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1.2.8 Consumer and producer surplus

Defining surplus

Definition

Consumer surplus: the difference between the most buyers are willing to pay and the price they actually pay; on a diagram, the area below the demand curve and above the market price.

Producer surplus: the difference between the price producers receive and the lowest price they would accept; the area above the supply curve and below the market price.

  1. The curves read as willingness: the demand curve shows each buyer's maximum willingness to pay and the supply curve each producer's minimum acceptable price, so the gaps up to the market price are the surpluses.
    1. With price on the vertical axis and quantity on the horizontal axis, each surplus is a triangle resting on the market price line.
Example
  • Take a market where the demand curve meets the price axis at £8 and the supply curve at £2, with equilibrium at a price of £5 and a quantity of 100 units.
  • A buyer willing to pay £8 but paying the £5 price enjoys £3 of consumer surplus on that unit, and summing across buyers gives the triangle below demand and above £5.
CS=12×100×(8−5)=150 CS = \dfrac{1}{2} \times 100 \times (8 - 5) = 150 CS=21​×100×(8−5)=150 PS=12×100×(5−2)=75 PS = \dfrac{1}{2} \times 100 \times (5 - 2) = 75 PS=21​×100×(5−2)=75
  • So consumer surplus is £150 and producer surplus is £75, giving community surplus of £225.

Meaning and significance of consumer surplus

Meaning and significance of producer surplus

Community surplus

Definition

Community surplus (total welfare): consumer surplus plus producer surplus, the whole area between the demand and supply curves up to the equilibrium quantity.

  1. Why it peaks at equilibrium: community surplus is largest at the competitive equilibrium, because every unit whose value to buyers exceeds its cost to sellers is traded and none beyond, which is allocative efficiency.
Analogy
  • Consumer surplus feels like finding your favourite trainers on sale for £40 when you would happily have paid £60.
  • Producer surplus is the shop's gain when it would have sold them for £30 but the market price is £40.

Changes in surplus

  1. Price moves split the gains: a fall in price raises consumer surplus and reduces producer surplus, while a rise in price does the reverse.
    1. An increase in supply lowers the equilibrium price, which raises consumer surplus.
    2. An increase in demand raises the equilibrium price, which tends to raise producer surplus.
  2. Elasticity sets the size: the size of each change depends on the price elasticities of demand and supply, because inelastic curves concentrate the change.
Exam technique
  • On a labelled diagram, shade consumer surplus below demand and above price, and producer surplus above supply and below price.
  • Show the new areas after a shift in demand or supply, or a change in price.
  • Link the size of any change to the elasticities of demand and supply.
Common Mistake
  • Do not confuse the two: consumer surplus sits below the demand curve, while producer surplus sits above the supply curve.
  • Do not treat producer surplus as profit, since it does not net off fixed costs.
  • Do not treat the size of a surplus change as fixed, because it depends on elasticity.
Self review
  • Define consumer surplus.
  • Define producer surplus.
  • Where on a diagram is producer surplus shown?
  • How does a fall in price change consumer and producer surplus?
  • What determines the size of a change in surplus?

Causes of changes in consumer and producer surplus

Recap questions

1 of 5

A concert ticket sells for £18. One student would still have bought it at £25. What is that student's consumer surplus?

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Supply and demand diagram with equilibrium at P* and Q*, consumer surplus shaded above the price line and producer surplus shaded below it A demand curve shows willingness to pay for each extra unit, so economists also read it as marginal benefit. A supply curve shows the minimum price firms will accept for each extra unit, so it is also marginal cost.

At the market equilibrium, demand equals supply at P∗P^*P∗ and Q∗Q^*Q∗. Consumer surplus is the area below demand but above the market price, while producer surplus is the area above supply but below the market price.

The reason consumer surplus sits above the price line is simple: many buyers would have paid more than P∗P^*P∗. The reason producer surplus sits below the price line is that many sellers would have accepted less than P∗P^*P∗.

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What is consumer surplus?

1.2.8 Consumer and producer surplus Revision Guide

  1. A Level
  2. /Economics
  3. /1.2.8 Consumer and producer surplus