SLIDES BY SOLINA LINDAHL

CHAPT
ER

Consumer and
Producer Surplus

What you will

learn in this
chapter
What consumer surplus is and its relationship to
the demand curve
What producer surplus is and its relationship to the
supply curve
What total surplus is and how it can be used both
to measure the gains from trade and to illustrate why
markets work so well
Why property rights and prices as economic
signals are critical to smooth functioning of a market
Why markets typically lead to efficient outcomes
despite the fact that they sometimes fail
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MEASURING MARKET EFFICIENCY

Markets are (usually) efficient, and we

can measure their benefit to society
by measuring:
consumer surplus.
producer surplus.

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CONSUMER SURPLUS
Consumer surplus: the difference
between market price and what
consumers (as individuals or the
market in total) would be willing to
pay.
Key intuition: The demand
curve for a good or service
can be thought of as
measuring consumers
willingness to pay for a
marginal unit of the good or
service.
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THE DEMAND CURVE FOR USED

A consumers
TEXTBOOKS
willingness to pay for a
good is the maximum
price at which he or she
would buy that good.

Price of
book
Aleisha

$59

Potential
buyers
Demand
Curve

Brad

45

Claudia

35

Willingne
ss to pay

Aleisha
Brad

$59

Claudia

35

Darren
Edwina

25

45

10

Darren

25

Plotting each persons

willingness to pay (in
decreasing order) gives
us a demand curve for
used textbooks.

Edwina

10

D
0

Quantity of books

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CONSUMER SURPLUS
Price of
book
$59

Say the market price of a

used textbook is $30.
Aleisha, Brad, and Claudia
would purchase a used
textbook, because their
willingness to pay is higher
than the market price.

Aleisha

45

Brad

35

Claudia

30

Price = $30

25

Darren

10

Darren and Edwina would

not purchase a used
textbook, because the
market price is higher than
their willingness to pay.

Edwina

D
0

Quantity of books

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CONSUMER SURPLUS
Price of
book

35

Each individuals
Aleishas consumer
surplus:
consumer surplus is the
$59 $30 = $29
difference between what
Aleisha
they would be willing to pay
Brads consumer
and the market price.
surplus:
$45 $30 = $15
Brad
Claudias consumer
surplus: $35 $30 =
$5
Claudia

30

Price = $30

$59

45

25

Total consumer surplus

is the entire shaded area
the sum of the
individual consumer
surpluses of Aleisha, Brad,
and Claudia ($29 + $15 +
$5 = $49).

Darren

10

Edwina

D
0

Quantity of books

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LEARN BY DOING: PRACTICE QUESTION

George is considering the purchase of
some new shirts for work. He is willing to
pay $35
for the first shirt, $25 for the second shirt,
and $15 for the third. Oxford Clothiers, his
favorite shirt manufacturer, is selling shirts
for $28 each. What is the effi cient
number of shirts for George to buy?
What is Georges consumer surplus?
Answer: George buys 1 shirt, and his
consumer surplus is $10.
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CONSUMER SURPLUS
Price of
widgets

In the previous example, we had

a market with only 5 consumers,
each with an individual
willingness to pay, which gave us
a stepped-looking demand curve.
Now imagine we have
thousands of consumers
(maybe more), and that their
individual WTPs trace out a
continuum of values, such that
the stepped-looking demand
curve becomes smooth.
D
Quantity of widgetsBack to
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CONSUMER SURPLUS
Consumer surplus is the area beneath the demand curve and above
the price.
Price of
Area of triangle
widgets
Height
80
Total consumer
surplus at a price of
$20

20

(base x height)
Base

(80 20) 90 =
$2,700
D
Quantity of widgetsBack to

90
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LEARN BY DOING: PRACTICE QUESTION

If the price is $2010, what is the
consumer surplus?
a) $3.588 million
b) $1.794 million
c) $6 million
d) $3 million

0.5 1,200 ($5,000 - $2,010) = $1.794

million
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CONSUMER SURPLUS RISES WITH

A FALL IN PRICE
Price of
book
Increase in
Aleishas
Aleisha consumer
surplus
Increase in Brads
consumer surplus
Brad

$59

45

Increase in Claudias
consumer surplus

Claudia

35

Original buyers get an

increase in consumer
surplus, and new buyers
add more consumer
surplus.

30

Original price = $30

Darren

25
20

New price = $20

10

Darrens
consumer
surplus

Edwina
D

0
C

1
Y

2
G

3
2

4
0

5
W

Quantity of books
O

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HOW THE GAINS IN CONSUMER

SURPLUS ARE SPLIT
Price of
computers

Increase in
consumer surplus to
original buyers

$5,000

Consumer
surplus gained
by new buyers

1,500
D
0

200,000

1 millionQuantity of computers

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PRODUCER SURPLUS

Producer surplus: the difference

between market price and the
payment sellers (firms) would be
willing to accept for the product.
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PRODUCER SURPLUS
Key intuition: What is the lowest payment a
seller would be willing to accept for a given
product? It depends on the seller and the
good/service being sold.
For an individual, its the opportunity cost of
selling the marginal unit of the good or
service.
For a firm, its the cost of producing the
marginal unit of the good or service.

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THE SUPPLY CURVE FOR USED

TEXTBOOKS
Price of
book

Potential
sellers

$45

Engelbert

Donna

35

25

Carlos

15

Andrew

Andrew

$5

Donna

15

Carlos

25

Betty
Engelbert

35
45

Plotting each persons

willingness to accept (in
increasing order) gives
us a supply curve for
used textbooks.

Betty

Cost

Quantity of books
1

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PRODUCER SURPLUS
Price of
book

Donna and Engelbert

would not sell a used
textbook, because the
market price is lower than
their willingness to accept.

Say the market

price of a used
textbook is $30.
Andrew, Betty, and
Carlos would sell a
used textbook,
because their
willingness to
accept is lower than
the market price.

$45

Engelbert

35

Donna

25

Carlos
Betty

15
5

Andrew

Price = $30
Carloss
producer
surplus
Bettys
producer
Andrews surplus
producer
surplus

30

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PRODUCER SURPLUS
Price of
book

Each individuals producer

surplus is the difference
between the market price
and what they would be
willing to accept.

$45

Engelbert

35

Donna
Price = $30
Carloss producer surplus:
$30 - $25 = $5

30
25

Carlos

5
0

Bettys producer
surplus: $30 - $15 =
$15
Andrews producer surplus:
$30 - $5 = $25

Betty

15

Andrew
1

Total producer
surplus is the
entire shaded area
the sum of the
individual producer
surpluses of
Andrew, Betty, and
Carlos ($25 + $15
+ $5 = $45).

Quantity of books

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LEARN BY DOING: PRACTICE QUESTION

Sellers minimum
price
to sell (= the sellers
opportunity cost)

Actual market price

for tutoring

Producer surplus

Janes price = $12

$10

n/a

Doras
Doras price
price =
= $10
$10
Lees price = $8
Lees price = $8
Sams price = $6
Sams price = $6
Kathys price = $4
Kathys price = $4

$10
$10
$10
$10
$10
$10
$10
$10

$0
$2
$4
$6

Calculate the producer surplus for each

seller.

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LEARN BY DOING: PRACTICE QUESTION

If a dinner at Fast Eddys tonight
sells for $13, what is the value of
Fast Eddys producer surplus?
a) $10
b) $17
c) $20
d) $21

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PRODUCER SURPLUS
In the previous example, we had
a market with only 5 sellers, each
with an individual willingness to
accept, which gave us a steppedlooking
supply curve.
S

Price of wheat (per

bushel)

Now imagine we have many

sellers, and that their individual
WTAs trace out a continuum of
values, such that the steppedlooking supply curve becomes
smooth.

0
Quantity of wheat
(bushels)

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PRODUCER SURPLUS
The total producer
surplus from sales
of a good at a given
price is the area
above the supply
curve but below
that price.

Price of wheat (per

bushel)
S

$5

Price = $5
Producer
surplus

1 million
Quantity of wheat
(bushels)

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LEARN BY DOING: PRACTICE QUESTION

Using the following diagram,
calculate total producer surplus if
the price of oil is $50 per barrel.
Price
a) 0
b)$45m
c) $1,350m
d)$2,700m
Quantity of Oil
(Millions of Barrels per
day)

0.5 60m ($50 - $5) = $1,350 million

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PRODUCER SURPLUS RISES IF THE

PRICE INCREASES
Price of wheat (per
bushel)
Increase in
producer surplus
to original sellers

Producer surplus
gained by new
sellers

$7

1 million

1.5 million
Quantity of wheat (bushels)

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TOTAL SURPLUS IS MAXIMIZED AT

MARKET EQUILIBRIUM
Total surplus: the sum of the producer and consumer
surpluses.
Price of book

Equilibrium
price

Consumer
surplus

$30

Producer
surplus

D
0

1,000

Quantity of
books

Equilibrium quantity
C

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Total Surplus is Maximized at

LEARN BY DOING: PRACTICE QUESTION
Market
Equilibrium
What is the total surplus when price is at
equilibrium?
$22
a)$480
b)$720
Price of Lobster
c)$1,080
d)$1,440
10
CS = 0.5 120 ($22 $10)
= $720
PS = 0.5 120 ($10 $4)
= $360
CS + PS = $720 + $360
= $1,080

120

Quantity of
lobster

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LEARN BY DOING: DISCUSS

With a partner, discuss and be

ready to share:

Are you in favor of legalizing the

sale of kidneys? Why or why not?
Do you support the move to
distribute organs in the United
States based on net benefit
rather than simply whos been on
the waiting list longest? Why or
why not?

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THREE WAYS YOU MIGHT

(UNSUCCESSFULLY) TRY TO INCREASE THE
TOTAL SURPLUS
1.reallocate consumption among
consumers
2.reallocate sales among sellers
3.change the quantity traded

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WHY REALLOCATING CONSUMPTION

LOWERS CONSUMER SURPLUS
Price of book

Its
worth
$35

Loss in consumer
surplus if the
book is taken
from Ana and
given to Bob

Its
worth
$25

A
$35
E

30

B
25

1,000

Quantity of books

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Why Reallocating Sales Lowers Producer Surplus

Price of book

Id sell it
for $25
minimum.

Id take
no less
than
$35.

$35

Loss in producer
surplus if Yvonne is
made to sell the book
instead of Xavier

30
X

25

1,000

Quantity of books

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WHY CHANGING THE QUANTITY

LOWERS TOTAL SURPLUS
Price of
book

Loss in total surplus if

the transaction
between Ana and
Xavier is prevented
A

$35

Y
Loss in total surplus if
the transaction between
Yvonne and Bob is forced

30
25

D
0

1,000

Quantity of books

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THE EFFICIENCY OF MARKETS

Competitive markets are usually efficient:
1. They allocate consumption of the good to the
potential buyers who most value it.
2. They allocate sales to the potential sellers
who most value the right to sell the good
(e.g., who have the lowest cost).
3. They ensure that all transactions are
mutually beneficial: Every consumer who
makes a purchase values the good more
than every seller who makes a sale.
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EQUITY AND EFFICIENCY

Efficiency is important, but
society also cares about
equity.
Sometimes societies
choose to have
governments intervene in
markets to increase
efficiency (even though it
reduces efficiency).
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LEARN BY DOING: APPLICATION VIDEO

This scene from The Bourne Identity
shows how trade creates consumer and
producer surplus. Click here or on the
picture. (2 minutes)

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WHY MARKETS TYPICALLY WORK SO WELL

Well-functioning markets are
effective because of:
1. property rights.
2. economic signals.

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LEARN BY DOING: PRACTICE QUESTION

In your opinion, which is the best
way for society to distribute its
goods?
a) The free market outcome
should not be tampered with.
b) From each according to his
ability; to each according to
his need.
c) Distribute goods so that
societys total happiness is
maximized, even if it requires

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WHY PRIVATE PROPERTY

MATTERS

Private property rights create and

protect incentives to trade with others
and to innovate.
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WHY GOOD ECONOMIC SIGNALS MATTER

Equilibrium prices
signal to
resources exactly
where they are
most valued.

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WHY GOOD ECONOMIC SIGNALS

MATTER
Prices translate complex information into an
easy signal for producers:
Profits rise in industries when consumers
want more of that industrys products.
Profits decline in industries when
consumers want less of that industrys
products.
The high price of ice in post-Katrina New
Orleans made it more attractive for firms
to provide ice where society needed it
most.
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LEARN BY DOING: DISCUSS

Think, pair, share:

Discuss with your neighbor: Are
you in favor of price gouging
(charging what the market will
bear) during natural disasters?
Why or why not?

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A FEW WORDS OF CAUTION

Markets arent always
efficient; sometimes
they fail.
Inefficient:
Opportunities are
missed. Some people
could be made better off
without making other
people worse off.
Well learn more about
market failures later.
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