5.12 Consumer and producer surplus

Define consumer surplus

A measure of the economic welfare enjoyed by consumers: surplus utility received over and above the price paid for a good.

Define producer surplus

A measure of the economic welfare enjoyed by firms or producers: the difference between the price a firm succeeds in charging and the minimum price it would be prepared to accept

Consumer and producer surplus shown on a diagram

page 158

What happens to consumer and producer surplus when a perfectly competitive market is transformed to a monopoly?

(page 159) The diagram shows how consumer surplus falls and producer surplus increases when the perfectly competitive industry is transformed into a monopoly - provided we assume that neither economies of scale nor dynamic efficiency improvements result from the transformation: that is, assuming that the marginal costs under monopoly and perfect competition is the same.

As the diagram shown, industry output in perfect competition is determined at point A, with output at Q1 and price at P1. However, monopoly equilibrium is determined at point B where MC = MR. The diagram illustrates the standard case against monopoly, namely that compared to perfect competition, monopoly restricts output and raises prices.

What is deadweight loss?

The loss of economic welfare when the maximum attainable level of total welfare fails to be achieved

How does deadweight loss a market failure of monopoly?

(page 159) The diagram illustrates how consumer surplus and producer surplus are affected by a monopoly replacing perfect competition. By raising the price from P1 to P2 the monopoly gains some of the consumer surplus that would have existed under perfect competition. The reduction in consumer surplus is equal to the rectangular area P1P2CD. This means that producer surplus increases at the expense of consumer surplus. Over and above this transfer, however, there is a net loss of economic welfare caused by the fact that the amount bought and sold falls to Q2. The welfare loss or deadweight loss is when by the two shaded areas in the diagram, which depict the loss of consumer surplus and the loss of producer surplus. The dead-weight loss is evenidence of market failure in monopoly.

How does price discrimination affect consumer surplus?

Firms undertaking price discrimination usually benefit from the practise, but their customers generally suffer. What is an advantage to firms or producers is a disadvantage for consumers. Consumer surplus therefore falls when different prices are charged to different customers. Because consumer surplus is a measure of consumer welfare, consumers end up being worse off as a result of price discrimination. By contrast, the firms undertaking the price discrimination benefit. Their profits and producer surplus increase as a result of consumer surplus away from the consumers