Markets generate value. But how much value, and who captures it? Welfare analysis provides the tools to answer these questions — and to evaluate government policies.
Consumer surplus is the difference between what buyers are willing to pay and what they actually pay. On a graph, it is the area between the demand curve and the market price. Producer surplus is the difference between the market price and the minimum price sellers would accept — the area between the price and the supply curve. Together, they measure the total gains from trade.
In a free market equilibrium, total surplus is maximized. Any other allocation creates deadweight loss — value that is destroyed, captured by no one.
Price controls demonstrate this vividly. A price ceiling (like rent control) set below equilibrium creates a shortage and deadweight loss. Consumers who manage to buy at the lower price gain, but many cannot find the good at all. A price floor (like a minimum wage) set above equilibrium creates a surplus and its own deadweight loss.
Taxes drive a wedge between the price buyers pay and the price sellers receive. The burden of a tax does not depend on who writes the check — it depends on elasticities. The more inelastic side of the market bears more of the tax burden. Subsidies work in reverse, encouraging more production and consumption but at a cost to taxpayers, and they also create deadweight loss when the subsidy exceeds the external benefit.
Interactive surplus graphs let you shade areas, add taxes, and see exactly how welfare changes — making these abstract concepts concrete.