Mirco Soffritti

Microeconomics
What you will learn
i. What is consumer surplus?
ii. What is producer surplus?
iii. What is total surplus and why is it used to illustrate the gains from
trade in a market?
iv. Why can a market sometimes fail and be inefficient?
v. Efficiency vs equity
The content of Topic 6

Consumer surplus Producer surplus Total surplus

Consumers’ well being Producers’ well being Everyone’s well being

Market efficiency Efficiency vs equity

Final thoughts
01 Consumer surplus
Consumer surplus
Consumer surplus (CS) provides insight into the benefits that consumers receive from
participating in a market. It serves several purposes in economic analysis:
Measuring Consumer Welfare: CS quantifies the economic well-being of consumers by
capturing the difference between what they are willing to pay and what they actually pay.
Evaluating Market Efficiency: By analyzing CS, economists can assess whether
resources are being allocated efficiently in the market.
Policy Making and Regulation: Understanding CS helps policymakers evaluate the impact
of taxes, subsidies, and other interventions.
Price Setting and Business Strategy: For businesses, understanding CS can guide
pricing strategies. By estimating CS, firms can set prices that maximize their revenue
while still offering value to consumers.
Comparing Market Scenarios: CS allows for the comparison of different market
scenarios or policy interventions to provides the greatest benefit to consumers.
Consumer surplus
The Consumer Surplus (CS) is the difference between the maximum price
consumers are willing to pay for a good or service and the actual price they
pay.
It measures the economic benefit to consumers from engaging in market
transactions.
It represents the extra satisfaction consumers receive from purchasing
goods at a price lower than their willingness to pay.

Graphical Representation:
CS is typically illustrated as the area under the demand curve and above the
price level in a demand-supply diagram.
Maximum willingness to pay
A consumer’s willingness to pay for a good is the maximum price at which
he or she would buy that good.
Máximum willingness to pay (MWP) by potential buyer of a used Microeconomics book
This is the demand curve
for used Microeconomics
books. Isn’t it?
Consumer surplus
Assume that the price at which the book is sold is $30. Three agents, Aleisha,
Brad, and Claudia will purchase a book and benefit from the transaction
Their enjoyment is valued by the excedence between MWP and Price (surplus)

The consumer surplus (CS) is the size of the

entire shaded area—the sum of the individual
consumer surpluses of Aleisha, Brad, and
Claudia
CS = $29 + $15 + $5 = $49
To practice with individual surplus
George is considering the purchase of some new T-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.
a) What is the efficient number of shirts for George to buy?
b) What is George’s consumer surplus?
To practice with individual surplus
Consider again the sequence of MWP’s for the Microeconomics used books.
If the price of one book is $70, what is the CS? What if the price is $20? At what
price 𝑝 ≥ 0 would there be the maximum CS?
CS and dropping price
Consider again the market for copies of Microeconomics used books.
An easy principle: as the price drops (for ex. from $30 to $20) the CS either
increases or stays the same.
Under what condition(s) would CS stay
the same when the price decreases?
Consumer surplus (divisible good case)
Assume that the good is perfectly divisible (i.e. any amount, including non-integer,
can be purchased…like milk, sugar, etc.)
In this case, the MWP curve (demand curve) would not have steps and be continuous

The consumer surplus (CS) is the size of the

entire shaded area — the sum of the individual
$2000

consumer surpluses — between the demand

curve and the price line, up to the designed
quantity (area of a triangle).

CS = (2,000 - 500) 1 /2 = $750 (million)

02 Producer surplus
Producer surplus
Producer surplus (PS) measures the benefits that producers or sellers receive from
participating in a market. It serves several important purposes in economic analysis:
Measuring Producer Welfare: PS quantifies the economic well-being of producers
by capturing the difference between the price at which they are willing to sell and
the actual market price.
Assessing Market Efficiency: By analyzing PS, economists can determine whether
resources are being allocated efficiently, indicating how well the market functions.
Policy Making and Regulation: Understanding PS helps policymakers evaluate the
impact of taxes, subsidies, and regulations on producers.
Price Setting and Business Strategy: For businesses, understanding PS can guide
pricing strategies. By estimating PS, firms can set prices that maximize their profit
margins while remaining competitive.
Comparing Market Scenarios: PS enables the comparison of different market
conditions or policy interventions to identify scenarios that provide the greatest
benefit to producers.
Maximum willingness to charge
A producer’a willingness to charge for a good is the minimum price at which he
or she would charge for the good.
Minimum willingness to charge (MWC) by potential seller of a used Micro book
This is the supply curve for
used Microeconomics
books. Isn’t it?
Producer surplus
Assume that the price at which the book is sold is $30. Three agents, Andrew,
Betty, and Carlos will sell a book and benefit from the transaction
Their enjoyment is valued by the excedence between Price and MWC (surplus)

The producer surplus (PS) is the size of the

entire shaded area—the sum of the individual
producer surpluses of Andrew, Betty, and
Carlos
PS = $25 + $15 + $5 = $45
To practice with individual surplus
Oxford Clothiers, is evaluating its potential producer profit and surplus from
selling T-shirts. The company can produce T-shirts at varying costs due to
differences in material quality and production methods. Here is the cost
breakdown for producing three shirts:
• The cost to produce the first shirt is $20.
• The cost to produce the second shirt is $25.
• The cost to produce the third shirt is $30.
Oxford Clothiers is selling each shirt for $28.
By using cost benefit analysis, what is the profit maximizing
number of shirts for Oxford Clothiers to produce and sell?
a) 1 shirt
b) 2 shirts
c) 3 shirts
d) None, as the price is too low
To practice with individual surplus
Oxford Clothiers, is evaluating its potential producer profit and surplus from
selling T-shirts. The company can produce T-shirts at varying costs due to
differences in material quality and production methods. Here is the cost
breakdown for producing three shirts:
• The cost to produce the first shirt is $20.
• The cost to produce the second shirt is $25.
• The cost to produce the third shirt is $30.
Oxford Clothiers is selling each shirt for $28.
What is Oxford Clothiers' total producer surplus from selling
the efficient number of shirts?
a) $6
b) $8
c) $11
d) $16
To practice with individual surplus
Consider again the sequence of MWC’s for the Microeconomics used books.
If the price of one book is $17, what is the PS? What if the price is $50? At what
price(s) 𝑝 ≥ 0 would there be the maximum PS?
PS and rising price
Consider again the market for copies of Microeconomics used books.
Another easy principle: as the price increases (for ex. from $30 to $40) the PS
either increases or stays the same.
Under what condition(s) would CS stay
the same when the price increases?
Price = $40
Producer surplus (divisible good case)
Assume that the good is perfectly divisible (i.e. any amount, including non-integer,
can be purchased…like milk, sugar, etc.)
In this case, the MWC curve (supply curve) would not have steps and be continuous

The producer surplus (PS) is the size of the

entire shaded area — the sum of the individual
consumer surpluses — between the demand
curve and the price line, up to the designed
quantity (area of a triangle).

$1
PS = (5 - 1) 1 /2 = $2 (million)
03 Total surplus
Total surplus
Total surplus (TS) is the sum of consumer surplus and producer surplus:
TS = CS + PS
It measures de overall (total) welfare by all agents trading in a market.
Total surplus
Total surplus (TS) is the sum of consumer surplus and producer surplus:

$50
CS = (50 -30) 1,000/2 = 10,000
PS = (30 - 15) 1,000/2 = 7,500
TS = 10,000 + 7,500 =17,500*

$15

*TS = (50 – 15) 1,000/2 =17,500

To practice with CS and PS
Assume the following demand and supply function
𝑞𝑑 = 𝐷 𝑝 = 20 − 2𝑝 and 𝑞𝑠 = 𝑆 𝑝 = −7 + 𝑝
where 𝑝 denotes the unit price of ice creams and
𝑞 (lt) the demanded for goods.
• Find the equilibrium price and quantity
• Draw and calculate the CS
• Draw and calculate the PS
• Draw and calculate the TS
04 Market inefficiency
(Pareto) efficiency… in economics
Efficiency in economics refers to any situation where resources are used
in a way that maximizes the total benefit to society.
In other words, it means producing the goods and services that people
want, in the right quantities, at the lowest possible cost.
An efficient market is one where no one can be made better off without
making someone else worse off, meaning that resources are allocated in
the most effective way possible.
This definition of efficiency is typically called Pareto
efficiency after Vilfredo Pareto (1848-1923) who was
an Italian economist, sociologist, and engineer.
Market efficiency
Total surplus is maximized with markets: Markets are efficient.

Three ways you might (unsuccessfully) try to increase the total surplus
1. reallocate consumption among consumers
2. reallocate sales among sellers
3. set the price away from equilibrium price (price control)
Market efficiency
Total surplus is maximized with market equilibrium. Try different prices and see!

Three ways one might (unsuccessfully) try to increase the total surplus
1. reallocate consumption among consumers
2. reallocate sales among sellers
3. change the quantity traded
Inefficiency: reallocating consumption
Reallocating consumption away from equilibrium outcome reduces CS and TS
Assume that the equilibrium price is $30.
According to the MWP, Aleisha, Brad and
Claudia will purchase the book and CS = $49
(see diapo 7)
Now imagine reallocating one book from Brad to
Darren (we don’t give a book to a student who
values it more than $30 and we force one who
values it less to pay $30 ).
Then:
CS’ = CS -$15 -$5) = $49 -$20 =$29
which is less than CS. PS stays the same
Inefficiency: reallocating sales
Reallocating sales away from equilibrium outcome reduces PS and TS
Assume that the equilibrium price is $30.
According to the MWC, Andrew, Betty and
Carlos will sell the book and PS = $45 (see
diapo 16)
Now imagine reallocating one book from Betty
to Donna (we don’t allow a book to be sold by a
person who values it less than $30 and we
force one who values it more to accept $30 ).
Then:
PS’ = PS -$15 - $5) = $45 -$20 =$25
which is less than PS. CS stays the same
Inefficiency: price control (ceiling)
Imagine forcing a price lower than the equilibrium price (price ceiling)

Given the short-side rule of a market (we

trade the minimum between quantity
supplied and quantity demanded), there will
be a shortage.
• Producer surplus shrinks
• Consumer surplus may increase,
decrease, or stay the same
• Total surplus will decrease (dead-weight
loss)
Inefficiency: price control (floor)
Imagine forcing a price lower than the equilibrium price (price floor)

Given the short-side rule of a market (we

trade the minimum between quantity
supplied and quantity demanded), there
will be a surplus.
• Consumer surplus shrinks
• Producer surplus may increase,
decrease, or stay the same
• Total surplus will decrease (dead-
weight loss)
 Efficiency vs
05 equity
Efficiency of competitive markets
Competitive markets are efficient because:
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.
Efficiency vs equity
Efficiency and equity are two fundamental concepts in economics that often
come into conflict with each other.
Efficiency refers to the optimal allocation of resources where no one can be
made better off without making someone else worse off. In other words, an
efficient economy maximizes total welfare, ensuring that resources are utilized
in the most productive way (Pareto efficiency)
Equity, on the other hand, concerns the fairness of
the distribution of wealth and resources among agents.
While efficiency focuses on the size of the
economic pie, equity is concerned with how that pie
is divided. Equity can take various forms, including
equality of opportunity, equality of outcome, or a sense
of fairness in economic transactions.
Efficiency vs equity
Policies aimed at increasing equity, such as progressive taxation or social
welfare programs, may reduce efficiency by distorting incentives and leading
to less productive economic behavior.
Conversely, policies that enhance efficiency, such as deregulation or free
markets, can sometimes lead to unequal outcomes that many consider unfair.
In policy-making, to find a balance between efficiency
and equity often involves trade-offs, as efficiency
might lead to significant inequities, while efforts to
achieve complete equity might reduce overall economic
efficiency. The balance struck depends on the values
and priorities of a society (normative economics).
To practice
Oxford Clothiers can produce T-shirts at varying costs. The first shirt costs
$20, the second $25, and the third $30. If the market price is $28, what is
the total producer surplus if they produce and sell two shirts?
a) $11
b) $8
c) $14
d) $6
To practice
Which of the following is a true statement about the effect of a
government-imposed price floor?
a) consumer surplus will increase.
b) all firms will gain.
c) there will be a shortage.
d) total surplus will decrease.
To practice
Consider a market where the equilibrium price is $64.
If the demand curve is 𝑝 = 100 − 2𝑄 and the supply curve is 𝑝 = 10 + 3𝑄,
what is the total surplus at equilibrium?
a) $324
b) $486
c) $810
d) None of the above
To practice (challenging)
Determine the amount of consumer surplus generated in each of the following
situations.
a. Leon goes to the clothing store to buy a new T-shirt, for which he is willing
to pay up to $10. He picks out one he likes with a price tag of exactly $10.
When he is paying for it, he learns that the T-shirt has been discounted by
50%.
b. Alberto goes to the music store hoping to find a used copy of Nirvana’s
Nevermind for up to $30. The store has one copy of the record selling for
$30, which he purchases.
c. After soccer practice, Stacey is willing to pay $2 for a bottle of mineral
water. The 7-Eleven sells mineral water for $2.25 per bottle, so she declines
to purchase it.
To practice (challenging)
Determine the amount of producer surplus generated in each of the following
situations.
a. Gordon lists his old Lionel electric trains on eBay. He sets a minimum
acceptable price, known as his reserve price, of $75. After five days of
bidding, the final high bid is exactly $75. He accepts the bid.
b. So-Hee advertises her car for sale in the used-car section of the student
newspaper for $2,000, but she is willing to sell the car for any price higher
than $1,500. The best offer she gets is $1,200, which she declines.
c. Sanjay likes his job so much that he would be willing to do it for free.
However, his annual salary is $80,000.
To practice (challenging)
There are six potential consumers of computer games, each willing to buy only
one game. Consumer 1 is willing to pay $40 for a computer game, consumer 2 is
willing to pay $35, consumer 3 is willing to pay $30, consumer 4 is willing to pay
$25, consumer 5 is willing to pay $20, and consumer 6 is willing to pay $15.
a. Suppose the market price is $29. What is the total consumer surplus?
b. The market price decreases to $19. What is the total consumer surplus
now?
c. When the price falls from $29 to $19, how much does each consumer’s
individual consumer surplus change? How does total consumer surplus
change?
Summary of Topic 6
Consumer Surplus (CS):
• Definition: The difference between what consumers are willing to pay and
what they actually pay.
• Significance: Measures consumer welfare, helps in evaluating market
efficiency, guides policy-making, and business strategies.
• Example: Graphical representation showing CS as the area under the
demand curve and above the price level up to the equilibrium quantity.
Producer Surplus (PS):
• Definition: The difference between the price producers are willing to sell at
and the actual market price.
• Importance: Reflects producer welfare, aids in assessing market efficiency,
and is crucial for policy-making and business pricing strategies.
• Example: Illustrated through a supply curve, showing PS as the area above
the supply curve and below the price line up to equilibrium quantity.
Summary of Topic 6
Market Efficiency
Total Surplus (TS):
• Definition: The sum of Consumer Surplus (CS) and Producer Surplus (PS).
• Purpose: Reflects the total welfare in a market, representing the gains from
trade for all participants.
• Example: Calculated as the sum of CS and PS in a market scenario.
Market Efficiency:
• Definition: A situation where no one can be made better off without making
someone else worse off (Pareto efficiency).
• Importance: Efficient markets maximize total surplus and allocate resources
optimally.
• Example: Inefficiencies arise from price controls, such as price ceilings and
floors, leading to deadweight loss.
Summary of Topic 6
Efficiency:
• Examples: Competitive markets are efficient as they allocate consumption and
sales to those who value them most.

Equity:
• Concerns the fairness of wealth and resource distribution among individuals.
• Trade-off: Policies that enhance efficiency might lead to inequities, while those
aimed at equity might reduce overall economic efficiency.
• Example: Progressive taxation and social welfare programs may improve equity
but can reduce efficiency by distorting economic incentives.