Module 6.2 Consumer Surplus Lecture

Demand and Supply Curves

• Demand Curves: Indicate willingness to pay for marginal benefit.

• Supply Curves: Indicate willingness to accept for marginal cost.

Market Equilibrium

• Equilibrium: The price and quantity where there is no tendency to change; where marginal benefit equals marginal cost.

• Surpluses and Shortages:

  • If price > equilibrium, there’s a surplus leading to price decrease.

  • If price < equilibrium, there’s a shortage leading to price increase.

Gains from Trade

• When marginal benefit > marginal cost, there are gains from trade.

• Example:

  • Willing to pay $4 for a taco, but only pays $3; the seller prefers receiving $3 over their cost of $2.

Consumer Surplus

• Consumer surplus is the difference between willingness to pay and actual price paid.

• Example of Consumer Surplus Calculation:

  • Highest willingness to pay is $7 for the first taco, with a price of $3:

    • Consumer Surplus: $7 (willingness) - $3 (price) = $4.

  • Second consumer willing to pay $6:

    • Consumer Surplus: $6 - $3 = $3.

  • A consumer willing to pay exactly $3 has zero consumer surplus.

Total Consumer Surplus Calculation

• Shape: The area between demand curve and price level, typically a triangle.

• Calculating Total Consumer Surplus:

  • Base: Total quantity sold (100 tacos).

  • Height: Difference between maximum willingness to pay ($7) and price ($3): $4.

  • Formula: Total Consumer Surplus = 1/2 * base * height

    • Total Consumer Surplus = 1/2 * 100 * 4 = $200.

Effect of Price on Consumer Surplus

• Higher equilibrium price results in lower consumer surplus (smaller differences between willingness to pay and price).

• Example: The diamond-water paradox:

  • First gallons of water valued highly; consumer surplus is large.

  • Marginal benefit decreases with each additional gallon.

Importance of Marginal Thinking

• Understanding individual decisions based on marginal benefit and willingness to pay enhances personal satisfaction and economic efficiency.