3.5.12 - Consumer and Producer Surplus

Question 1

What is consumer surplus?

Answer 1

A measure of the economic welfare enjoyed by consumers.
The utility received over the price paid for a good.

Question 2

What is producer surplus?

Answer 2

A measure of the economic welfare enjoyed by firms.
The difference between the price a firm charges to the minimum price they would be willing to accept.

Question 3

Where is the producer surplus in this graph?

Answer 3

Below Price and Above Supply.

Question 4

Where is the consumer surplus in this graph?

Answer 4

Above price and below Demand.

Question 5

What happens to consumer surplus when consumer welfare increases?

Answer 5

Consumer surplus increases.

Question 6

What does this graph demonstrate?

Answer 6

How consumer surplus falls and producer surplus rises when the perfectly competitive industry is transformed into a monopoly. (provided there are no changes in economies of scale)

Question 7

Where is the optimal industry output in perfect competition?

Answer 7

A.

Question 8

Where does the monopoly choose to produce?

Answer 8

B.

Question 9

What does this diagram make abundantly clear?

Answer 9

The case against monopolies, as they restrict output and raise prices.

Question 10

How does this diagram demonstrate changes in consumer and producer welfare?

Answer 10

Consumer surplus and producer surplus are both affected by monopolies.
Consumer is reduced and producer is increased at the expense of the consumer surplus.

Question 11

What is the marginal cost curve in monopolies equal to in perfect competition?

Answer 11

The market supply curve.

Question 12

What is deadweight loss?

Answer 12

The loss of economic welfare when the maximum attainable level of total welfare fails to be achieved.

Question 13

What does the monopoly gain in increasing the price from P1 to P2? (other than more profit)

Answer 13

They take some consumer surplus and convert it to producer surplus.

Question 14

What area of consumer surplus is transferred to producer surplus?

Answer 14

P1P2CD.

Question 15

What else happens to total welfare outside of transfers?

Answer 15

The total welfare is reduced, demonstrated on the graph by the area ABC.

Question 16

Why is there a net loss of welfare?

Answer 16

The amount bought and sold falls to Q2.

Question 17

What is the deadweight loss evidence of?

Answer 17

Market failure in monopolies.

Question 18

Who benefits from price discrimination?

Answer 18

Firms. (Usually)

Question 19

Who suffers from price discrimination?

Answer 19

Consumers. (Usually)

Question 20

What is the general rule about benefits for producers?

Answer 20

Any producer benefit usually means a disadvantage to consumers.

Question 21

What does this graph demonstrate?

Answer 21

The reduction in consumer welfare due to price discrimination.

Question 22

Why does the Marginal Cost Curve slope upwards in the combined market?

Answer 22

Graphically depicts the law of diminishing returns.

Question 23

What price do consumers pay in the absence of price discrimination?

Answer 23

The price P_CM.

Question 24

Where is the consumer surplus in this graph with no price discrimination?

Answer 24

Shaded area on (c), labelled 1.

Question 25

Where is consumer surplus during price discrimation?

Answer 25

The shaded areas labelled 2 and 3.

Question 26

What is another name for first degree price discrimation?

Answer 26

‘Perfect’ price discrimation.

Question 27

What is perfect price discrimination?

Answer 27

Each consumer is charged the maximum price they are prepared to pay.
All consumer surplus is converted to producer surplus.

Question 28

Where do monopolies charge without price discrimination?

Answer 28

P1
Where MC = MR.
(The point of equilibrium)

Question 29

Where is the abnormal profit on this graph without price discrimination?

Answer 29

C1BAP1.

Question 30

Where is consumer surplus without price discrimination?

Answer 30

P1AZ (triangle)

Question 31

What happens if first degree price discrimination is employed to customers Q_W and Q_V?

Answer 31

All consumer surplus is removed, and is all transferred to producer surplus.

Question 32

Why is price discrimination generally viewed as undesirable?

Answer 32

Price discrimination leads to a loss of consumer surplus or consumer welfare. Firms exploit their producer sovereignty and monopoly power, charging most consumers higher prices than would be charged in the absence of price discrimination.

However, some consumers can benefit from price discrimination. Namely the poorest consumers.

Question 33

Why are the poorest consumers benefactors of price discrimination?

Answer 33

As each consumer is charged a different price, one consumer does not affect the other.

When each customer pays the maximum price they are prepared to pay, the demand curve is now equal to the firm’s MR curve.
For this reason, MR = MC rises to Q₂.

Poor consumers who were unwilling to buy the good at P₁, are now willing to purchase the extra output at a lower cost.

Most consumers pay a higher price, but the poorest consumers will end up paying less.

Question 34

What are some situations where price discrimination is absolutely necessary?

Answer 34

In instances where firms cannot make enough profit to stay in business, price discrimination is necessary to be employed to take some consumer surplus and transfer it to the producers.

(e.g. a doctor in a rural town. If they cannot stay in business, no-one has access to a doctor. Charging the richer customers a higher price ensures the doctor stays in business, while ensuring everyone gets a necessary service.)

Question 35

What happens when perfect competition is transferred to monopoly?

Answer 35

Some of the consumer surplus is transferred to the monopoly.