Download Consumer and Producer Surplus

Principles of Microeconomics
Consumer Surplus and Producer
Surplus
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Welfare Economics
• How the allocation of resources and market outcomes
affect economic well-being
• Reaching equilibrium: maximizes welfare (in most
cases)
• Welfare Economics: Consumer Surplus, Producer
Surplus and Total Surplus
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Consumer Surplus
Willingness to pay – price actually paid
• Every buyer has a maximum price they are
willing to pay for every good
• At lower prices, his consumer surplus is larger
– he is “better off” because not paying his full
maximum price
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Consumer Surplus
Willingness to pay – price actually paid
• Every buyer has a maximum price they are
willing to pay for every good
• At lower prices, his consumer surplus is larger
– he is “better off” because not paying his full
maximum price
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Consumer Surplus
Consider what you would pay for a bottle of water at a
summer concert
• If the price of water is actually $2.50 per
bottle, would you buy the water?
P
$2.50
– If your max price is $5 then yes! Your
consumer surplus is $2.50
– If your max price is $2 then no
CS
• What happens if the price falls to $70
per day?
Q
– If your max price is $100: Your consumer
surplus rises to $30
– If yous max price is $85 – now you buy the
tickets and have positive consumer surplus of
$15
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Consumer Surplus
Consider what you would pay for a bottle of water at a
summer concert
• If the price of water is actually $2.50 per
bottle, would you buy the water?
P
$2.50
– If your max price is $5 then yes! Your
consumer surplus is $2.50
– If your max price is $2 then no
CS
NEW CS
$1.50
• What happens if the price falls to $1.50
per day?
Q
– If your max price is $5: Your consumer surplus
rises to $3.50
– If your max price is $2 – now you buy the
water and have positive consumer surplus of
$1
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Producer Surplus
Price actually received – willingness to sell
• Every seller faces a minimum value they are willing
to accept to sell their goods
• This reflects the cost of production
• At higher prices, his producer surplus is larger – he
is “better off” from selling his goods above cost
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Producer Surplus
Price actually received – willingness to sell
• Every seller faces a minimum value they are willing
to accept to sell their goods
• This reflects the cost of production
• At higher prices, his producer surplus is larger – he
is “better off” from selling his goods above cost
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Producer Surplus
Consider independent food and beverage vendors at
the summer music festival, each with the following
willingness to sell a bottle of water:
Willingness to sell
Vendor A
$3.00
Vendor B
$2.75
Vendor C
$2.00
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Producer Surplus
• If the price of a bottle of water is
$2.25, how many vendors will sell
water?
P
– Only vendor C
– P.S. will be $0.25
$2.25
• What happens if the price rises to
$3.50 per bottle?
PS
Q
–
–
–
–
All vendors will sell water
PS Vendor A: $0.50
PS Vendor B: $0.75
PS Vendor C: $1.50
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Producer Surplus
• If the price of a bottle of water is
$2.25, how many vendors will sell
water?
P
– Only vendor C
– P.S. will be $0.25
$3.50
New PS
$2.25
• What happens if the price rises to
$3.50 per bottle?
PS
Q
–
–
–
–
All vendors will sell water
PS Vendor A: $0.50
PS Vendor B: $0.75
PS Vendor C: $1.50
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Total Economic Surplus
Combines consumer surplus and producer surplus
Total Surplus = (Willingness to pay – price actually paid) +
(Price actually received – willingness to sell)
Total Surplus = Willingness to pay - Willingness to sell
or
Total Surplus = Value to Buyers – Cost to Sellers
Total Surplus and Free Market Outcomes
Free market allocation of resources
produces most efficient outcomes:
• Buyers who value them most
highly, as measured by their
willingness to pay.
P
CS
$2.75
• Sellers who can produce them at
the lowest cost.
PS
Q
The free market yields an equilibrium quantity and price that
maximizes both consumer and producer surplus
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Total Surplus and Free Market Outcomes
P
• GOODS WILL BE ALLOCATED TO:
• Buyers who value them most highly,
as measured by their willingness to
pay.
CS
$2.75
PS
• Sellers who can produce them at the
lowest cost.
Q
The free market yields an equilibrium quantity and price that
maximizes both consumer and producer surplus
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Application
Consider the following demand and supply equations:
Demand: Q = 3600 – 100P
Supply: Q = 300P
• Solve for the market equilibrium quantity and price
• What is the consumer surplus?
• What is the producer surplus?
Application
• Solving for market equilibrium:
Demand = Supply
3600 – 100 P = 300P
3600 = 400 P  P = 9; Q = 2700
• Solving for consumer surplus:
When Q = 0  3600 = 100 P; P = 36
CS = ½ (36 – 9) * 2700 = 36,450
• Solving for producer surplus:
When Q = 0  P = 0
PS = ½ (9-0)* 2700 = 12,150
Application Reflection
Why does this matter?
•
•
•
We can derive the equilibrium point mathematically and determine the size of consumer
surplus and size of producer surplus based on the area of the triangles
CS = AREA ABOVE PRICE & BELOW DEMAND
PS = AREA BELOW PRICE & ABOVE SUPPLY
What’s the most important takeaway?
•
•
•
Quantifying the size of consumer surplus and producer surplus
Next: we will see how it changes when there are changes in the market
We will be able to quantify the size of those changes and determine who is more
affected by the change
MUDDIEST POINT?
Key Takeaways
• Welfare Economics is the analysis of the economic well-being
of producers and consumers
• Assume that market outcomes lead to maximized total surplus
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