1.2.8 Consumer and producer surplus Flashcards
Consumers surplus
The difference between the price the consumer is willing to pay and the price they actually pay, set by the price mechanism.
The demand curve shows the price consumers are willing to pay, and so the difference between the demand curve and the price shows the consumer surplus.
Producer surplus
The difference between the price the supplier is willing to produce their product at and the price they actually produce at, set by the price mechanism.
The supply curve shows the price suppliers are willing to sell the good for, and so the difference between the supply curve and the price shows the consumer surplus.
Demands effect on consumer and producer surplus
A decrease in demand from D1 to D2 will lead to a fall in consumer and producer surplus, as both price and output decrease. Consumer surplus falls from ABP1 to CDP2 and producer surplus falls from P1B0 to P2D0. An increase in demand would have the opposite effect and increase consumer and producer surplus.
Supply’s effect on consumer and producer surplus
A decrease in supply from S1 to S2 will lead to a fall in consumer and producer surplus.
Consumer surplus falls from ABP1 to CDP2 and producer surplus falls from P1B0 and
P2D0. An increase in supply would have the opposite effect and increase consumer and producer surplus.
Community surplus *
The total welfare to society is the community surplus: consumer surplus plus producer surplus.
The price mechanism can be shown to efficiently allocate resources as increasing the welfare of one group will the decrease the welfare of another, so community welfare is maximised. Any other price/output combination will have the same community surplus. As a result, the price mechanism fulfills pareto criterion.
Consumer/Producer surplus - Synoptic point **
Macroeconomic policies can be assessed by considering their effect on producer and consumer surplus.
For example the use of tariffs leads to a loss of consumer surplus.
