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Consumer and Producer SurplusConsumer and Producer Surplus
February 6, 2007
Reading: Chapter 6
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Consumer and Producer SurplusConsumer and Producer Surplus
(^) IntroductionIntroduction
(^) Consumer surplusConsumer surplus
(^) Producer surplusProducer surplus
Efficiency and the gains from tradeEfficiency and the gains from trade
ApplicationsApplications
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Introduction Introduction
Connections to:Connections to:
Opportunity costs to consumers and producersOpportunity costs to consumers and producers
Marginal Decisions: to obtain supply andMarginal Decisions: to obtain supply and demand curves and gains to buyers and sellersdemand curves and gains to buyers and sellers
^ Supply and Demand: to examine marketsSupply and Demand: to examine markets
Gains from Trade: What is the gain from tradeGains from Trade: What is the gain from trade due to marketsdue to markets
Efficiency: How markets promote efficiencyEfficiency: How markets promote efficiency
Government interventions: How to measureGovernment interventions: How to measure efficiency losses?efficiency losses?
^ Elasticity: How does elasticity affect efficiencyElasticity: How does elasticity affect efficiency losseslosses (^4)
Potential buyer’s willingness to pay is the maximum amount he/she will pay for a good
Individual consumer surplus is the net gain to an individual buyer from the purchase of a good. It is equal to the difference between the buyer’s willingness to pay and the price paid.
Total consumer surplus in a market is the sum of the individual consumer surpluses of all the buyers of a good.
We will see that the total consumer surplus is the area under the demand curve above the market price
Consumer Surplus
Definition
price
quantity
price
Demand curve
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Consumer Surplus Individual consumer surplus
Purchase of one unitPurchase of one unit^ Purchase of several unitsPurchase of several units
price
(^1) quantity
Consumer surplus
Price paid
Willingness to pay
price
1 2 3 45 6 quantity
price
Willingness to pay
Consumer surplus
Amount paid
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Consumer Surplus Willingness to pay and demand curve
One unit for each consumer
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Consumer Surplus
Willingness to pay and total consumer surplus
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Consumer Surplus Total consumer surplus
The total consumer surplus generated by purchases of a good at a given price is equal to the area below the demand curve but above that price.
Valid for each consumer buying one unit or each buying several units. With many consumers the curve is smooth.
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Consumer Surplus
Effect of fall in price
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Producer Surplus
Definition
A potential seller’s cost is the lowest price at which he or she is willing to sell a good.
Individual producer surplus is the net gain to a seller from selling a good. It is equal to the difference between the price received and the seller’s cost.
Total producer surplus in a market is the sum of the individual producer surpluses of all the sellers of a good.
We will see that the total producer surplus is the area under the market price above the supply curve
price
quantity
Supply curve
price
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Producer Surplus
Cost and the Supply Curve
Works for each seller producing several units (as in the case of the consumer)
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Producer Surplus Cost and the supply curve
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Efficiency and the Gains from Trade
Changing the Quantity Lowers Total Surplus
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Efficiency and the Gains from Trade
Four functions of the Market which maximize surplus
1. Allocates consumption of the good to potential buyers who value it the most (in terms of their willingness to pay). 2. Allocates sales to potential sellers who most value the right to sell the good (in terms of cost). 3. Ensures that every consumer who makes a purchase values the good more than every seller who makes a sale. 4. Ensures that every potential buyer who doesn’t make a purchase values the good less than every potential seller who doesn’t make a sale.
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Efficiency and the Gains from Trade
Caveats
Market outcome is not the best for each person.Market outcome is not the best for each person. ^ Distribution is not taken into accountDistribution is not taken into account –– moremore willingness to pay may be due to having morewillingness to pay may be due to having more income, not stronger preference.income, not stronger preference. Market failures. Examples:Market failures. Examples: (^) MonopolyMonopoly ExternalitiesExternalities Imperfect informationImperfect information Public goodsPublic goods
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Application
Effect of Tax on Consumer and Producer Surplus
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Application
Deadweight Loss and Elasticities
Deadweight loss measures loss in total surplus due to tax.
What kinds of market produce a lower deadweight loss when tax is imposed?
For a tax imposed when demand or supply, or both, is inelastic will cause a relatively small decrease in quantity transacted and a small deadweight loss.
If objective is to reduce quantity, then better to haveIf objective is to reduce quantity, then better to have higher elasticity.higher elasticity. 24
Application
Deadweight Loss and Elasticities, cont.
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Application
Deadweight Loss and Elasticities, cont.
