Chapter 1
Consumer and
Producer Surplus
11
Learning Objective
Consumer surplus
2. Producer surplus
3. Market efficiency and Deadweight
Loss
4. Price Floors and Ceilings
1.
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1. Consumer Surplus
Measures
the value between the price
consumers are willing to pay for a
product along the demand curve and the
price they actually pay.
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Consumer Surplus
Using
the demand curve to measure
consumer surplus
Consumer surplus
Closely related to the demand curve
Demand schedule
Derived from the willingness to pay of the
possible buyers
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Consumer Surplus
Using
the demand curve to measure
consumer surplus
Demand curve
Reflects buyers willingness to pay
Measure consumer surplus
Consumer
surplus in a market
Area below the demand curve and above the
price
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How the price affects consumer surplus
Price
P1
(a) Consumer surplus at price P1
Price
Consumer
surplus
Initial
consumer
surplus
P1
B
Demand
(b) Consumer surplus at price P2
Q1
Quantity
P2
C
new Consumer
surplus
F
Demand
Q1
Q2
Quantity
In panel (a), the price is P1, the quantity demanded is Q1, and consumer surplus equals the area of
the triangle ABC. When the price falls from P1 to P2, as in panel (b), the quantity demanded rises
from Q1 to Q2, and the consumer surplus rises to the area of the triangle ADF. The increase in
consumer surplus (area BCFD)
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Example: Consumer Surplus
for Ice Tea
7
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Consumer Surplus
What does consumer surplus mean?
Consumer surplus
Benefit that buyers receive from a good
As the buyers themselves perceive it
Good measure of economic well-being
Exception: Illegal drugs
Drug addicts
Willing to pay a high price for heroin
Societys standpoint
Drug addicts dont get a large benefit from
being able to buy heroin at a low price
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2. Producer Surplus
Measures
the value between the
actual selling price of a product and
the price along the supply curve at
which sellers are willing to sell the
product.
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Producer Surplus
Using
the supply curve to measure
producer surplus
Producer surplus
Closely related to the supply curve
Supply schedule
Derived from the willingness to sell of the
possible sellers
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Producer Surplus
Using
the supply curve to measure
producer surplus
Supply curve
Reflects sellers willingness to sell.
Measure producer surplus
Producer
surplus in a market
Area below the price and above the supply
curve
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How the price affects producer surplus
Price
(a) Producer surplus at price P1
(b) Producer surplus at price P2
Price
P2
P1
B
Producer
surplus
Supply
New producer
surplus
Supply
P1
D
B
Initial
producer
surplus
Q1
Q2 Quantity
0
Quantity
In panel (a), the price is P1, the quantity supplied is Q1, and producer surplus equals the area of the
triangle ABC. When the price rises from P1 to P2, as in panel (b), the quantity supplied rises from Q1
to Q2, and the producer surplus rises to the area of the triangle ADF. The increase in producer
surplus (area BCFD)
0
Q1
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Calculation of Consumer and Producer
Surplus
Consumer Surplus = CS = the difference
between what consumers are willing to pay and
what they actually pay for a good or service.
Producer Surplus = PS = the difference between
what producers are willing to accept for their
produce and what they actually receive for a
good or service.
Total Surplus = CS + PS
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Calculation of Consumer and Producer
Surplus (Standardize)
CS = area above equilibrium price
and below demand
P
S
PS = area below equilibrium price
and above supply
CS
TS = CS + PS
PS
Q
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Since Consumer Surplus and Producer Surplus are represented by triangles, to calculate
Base * Height
their value you can utilize the formula for the area of a triangle =
.
2
CS = (1/2)(40 0)(120 70)
= (1/2)(40)(50)
= (1/2)(2000)
= 1000
P
120
S
PS = (1/2)(40 0)(70 50)
= (1/2)(40)(20)
= (1/2)(800)
= 400
70
50
40
SS = 1000 + 400 = 1400
Q
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3. Market Efficiency and Deadweight Loss
An allocation of resources is efficient if it maximizes
total surplus. Efficiency means:
The goods are consumed by the buyers who
value them most highly.
The goods are produced by the producers with
the lowest costs.
Raising or lowering the quantity of a good
would not increase total surplus.
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Consumer and producer surplus in the market
equilibrium
Price
Supply
Equilibrium
price
Consumer
surplus
E
Producer
surplus
B
C
Demand
Equilibrium
Quantity
quantity
Total surplusthe sum of consumer and producer surplusis the area
between the supply and demand curves up to the equilibrium quantity
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Deadweight Loss
Deadweight loss is the reduction in economic
surplus resulting from a market not being in
competitive equilibrium.
The net loss of both consumer & producer
surplus resulting from underproduction or
overproduction of a product.
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Deadweight Loss
FIGURE
4-7 Is Not in Equilibrium, There Is a Deadweight Loss
When
a Market
Economic surplus is maximized when a market is in competitive equilibrium. When a
market is not in equilibrium, there is a deadweight loss.
When the price of Thai tea is $2.20, instead of $2.00, consumer surplus declines from an
amount equal to the sum of areas A, B, and C to just area A. Producer surplus increases
from the sum of areas D and E to the sum of areas B and D. At competitive equilibrium,
there is no deadweight loss. At a price of $2.20, there is a deadweight loss equal to the
sum of areas C and E.
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4. Price Ceilings & Price Floors
A price ceiling is a legal maximum on the price of a good.
An example is rent control. If the price ceiling is below the
equilibrium price, it is binding and causes a shortage.
A price floor is a legal minimum on the price of a good. An
example is the minimum wage. If the price floor is above the
equilibrium price, it is binding and causes a surplus. The
labor surplus caused by the minimum wage is
unemployment.
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Price Ceiling
Price
Supply
Equilibrium
price
$3
2
Price
ceiling
Shortage
Demand
0
75
125
Quantity Quantity
supplied demanded
Quantity
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Price Floor
Price
Supply
4
Price
floor
$3
Equilibrium
price
Demand
0
100
Equilibrium Quantity
Quantity
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Example of Price Floors: Government Policy in
Agricultural Markets
The Economic Effect of a Price
Floor in the Wheat Market
If wheat farmers convince the government
to impose a price floor of $3.50 per bushel,
the amount of wheat sold will fall from 2.0
billion bushels per year to 1.8 billion.
If we assume that farmers produce 1.8
billion bushels, producer surplus then
increases by the red rectangle Awhich is
transferred from consumer surplusand
falls by the yellow triangle C.
Consumer surplus declines by the red
rectangle A plus the yellow triangle B.
There is a deadweight loss equal to the
yellow triangles B and C, representing the
decline in economic efficiency due to the
price floor. In reality, a price floor of $3.50
per bushel will cause farmers to expand
their production from 2.0 billion to 2.2 billion
bushels, resulting in a surplus of wheat.
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Example of Price Floors in Labor Markets:
The Debate over Minimum Wage Policy
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Example Price Ceilings: Government Rent
Control Policy in Housing Markets
The Economic Effect of a Rent
Ceiling
Without rent control, the equilibrium rent
is $1,500 per month. At that price,
2,000,000 apartments would be rented.
If the government imposes a rent ceiling
of $1,000, the quantity of apartments
supplied falls to 1,900,000,
and the quantity of apartments
demanded increases to 2,100,000,
resulting in a shortage of 200,000
apartments.
Producer surplus equal to the area of
the blue rectangle A is transferred from
landlords to renters, and there is a
deadweight loss equal to the areas of
yellow triangles B and C.
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Summary
Consumer
surplus equals buyers
willingness to pay for a good minus the
amount they actually pay for it.
Consumer surplus measures the benefit
buyers get from participating in a market.
Consumer surplus can be computed by
finding the area below the demand curve
and above the price.
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Summary
Producer
surplus equals the amount
sellers receive for their goods minus their
costs of production.
Producer surplus measures the benefit
sellers get from participating in a market.
Producer surplus can be computed by
finding the area below the price and
above the supply curve.
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Summary
The
equilibrium of demand and supply
maximizes the sum of consumer and
producer surplus.
This is as if the invisible hand of the
marketplace leads buyers and sellers to
allocate resources efficiently.
Deadweight loss is the reduction in
economic surplus resulting from a market
not being in competitive equilibrium.
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Summary
A price
ceiling is a legal maximum on the price of a
good. An example is rent control. If the price
ceiling is below the equilibrium price, it is binding
and causes a shortage.
A price
floor is a legal minimum on the price of a
good. An example is the minimum wage. If the
price floor is above the equilibrium price, it is
binding and causes a surplus. The labor surplus
caused by the minimum wage is unemployment.
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