The accompany diagram shows the market for gasoline, in which there are 1,000 consumers. Gasoline can be produced at a constant marginal cost of $2 per gallon. When the market is in equilibrium, the average consumer uses 15 gallons of gasoline per week.

Question

Suppose a war breaks out, temporarily limiting the amount of gasoline available for civilian use to 10,000 gallons per week. In the interest of fairness, the government allocates 10 gallons per week to each consumer, taxes each consumer $20 per week, and forbids barter in gasoline. Will the shaded area in the diagram accurately measure the loss in consumers' surplus? Why or why not?

Answer 1

The shaded area will underestimate the loss in consumers' surplus. When the area beneath the demand curve above the price paid is used to measure consumers' surplus, it is implicitly being assumed that the good is being allocated to those consumers who value it the most. While this does occur in a competitive market, this likely will not happen in the government's allocation scheme. Some consumers may place a very high marginal value on the 10th gallon of gasoline, while others may place a very low value on it. The loss in consumers' surplus is not due only to the reduction in quantity as shown in the diagram-the losses due to misallocations must also be taken into account.