This document discusses consumer surplus and producer surplus. It defines consumer surplus as the difference between the maximum price a consumer is willing to pay and the actual price paid. Producer surplus is defined as the difference between the sale price received and the minimum price a producer is willing to accept. The document provides examples and diagrams to illustrate how consumer surplus and producer surplus are calculated using demand and supply curves. It also explains how the two surpluses combine to represent the total economic surplus or social surplus from market exchange.
This document discusses consumer surplus and producer surplus. It defines consumer surplus as the difference between the maximum price a consumer is willing to pay and the actual price paid. Producer surplus is defined as the difference between the sale price received and the minimum price a producer is willing to accept. The document provides examples and diagrams to illustrate how consumer surplus and producer surplus are calculated using demand and supply curves. It also explains how the two surpluses combine to represent the total economic surplus or social surplus from market exchange.
This document discusses consumer surplus and producer surplus. It defines consumer surplus as the difference between the maximum price a consumer is willing to pay and the actual price paid. Producer surplus is defined as the difference between the sale price received and the minimum price a producer is willing to accept. The document provides examples and diagrams to illustrate how consumer surplus and producer surplus are calculated using demand and supply curves. It also explains how the two surpluses combine to represent the total economic surplus or social surplus from market exchange.
1 BBA Consumer Surplus Mr. Sachin Rohatgi AMITY GLOBAL BUSINESS SCHOOL Noida Market Equilibrium Earlier, we saw that market equilibrium occurs when the quantity of a good offered by sellers at a given price equals the quantity buyers are willing and able to purchase at that same price.
That is, market equilibrium occurs at price equals P * and quantity equals Q * . Q P D S Q *
P *
AMITY GLOBAL BUSINESS SCHOOL Noida Measuring the Gains from Trade Whenever an exchange (or trade) takes place between a consumer and a producer, both parties gain from that exchange (or trade) The consumers gain from the trade is termed as The consumers surplus The producers gain from the trade is termed as The producers surplus The sum of the consumers and producers surplus is the total gains from a particular trade (or exchange). AMITY GLOBAL BUSINESS SCHOOL Noida Consumer Surplus
Willingness to pay- the maximum price a consumer would pay how much a consumer values a good/service called the marginal benefit (MB)
Consumer Surplus- buyers willingness to pay minus price paid
CS = MB Price Paid
4 AMITY GLOBAL BUSINESS SCHOOL Noida Consumer Surplus
When you purchase something for a price that is less than your maximum willingness to pay? E.g. you are willing to pay Rs.20,000 for a new car and you buy it for Rs.18,000 here; You receive a surplus of willingness to pay cost =Rs.2,000.
5 AMITY GLOBAL BUSINESS SCHOOL Noida Consumer Surplus - Example Assume a boy wants to buy a cake. Demand curve tells his willingness to pay for each piece of cake. 1 st cake is worth Rs. 20 but price is Rs.14 so he generates Rs.6 worth of surplus. We can measure this for each piece of cake. Total surplus is sum of surplus from each cake purchased. AMITY GLOBAL BUSINESS SCHOOL Noida The consumer surplus of purchasing 6 pieces of cake is the sum of the surplus derived from each one individually. Consumer Surplus 6 + 5 + 4 + 3 + 2 + 1 = 21 Consumer Surplus - Example Piece of cakes Price (Rs. Per Cake) 2 3 4 5 6 13 0 1 14 15 16 17 18 19 20 Market Price Will not buy more than 7 because surplus from additional ticket is negative AMITY GLOBAL BUSINESS SCHOOL Noida Consumer Surplus The stepladder demand curve can be converted into a straight-line demand curve by making the units of the good smaller. Consumer surplus measures the total net benefit to consumers = total benefits from consumption (-)the total expenses. Thus, consumer surplus is area under the demand curve and above the price. Note that the area under the demand curve up to the level of consumption measures the total benefits. AMITY GLOBAL BUSINESS SCHOOL Noida Demand Curve Consumer Surplus Consumer Surplus Piece of cake Price (Rs. per cake) 2 3 4 5 6 0 1 Actual Expenditure 14 20 Market Price AMITY GLOBAL BUSINESS SCHOOL Noida Consumer Surplus and Market Price A lower market price will usually increase consumer surplus. A higher market price will usually reduce consumer surplus. Consumer surplus will be smaller when the demand curve is more elastic and larger when the demand curve is inelastic. AMITY GLOBAL BUSINESS SCHOOL Noida How the Price Affects Consumer Surplus? Initial consumer surplus Quantity Consumer Surplus at Price P2 vs. at Price P1 Price 0 Demand A B C D E F P1 Q1 P2 Q2 Consumer surplus to new consumers Additional consumer surplus to initial consumers AMITY GLOBAL BUSINESS SCHOOL Noida Consumer Surplus Price Quantity D P o
Q o
Maximum Willingness to Pay for Q o
What is paid Consumer Surplus AMITY GLOBAL BUSINESS SCHOOL Noida Original Consumer Surplus Change in Consumer Surplus: Price Increase Quantity New Consumer Surplus Loss in Surplus: Consumers paying more Loss in Surplus: Consumers buying less Price D P o
Q o
P 1
Q 1
AMITY GLOBAL BUSINESS SCHOOL Noida Producer Surplus
The amount a seller is paid , minus the sellers cost.
It is the area above the supply curve, and below the equilibrium price.
AMITY GLOBAL BUSINESS SCHOOL Noida Minimum Amount Needed to Supply Q o
Producer Surplus Price Quantity P o
Q o
What is paid Producer Surplus S AMITY GLOBAL BUSINESS SCHOOL Noida Consumer and Producer Surplus Price Quantity P o
Q o
S Producer Surplus Consumer Surplus D AMITY GLOBAL BUSINESS SCHOOL Noida The magic of perfectly competitive markets At equilibrium, both consumer and producer surplus are at their maximum
Any interference with the equilibrium price in perfectly competitive markets will reduce total consumer and producer surplus AMITY GLOBAL BUSINESS SCHOOL Noida Consumers and Producers Surpluses A Mathematical Application Suppose that the demand and supply function are given by Q D = 40 2P Q S = 2P
Market equilibrium occurs at the intersection of the demand and supply functions. Thus, at the market equilibrium Q S = Q D
Now, setting Q S = Q D , we have 40 2P = 2P => 4P = 40 => P* = 10 (equilibrium price) Plugging the equilibrium price to either the demand or supply function Q D = 40 2(10) => Q D = 20 Q D = 20 = Q S (equilibrium quantity)
AMITY GLOBAL BUSINESS SCHOOL Noida Consumers and Producers Surpluses :A Mathematical Application The consumers surplus is the area of the triangle between the price line and demand curve For Q D = 20, P = 10 (the equilibrium price and quantity exchanged) For Q D = 0, P = 20 (this is the vertical intercept of the inverse demand function) The vertical intercept above the price line is (20-10=) 10 The area of the triangle between the price line and the demand curve, i.e., CS= (1/2)*20*10 = 100 The producers surplus is the area of the triangle between the price line and supply curve For Q S = 20, P = 10 (the equilibrium price and quantity exchanged) The vertical intercept above the price line is 10 The area of the triangle between the price line and the supply curve, i.e., PS= (1/2)*20*10 = 100 The total surplus, TS = CS + PS = 100+100 = 200 AMITY GLOBAL BUSINESS SCHOOL Noida Total Economic Surplus or Social Surplus Total Economic Surplus or Social Surplus: The sum of the surpluses from trade of a commodity or service to all participants (all consumers and producers) Total economic surplus from all exchanges of a commodity occurred at a particular point in time can be calculated in the same way, using the aggregate (market) demand and supply functions (curves) Consumers surplus is the area of the triangle between the equilibrium price line and the market demand curve Producers surplus is the area of the triangle between the equilibrium price line and the market supply curve Economic Surplus = Consumers Surplus + rooducers Surplus