparing marginal benefit to marginal cost. Everyone who buys a good values it more than the market price. The people who value it less than the market price won't purchase it. So the market will allocate goods to those who have the highest marginal benefit, those who have the highest willingness to pay, and that will maximize economic surplus.