Subject 5. Consumer Surplus, Producer Surplus, and Total Surplus

Consumer Surplus

Consumer surplus is the area below the demand curve but above the actual price paid. It is the difference between the amount consumers are willing to pay and the amount they have to pay for a good.

Consider the market for a good.

  • If the market price is $100, then the 30th unit will not sell because those who demand it are only willing to pay $60 for the good.
  • At $100, the 17th unit will sell because those who demand it are willing to pay up to $100 for the good.
  • At $100, the 5th unit will sell because those who demand it are willing to pay up to $133 for the good.

  • For all those goods under 17 units, people are willing to pay more than $100.
  • The area represented by the distance above the actual price paid and below the demand curve is called consumer surplus.
  • This area represents the net gains to buyers from market exchange.

Lower market prices increase the amount of consumer surplus in the market.

Producer Surplus

Producer surplus is the difference between the minimum supply price, represented by the supply curve, and the actual sales price.

  • It is measured by the area below the price and above the supply curve, up to the quantity sold.
  • It accrues to owners of firms and resource suppliers.

Example

The actual selling price of bananas is $9 per kg.

Now imagine that there are only 10,000 kg bananas being supplied at the moment. The marginal cost per kg is only $3 but the selling price is $9. So there is an additional $6 per kg being raised. This is the producer surplus per kg. The total producer surplus when 10,000 kg are produced is thus $60,000.

Due to the surplus, more producers enter the market and another 10,000 kg are produced, so there are now 20,000 kg of bananas on the market. The marginal costs of producing this additional 10,000 kg have risen to $4.

Producer surplus is not the same as profit. Remember that profit is the return that accrues to owners of a firm and is the difference between sales revenue and total (not marginal) costs of production.

Total Surplus

The following figure shows that a competitive market creates an efficient allocation of resources at equilibrium.

  • In equilibrium, the quantity demanded equals the quantity supplied.
  • At the equilibrium quantity, marginal benefit equals marginal cost, so the quantity is the efficient quantity.
  • The sum of consumer and producer surplus is maximized at this efficient level of output. It is here that all potential gains from production and exchange are realized.

Practice Question 1

When people pay less for something than it is worth to them, they receive a(n) ______.

A. external benefit
B. deadweight loss
C. producer surplus
D. consumer surplus
Correct Answer: D

A consumer surplus is the value of a good minus the price paid for it, summed over the quantity bought.

Practice Question 2

People receive a consumer surplus in a market transaction because ______

A. price exceeds marginal benefit.
B. marginal benefit exceeds price.
C. marginal cost exceeds price.
Correct Answer: B

Practice Question 3

The minimum price that producers must receive to induce them to produce another unit of a good or service is equal to the good's ______.

A. marginal cost
B. marginal benefit
C. producer surplus
Correct Answer: Correct Answer: A

Marginal cost is the cost of producing one more unit of a good or service.

Practice Question 4

If the market price exceeds the cost of production to the producer, the producer receives a ______.

A. producer surplus
B. deadweight loss
C. external benefit
Correct Answer: A

Practice Question 5

At the equilibrium quantity, ______

I. marginal benefit equals marginal cost.
II. the sum of consumer surplus equals the sum of producer surplus.
III. the quantity demanded equals the quantity supplied.
Correct Answer: I and III

The consumer surplus and producer surplus are maximized but they are not necessarily equal to each other.

Practice Question 6

If you are willing to sell your old Rollerblades for $25 and someone offers you $40 for them, this transaction will generate ______.

A. $25 worth of consumer surplus and $15 worth of producer surplus
B. $15 worth of consumer surplus and $25 worth of producer surplus
C. $15 worth of producer surplus and an unknown amount of consumer surplus
Correct Answer: C

The information indicates that producer surplus is $15 (the difference between what the seller is willing to accept and the price), but there is no information on how much more the consumer might be willing to pay.

Practice Question 7

When people pay less for something than it is worth to them, they receive what is called a(n) ______.

A. consumer surplus
B. economic benefit
C. deadweight loss
Correct Answer: A

A consumer surplus is the value of a good minus the price paid for it, summed over the quantity bought.

Practice Question 8

The minimum price that producers must receive to induce them to produce another unit of a good or service is equal to the good's ______.

A. marginal cost
B. marginal benefit
C. producer surplus
Correct Answer: A

Marginal cost is the cost of producing one more unit of a good or service.

Practice Question 9

If other factors remain the same, a decrease in the price of a good will cause ______.

A. the quantity demanded of the good to increase and consumer surplus to decrease
B. the quantity demanded of the good to increase and consumer surplus to increase
C. the quantity demanded of the good to decrease and consumer surplus to decrease
Correct Answer: B

At a lower price the consumer will want to purchase more units. Consumer surplus will increase because additional units with consumer surplus will be purchased and earlier units will each have a larger consumer surplus.

Practice Question 10

The gains from trade for consumers are measured by ______.

A. external benefits
B. producer surplus
C. consumer surplus
Correct Answer: C

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Practice Question 11

If mangoes cost 10 India Rupees (INR) each, a consumer spends his budget on fruits that he values more highly than mangoes. However, at a price of 4 INR per mango the consumer buys 20 mangoes. The total consumer surplus (in INR) is closest to ______.

A. 26
B. 120
C. 60
Correct Answer: C

The consumer surplus is the value of the good minus the price paid for it (10-4) = 6, summed over the quantity bought. The total consumer surplus is the consumer surplus on each mango that the consumer buys added together. It is the area of the right triangle = (base x height) / 2, with base equal to 20 mangoes a week and the height equal to 6, the consumer surplus on each mango. Thus, the total consumer surplus = (20 x 6) / 2 = INR 60.