Consumer & Producer SurplusPages 126-129

Mr. HenryAP Economics

History• In economics, consumers and producers obtain “benefit surpluses” through market transactions

• Economic surplus, also known as Marshallian surplus, was named after Alfred Marshall

• Paul Alexander Baran was an American Marxist economist. In 1951 Baran was promoted to full professor at Stanford University and Baran was the only tenured Marxian economist in the United States until his death in 1964. Baran wrote The Political Economy of Growth in 1957 and co-authored Monopoly Capital with Paul Sweezy. Baran introduced the concept of "economic surplus" to deal with novel complexities raised by the dominance of monopoly capital.

Consumer Surplus

• Consumer surplus is the benefit received by a consumer or consumers in a market

• It is the difference between the maximum price a consumer is (or consumers are) willing to pay for a product and the actual price

• ie Mr. Henry loves the fact that a sweet tea is $1 and I can have more of them over the equilibrium since I would actually buy if they were $1.50.

Consumer Surplus Example• If the equilibrium price for a bag of oranges was $8, we

can calculate consumer surplus by subtracting the actual price from the maximum willingness to pay amount.

• As price increases, we see the green triangle would get smaller as the maximum willingness to pay decreases.

Producer Surplus

• Producer surplus is the benefit received by a producer or producers in a market

• It is the difference between the actual price a producer receives (or producers receive) and the minimum acceptable price.

• ie at the $8 equilibrium, Mr. Henry would buy tubs of cookie dough for a minimum acceptable price of $5, so there is $3 producer surplus.

Producer Surplus Example• If the equilibrium price for a bag of oranges was $8, we can

calculate producer surplus by subtracting the actual price from the minimum acceptable price.

• As price lowers, we see the equilibrium move and would reduce producer surplus. Higher prices make the producer surplus triangle grow.

Efficiency

• In this graph, we combine the supply and demand curves with the equilibrium price

• This graph reflects economic efficiency; with productive efficiency we see how competition forces producers to use the best techniques and combinations of resources in growing and selling their oranges.

Efficiency

• This graph also reflects allocative efficiency; producers utilize resources to produce the product most wanted by consumers (oranges).

• On the supply curve, points measure the marginal cost (MC) and on the demand curve measure the marginal benefit (MB). At the equilibrium MC=MB.

• Also on the supply curve, the equilibrium is the minimum acceptable price and also the maximum willingness to pay.

• So the combined consumer and producer surplus is at a maximum.

Efficiency Losses (Deadweight

Losses)

• This graph reflects efficiency losses, or reductions in combined consumer and producer surplus caused by an underallocation or overallocation of resources to the production of a good or service.

• If output was at Q2 rather than the efficient level Q1, instead of the sum of consumer and producer surplus being at abc, it falls to adec

• So the brown triangle represents an efficiency loss to buyers and sellers. This would be the deadweight loss to society.

• For Q2 to Q1, the maximum willingness to pay by consumers (as reflected on the demand curve) exceeds the minimum acceptable price of sellers (as reflected by points on the supply curve)

• Example – consumer is willing to pay $10 but producer is willing to accept $6, society suffers a loss of $4 (dbe)

Efficiency Losses (Deadweight

Losses)

• For Q3 to Q1, combined consumer and producer surplus declines by bfg, the brown triangle to the right of Q1

• For all units beyond Q1, the consumer’s maximum willingness to pay is less than the producer’s minimum acceptable price of sellers

• Example – consumer is willing to pay $7 but producer is willing to accept $10, society suffers a loss of $3 (bfg shows the overproduction)

Review Q’s

• The minimum acceptable price for a product that Arianna is willing to receive is $20. It is $15 for Dakota. The actual price they receive is $25. What is the amount of the producer surplus for Arianna and Dakota combined?

A) $10B) $15C) $20D) $25

B) $15

Review Q’s

• Given the demand curve, the consumer surplus isA) Increased by higher prices and decreased by lower pricesB) Decreased by higher prices and increased by lower pricesC) Increased by higher prices but not affected by lower

pricesD) Decreased by lower prices but not affected by higher

pricesB) Decreased by higher prices and increased by lower prices

Review Q’s

• When the combined consumer and producer surplus is at a maximum for a product,

A) The quantity supplied is greater than the quantity demanded

B) The market finds alternative ways to ration the product

C) The market is allocatively efficientD) The product is a nonpriced good

C) The market is allocatively efficient