Understanding Consumer and Producer Surplus in Markets

  • Markets are usually efficient. We can measure their benefit to society by measuring:

    • Consumer Surplus

    • Producer Surplus

      • Example: Candy Bar:

        • Value to consumer $1 vs $2

        • Value to firm $1 vs $2


Willingness To Pay: Maximum price at which one would buy that good.

  • Usually declines as an individual consumer's additional units. 


Consumer Surplus: Difference between market price and what consumers would be willing to pay. 


Individual Consumer Surplus: Net gain to an individual consumer from buying a good. 

  • WTP-Price

Total Consumer Surplus: Sum of the individual consumer surpluses of all the buyers of a good in a market. 

Cost: Value of everything a seller must give up to produce a good. 

  • Includes cost of all resources used to produce a good, including value of the seller’s time. 

  • A seller will only produce and sell the good if the price exceeds their cost. 


Producer Surplus: Difference between market price and the price at which firms are willing to supply the product. 


Individual Producer Surplus: Net gain to an individual seller from selling a good. 

  • Price-Seller’s Cost

Total Producer Surplus: Sum of the individual producer surpluses of all the sellers of a good in a market. 

Total Surplus = Consumer Surplus + Producer Surplus

                    = Value to Buyers - Cost to Sellers


Efficiency: Marking the total surplus as big as possible. 


Equity: Whether the surplus is divided fairly. 

  • Hard to evaluate


Efficiency of Markets: 

  • Allocate consumption to the buyers who most value it. 

  • Allocate sales to the potential sellers who must value the right to sell the good (lowest cost). 

  • All transactions are mutually beneficial. 


Why markets are so efficient: 

  • Property Rights

  • Economic Signals


Property Rights: Rights of owners of valuable items, whether resources or goods, to dispose of those items as they choose. 


Economic Signal: Any piece of information that helps people make better economic decisions. 


Market Power: Single buyer or seller can influence the market.