Consumer & Producer Surplus

What is consumer surplus?

The difference between the amount the consumer is willing to pay for a product and the price they have actually paid.

What is producer surplus?

The difference between the amount that the producer is willing to sell a product for and the price they actually do.

What diagram shows consumer and producer surplus?

• The area between the equilibrium price and the demand curve represents the consumer surplus in the market (ABP_e)

  • The consumer surplus lies underneath the demand curve

• The area between the equilibrium price and the supply curve represents the producer surplus in the market (CBP_e)

  • Producer surplus lies above the supply curve

• When the market is at equilibrium the producer and consumer surplus are maximised

• Consumer surplus + producer surplus = social/community surplus

  • Any disequilibrium reduces the social surplus

How can market changes affect consumer and producer surplus?

• Any change to a non-price determinants of supply or demand will cause a shift in the relevant curve

• This shift will change the consumer and producer surplus in the market

What diagram shows the effect of an increase in supply on consumer and producer surplus?

• Prior to the change in supply

  • Consumer surplus was equivalent to ACE and producer surplus was equivalent to ACF

  • Social surplus was equivalent to ECF

• After the change, supply increased from S₁→S₂

  • Consumer surplus is now equivalent to BED and producer surplus is equivalent to BDG

  • Social surplus is equivalent to DEG

• Both the consumer surplus and producer surplus have increased as a result of the increased supply in the market

What diagram shows the effect of an increase in demand on consumer and producer surplus?

• Prior to the change in demand

  • Producer surplus was equivalent to ACE and consumer surplus was equivalent to ACF

  • Social surplus was equivalent to ECF

• After the change, demand increased from D₁→D₂

  • Producer surplus is now equivalent to BED and consumer surplus is now equivalent to BDG

  • Social surplus is equivalent to DEG

• Both the producer surplus and consumer surplus have increased as a result of the increased demand in the market

How can consumer and producer surplus be calculated from a diagram?

(b x h) / 2

• The following steps should be applied to each calculation

  • Identify the current equilibrium price

  • Draw a horizontal line from it to the Y axis

  • Ensure that both the demand and supply curves pass through the Y axis so as to complete the two surplus triangles

  • Using the formula, calculate the producer surplusfrom the triangle which lies below the equilibrium price (area above the supply curve)

  • Using the formula, calculate the consumer surplusfrom the triangle which lies above the equilibrium price (area beneath the demand curve)

What is allocative efficiency?

• Occurs at the level of output where the marginal benefit = marginal cost

• At this point, resources are allocated in such a way that consumers and producers get the maximum possible benefit

• No one can be made better off without making someone else worse off

• There is no excess demand or supply

What is productive efficiency?

• Occurs at the level of output where average costs are minimised

• There is no wastage of scarce resources and a high level of factor productivity