Question

In the situation of the artisan in the previous question, assume that the artisan has an accurate estimate of the customer's willingness to pay for each unit, and sets the lump sum fee just low enough that the customer decides to pay it. Remember that we are only assessing the artisan's transactions with one customer. In this case, what will be the deadweight loss and the distribution of surplus?

Answer 1

The deadweight loss in the scenario where an artisan sets a lump sum fee just below the customer's willingness to pay represents an inefficient reduction in the total social surplus, and stems from a quantity of transactions less than the market equilibrium. The distribution of surplus becomes skewed towards the artisan, resulting in reduced consumer surplus and not fully maximized producer surplus.

Step-by-step explanation:

When an artisan sets a lump sum fee based on accurate estimates of a customer's willingness to pay, and the fee is set just low enough for the customer to accept it, the deadweight loss is the total surplus lost due to the fee not being set at the market equilibrium. This loss represents an inefficient outcome where the total social surplus is reduced. Specifically, the deadweight loss is the sum of areas where the potential consumer surplus and producer surplus are not realized because the transaction quantity is less than what would be achieved in a truly competitive market.

The distribution of surplus ends up being skewed in favor of the artisan, as the fee captures almost all of the consumer's willingness to pay, leaving very little consumer surplus. Meanwhile, the artisan's producer surplus is increased, but not to the full potential extent because they are also losing out on additional transactions that would have occurred at the market equilibrium price.