Producer and Consumer SurplusWhen was the last time you got yourself a genuine bargain?

Lesson ObjectivesBy the end of this lesson you will:

Understand what is meant by the terms consumer surplus and producer surplus

Know how to calculate the amount of consumer and producer surplus at given prices

Be able to illustrate both consumer and producer surplus on a supply and demand diagram

Some key conceptsValuewhat we get from consuming a good or service

Pricewhat we pay for the right to consume something

[Definitions sourced from Tutor2u.com]

Value and the demand curveConsumers gain (in terms of their personal satisfaction or utility) from each extra unit of a product

This is known as the private marginal benefit

However, the more we consume the less we benefit from our consumption (In other words the benefit from each extra unit of consumption (the marginal benefit) falls as consumption rises

Therefore the standard downward sloping demand curve is the marginal benefit curve

Value and the demand curveThe fall in the marginal benefit means that we (as consumers) are willing to pay less for the next unit

This means the suppliers have to tempt us with lower prices to persuade us to buy more

But it is not quite that simple!

As consumers, we don always have to pay the maximum price we are willing to pay. In many cases, we actually get quite a good deal!

The following Tutor2u slides illustrate this using the example of buying a pizza

Deriving the Demand SchedulePrice (P)Quantity Demanded (Qd)As consumption increases, the marginal benefit from extra units is assumed to declinediminishing marginal satisfactionTherefore ..willingness to pay for the product will decline

Demand and Consumer SurplusPrice per Pizza ()Quantity of Pizzas Demanded (Qd)The marginal benefit from extra units of pizza is shown in the diagram this gives us the consumers demand curve for pizzaDemand

Demand and Consumer SurplusPrice per Pizza ()Quantity of Pizzas Demanded (Qd)Assume the current market price is 3 per pizza the consumer is prepared to buy 15 slices of pizza per week at this priceDemandMarket Price315th

Demand and Consumer SurplusPrice per Pizza ()Quantity of Pizzas Demanded (Qd)Consumer would be willing to pay 6 for 5 slices of pizza in fact the consumer only has to pay 3 for this pizzaDemandMarket Price5th6315th

Demand and Consumer SurplusPrice per Pizza ()Quantity of Pizzas Demanded (Qd)Consumer surplus is the difference between what the consumer is willing to pay and the price they actually do payDemandMarket Price5th6315th

Demand and Consumer SurplusPrice per Pizza ()Quantity of Pizzas Demanded (Qd)DemandMarket Price5th6315th4.5010th

Total Expenditure and Consumer SurplusPrice per Pizza ()Quantity of Pizzas Demanded (Qd)DemandMarket Price5th6315th4.5010thTotal Spending= price per unitXQuantity consumed

Consumer Surplus at the Equilibrium PricePrice per Unit ()QuantityMarket DemandMarket Supply20100Total willingness to pay- actual amount paid

Consumer Surplus & Elasticity of DemandPrice per Unit ()QuantityMarket DemandMarket Supply20100Inelastic demand, consumers are insensitive to price

Inelastic Demand High Consumer SurplusPrice per Unit ()QuantityMarket DemandMarket Supply20100

Elastic Demand Lower Willingness to PayPrice per Unit ()QuantityMarket DemandMarket Supply18100Elastic demand low level of consumer surplus

An Outward Shift in Consumer DemandPrice per Unit ()QuantityD1Market Supply18100Outward shift of demand rise in market price and quantityD222120

An Outward Shift in Consumer DemandPrice per Unit ()QuantityD1Market Supply18100Total consumer surplus is higher despite increased priceD222120

Consumer surplus definedConsumer surplusthe difference between how much buyers are prepared to pay for a good and what they actually pay

[Definition sourced from Anderton, 2003]

Consumer SurplusConsumer surplus is a measure of the welfare that people gain from the consumption of goods and services, or a measure of the benefits they derive from the exchange of goodsConsumer surplus is the difference between the total amount that consumers are willing and able to pay for a good or service (indicated by the demand curve) and the total amount that they actually pay (the market price)The level of consumer surplus is shown by the area under the demand curve and above the ruling market price

Consumer surplus and elasticityWhen the demand for a product is perfectly elastic, consumer surplus is zero because the price that people pay matches precisely the price they are willing to payThis is most likely to happen in perfectly competitive markets where each individual firm is a price taker in their chosen market and must sell as much as it can at the ruling market priceIn contrast, when demand is perfectly inelastic, consumer surplus is infinite. Demand is totally invariant to a price change. Whatever the price, the quantity demanded remains the same

Shifts in demand and consumer surplusPriceQuantity D1SupplyP1Q1Outward Shift in Demand(Higher consumer surplus)PriceQuantity DemandS1P1Q1Consumer SurplusS2P2Q2D2P2Q2Outward Shift in Supply(Higher consumer surplus)

Producer surplus definedProducer surplusthe difference between the market price which firms receive and the price at which they bare prepared to supply

[Definition sourced from Anderton, 2003]

Producer SurplusProducer surplus is a measure of producer welfare. It is measured as the difference between what producers are willing and able to supply a good for and the price they actually receiveThe level of producer surplus is shown by the area above the supply curve and below the market priceThe minimum price that the firm requires to supply to the market is shown by where the supply curve cuts the y-axisAs market price rises so supply expands (we move up the supply curve)

Showing Producer SurplusPrice per Unit ()QuantityMarket DemandMarket Supply20100Price is 20 but firms would be willing to supply some units at a lower price

Total Revenue (TR) = Price (P) x Quantity Supplied (Q)Price per Unit ()QuantityMarket DemandMarket Supply20100Total revenue = 2000

Producer SurplusPrice per Unit ()QuantityMarket DemandMarket Supply20100Producer Surplus

Total Economic Welfare (Consumer + Producer Surplus)Price per Unit ()QuantityMarket DemandMarket Supply20100Producer SurplusConsumer Surplus

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