Question

4. Suppose a consumer advocacy group has convinced legislators that vitamin pills should be free to consumers. Such a policy would enhance the health of the citizenry, they argue. Assuming a downward-sloping linear demand curve and a horizontal long-run supply curve, determine the resulting output and social welfare from such a policy. Compare this result to the competitive equilibrium.

Answer 1

The condition for maximization of Consumer surplus is that when price equals zero. The number of Output will be the quantity where the demand curve hits the X axis. The social welfare is less than the competitive equilibrium because for quantities beyond the competitive equilibrium, producers incur a cost for which they are not reimbursed. Some of this loss represents a transfer to consumers (the area under the demand curve to the right of the equilibrium quantity). The area above the demand curve and below the supply curve for quantities beyond the equilibrium quantity represents the deadweight loss.