Describe the relationship between the concepts of consumer surplus, Essay

Describe the relationship between the concepts of consumer surplus, moral hazard, and welfare loss - Essay Example For example, it works less well if commodity prices no longer represent the true cost of producing goods, or if the prices of resources no longer indicate their relative scarcity. It also works less well if agents are prevented from responding to price signals. Interventions of this kind include taxes and subsidies and quantity constraints (Leach 8). Hence, in a free, competitive market, the increased presence of interventions (e.g. taxes and quantity constraints) reduces the capacity of agents to respond to price-signals, and then surplus is not maximized but lessened. The lost surplus is called the welfare cost. However, Leach noted that there are also intervention types that do not harm this price-signaling mechanism such as the case of redistribution (8). In the case of a subsidy, which is the opposite of tax imposition, although both of the consumers and producers enjoy an increase in their surpluses, the gains in consumer and producer surplus would again be exceeded by the gove rnment's loss of surplus, thus incurring a welfare cost (Leach 14). Leach (12) cites that the welfare cost in this case occurs because the subsidy encourages trades that are not mutually beneficial. Each of these units was sold by a producer who placed a value of at least p* on the unit, and bought by a consumer who placed a value of no more than p* on it.