Consumer surplus and producer surplus

Overview

What consumer and producer surplus each measure, how they are read off a demand and supply diagram, and how a price change redistributes them.

What you need to know

Answer each one before you reveal it.

Questions from this subtopic

Each one with the model answer underneath.

1. 1

   Define consumer surplus.

   Model answer

   Consumer surplus is the difference between the maximum amount a consumer is willing to pay for a good and the amount actually paid. Across a whole market it is the total of that difference over all units bought. It measures the net benefit consumers gain from being able to buy at the market price rather than at the highest price they would have accepted.

2. 2

   Define producer surplus.

   Model answer

   Producer surplus is the difference between the price a producer actually receives for a good and the minimum price at which that producer would have been willing to supply it. Across the market it is the total of that difference over all units sold. It measures the net benefit producers gain from selling at the market price rather than at the lowest price they would have accepted.

3. 3

   Describe precisely how consumer and producer surplus appear on a demand and supply diagram, naming the axes.

   Model answer

   Put price on the vertical axis and quantity per period on the horizontal axis. Draw a downward-sloping demand curve and an upward-sloping supply curve crossing at equilibrium price P1 and quantity Q1, and draw a horizontal line across at P1. Consumer surplus is the area bounded above by the demand curve, below by the horizontal price line and on the right by the equilibrium quantity: the triangle between the demand curve and the price line. Producer surplus is the area between the price line and the supply curve over the same range: the triangle below the price line and above the supply curve. The two triangles meet along the price line at the equilibrium point.

4. 4

   Why is consumer surplus measured as the area under the demand curve and above the price?

   Model answer

   The height of the demand curve at each unit is the most a consumer is willing to pay for that unit, and the price line is what is actually paid. The vertical gap between them is therefore the gain on that unit. Adding the gaps across every unit bought, from the first up to the equilibrium quantity, gives the whole area between the curve and the price line, which is consumer surplus.

5. 5

   A consumer would pay at most £12, £10, £8 and £6 for a first, second, third and fourth unit of a good. The market price is £7. Calculate the units bought and the consumer surplus.

   Model answer

   The consumer buys any unit valued at £7 or more, so the first three units are bought and the fourth, valued at £6, is not. Consumer surplus is (£12 − £7) + (£10 − £7) + (£8 − £7) = £5 + £3 + £1 = £9. Total spending is £21 for goods valued at £30, so the consumer gains £9 of surplus.

6. 6

   Suppliers of a good would accept a minimum of £3, £5, £7 and £9 for the first, second, third and fourth unit. At a price of £7, calculate the units supplied and the producer surplus.

   Model answer

   Producers supply any unit whose minimum acceptable price is £7 or less, so three units are supplied and the fourth, needing £9, is not. Producer surplus is (£7 − £3) + (£7 − £5) + (£7 − £7) = £4 + £2 + £0 = £6. The third unit yields no surplus because the price exactly equals the minimum the producer would accept.

Other ways to work this

The same content, four other ways.

What is inside Levo

Six ways to work the same material.