consumer surplus

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Lesson 1Lesson 1

Consumer and Producer Surplus



1Chapter 6 1

Consumer surplus

Willingness to Pay:

A consumer¶s willingness to pay for a good is themaximum pr ice at which he or she would buy that good.

It¶s the maximum amount that a buyer will pay for a good.

P> willingness to pay: the buyer doesn¶t buy

P< willingness to pay: the buyer will buy

P= willingness to pay: the buyer is indifferent betweenbuying or not the good



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2

Consumer surplus

Consider this demand curve, with only 5 buyers:

Mark

Frank

Alex

Paul

Guy

Quantity of chocolates

Price

2

4

6

8

10



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3

Consumer surplus

Consumer Surplus:

Individual consumer surplus is the net gain toan individual buyer from the purchase of a good.It is equal to the difference between the buyer¶swillingness to pay and the pr ice paid.

It is a measure of the benef it a buyer has when

participating in the market.



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4

Consumer surplus

If the pr ice is 5 :

Mark

Frank

Alex

Paul

Guy


Price

2

4

6

8

10

5

Individual

surplus



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5

Consumer surplus

Total consumer surplus is the sum of theindividual consumer surpluses of all the buyers of a good. In our example: (10-5) + (8-5) + (6-5)= 9.

The term consumer surplus is often used torefer to both individual and to total consumer surplus.



6Chapter 6 6

Consumer surplus

How Changing Pr ices Affect Consumer Surplus:

Mark

Frank

Alex

Paul

Guy


Price

2

4

6

8

10

5

3



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7

Consumer surplus

With the usual demand curve:



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8

Consumer surplus

Conclusions:

The consumer surplus will increase when thepr ice decreases.

The consumer surplus will decrease when thepr ice increases.



9Chapter 6

9

Producer Surplus

Consider this supply curve, with only 5 sellers:

P S

A

E

D

C

B

8

6

10

4

2



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10

Producer Surplus

A potential seller¶s cost is the lowest pr ice at which he or she is willing to sell a good.

Individual producer surplus is the net gain to a seller from selling a good. It is equal to the difference betweenthe pr ice received and the seller¶s cost.

Total producer surplus in a market is the sum of theindividual producer surpluses of all the sellers of a good.

Economists use the term producer surplus to refer bothto individual and to total producer surplus.



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11

Producer Surplus

Individual surplus:

A, B or C

Total surplus:

A + B +C

Graph:

P S

A

E

D

C

B

8

6

10

4

2

Q

7

Individual

surplus



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12

Producer Surplus

Changes in Producer Surplus:



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13

Gains from tr ade

The total surplus generated ina market is the total net gain toconsumers and producers fromtrading in the market. It is the

sum of the producer and theconsumer surplus. It is also called Social Surplus. Both consumers and producers

are better off participating in themarket economy than they

would if everyone tr ied to be self suff icient.

Graph:the green arearepresents the total surplus

P

Quantity

D

S

5

1000

Consumers

surplus

Producers

surplus



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14

Thank Q



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15

Eff iciency of markets

We have the highest possible surplus when themarket is in equilibr ium.The competitiveequilibr ium maximize the sum of consumers and

producers surplus. Any change from the equilibr ium will cause a totalsurplus decrease.

We can try to reallocate the total surplus in 3different ways.



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1)Reallocate consumption amongconsumers:

Giving the good to B instead of

A will decrease the consumer surplus by 10$: 35-30 is lost (-5)and 25 -30 is the negativesurplus of B!

Totally -5-5=-10

Or: B values the good 25$ while Avalues it 35$, the surplus loss is10$.

Graph:



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2) Reallocate sales amongsellers:

It will lower the producer surplus: if Y sells at 35 andthe market pr ice is 30 Yloses 5$ (-5$ surplus),while X that is willing tosell at 25$ will lose 5$surplus selling at 30$market pr ice.

Graph:



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3) Change in the quantity traded:

If less or more than 1000 unitsare sold there is a surplus loss.

For example if Y sells to B 10$

surplus is lost: Y sells at 35$ butB is willing to pay only 25$.

If less that 1000 units are sold,there are transactions that don¶toccur the surplus coming from

those transactions is lost.

Graph:



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The market equilibr ium maximizes total surplus²the sumof producer and consumer surplus. It does this becausethe market performs four important functions:

1. It allocates consumption of the good to the potentialbuyers who value it the most, as indicated by the fact thatthey have the highest willingness to pay.

2. It allocates sales to the potential sellers who most valuethe r ight to sell the good, as indicated by the fact that theyhave the lowest cost.



20Chapter 6 20


3. It ensures that every consumer who makes apurchase values the good more than every seller who makes a sale, so that all transactions are

mutually benef icial. 4. It ensures that every potential buyer whodoesn¶t make a purchase values the good lessthan every potential seller who doesn¶t make asale, so that no mutually benef icial transactionsare missed.



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Attention: even if the market maximizes the totalsurplus this doesn¶t mean that it is the bestoutcome for every single consumer or producer.

Ceter is Par ibus every buyer would like to payless, and every producer to receive more.Furthermore some people may benef it from pr icecontrols and some sellers from pr ice sellers.



22Chapter 6 22

Eff iciency cost of a tax

The excess burden, or deadweight loss, from atax is the extra cost in theform of ineff iciency thatresults because the taxdiscourages mutuallybenef icial transactions.

Graph:



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Deadweight loss:

The area (Tax)xQt is the

tax revenue, the yellowtr iangle represents thepure loss, the deadweightloss of the tax.

Graph:



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25Chapter 6 25


The greater the elasticity of demand or supply,the greater the fall in the quantity bought and soldcaused by the tax.

consumer surplus

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