5.11 Consumer And Producer Surplus

Question 1

When is consumer and producer surplus maximised?

Answer 1

• both maximised at the free market equilibrium.

Question 2

What is consumer surplus?

Answer 2

• the difference between the price the consumer is willing and able to pay and the price they actually pay.
• This is based on what the consumer perceives their private benefit will be from consuming the good.

Question 3

Where is consumer surplus on a diagram?

Answer 3

• It is always the area above market price and below the demand curve.
• Due to the law of diminishing marginal utility, consumer surplus generally declines with extra units consumed.
• This is because the extra unit generates less utility than the one already consumed.
• Therefore, consumers are willing to pay less for extra units.
• Inelastic demand curves give a larger consumer surplus.
• This is because consumers are willing to pay a much higher price to consume the good.

Question 4

What is producer surplus?

Answer 4

• the difference between the price the producer is willing to charge and the
  price they actually charge.
• In other words, it is the private benefit gained by the producer that covers their costs, and is measured by profit.

Question 5

Where is the producer surplus on a diagram?

Answer 5

• This is always the area below the market price and above the supply curve.

Question 6

What would cause consumer surplus to increase?

Answer 6

• A shift in the demand curve to the right
• (increase in demand)

Question 7

What would cause consumer surplus to decrease?

Answer 7

• Supply has shifted to the left, which could be due to higher costs of production. -
• This causes market price to increase, and consumer surplus decreases

Question 8

What causes producer surplus to increase?

Answer 8

• This is caused by a shift in the supply curve to the right from S1 to S2, which could be due to
  lower average production costs, for example.
• Therefore market price decreases and producer surplus increases.
• This could also be due to an increase in demand which causes price to increase.

Question 9

Draw a demand and supply diagram and mark
*where the consumer surplus is
*where the producer surplus is
*where there is economic welfare

What is economic welfare?

Answer 9

• This is the total benefit society receives from an economic transaction.
• It is calculated by the area of producer surplus and consumer surplus added
  together.
• It is important when considering the effects of government policies, which could
  affect either producer or consumer surplus.

Question 10

What is price discrimination with a monopoly and how does it affect producer/consumer surplus?

Answer 10

• Price discrimination occurs in a monopoly, when the monopolist decides to charge different groups of consumers different prices, for the same good or service.
• This is not for cost reasons.
• It generally results in a loss of consumer welfare.
• By charging different prices, the monopolist can maximise their overall profits and producer surplus.

Question 11

What is the deadweight loss?
Shade this in on a diagram

Answer 11

• Deadweight loss is the loss of economic efficiency when the equilibrium price and quantity is not achieved.
• For example, higher prices due to monopoly power, could lead to a net deadweight loss to society.