Consumer and Producer Surplus

Overview

Description

Consumer and producer surplus refers to a difference between a price and the willingness to accept that price. Consumer surplus is the difference between how much a consumer will pay for something and the actual price of the item being purchased. Consumer surplus is derived from the demand curve: it is the area below the demand curve and above the market price. Producer surplus is the difference between the minimum price a producer wants to accept and the actual price. Producer surplus is derived from the supply curve: it is the area above the supply curve and below the market price. Both are used to further illustrate the gains from trade. The total surplus in a market is determined by adding up the individual consumer or producer surpluses and any government revenue, if it exists

. This information can be used to understand how a change in the market price affects these surpluses. It can also be used to understand what happens when producers get their market forecast wrong and either produce too much or too little compared to the quantity demanded in the market.

At A Glance

  • Consumer surplus is the difference between the maximum price a seller is willing to pay for a good or service and the actual market price the buyer pays.
  • The sum of individual consumer surpluses is the total consumer surplus, shown on a graph as the area below the market demand curve and above the market price.
  • Increases and decreases in price decrease or increase the consumer surplus respectively.
  • A price increase causes consumer surplus to decrease.
  • A price decrease causes an increase in consumer surplus.
  • Producer surplus is the difference between the minimum price a producer is willing to accept for a good or service and the actual market price the seller receives.
  • The sum of individual producer surpluses is the total producer surplus, shown on a graph as the area above the supply curve and below the market price.
  • Increases and decreases in market price impact producer surplus.
  • A price increase causes producer surplus to increase.
  • A price decrease causes producer surplus to decrease.
  • Total surplus is the total net gain to society from trading in a market.
  • When producers either oversupply or undersupply (relative to demand), they face the issue of deadweight loss, which reduces total surplus.
  • When quantity supplied is less than quantity demanded at the equilibrium price in the market, undersupply results. Both consumer and producer surplus are reduced.
  • When quantity supplied is more than quantity demanded at the equilibrium price in the market, oversupply results. Thus, producer surplus is reduced.