Consumer surplus and producer surplus

Definition of Consumer Surplus

• This is the difference between what the consumer pays and what he would have been willing to pay.
• For example: If you would be willing to pay £50 for a ticket to see the F. A. Cup final, but you can buy a ticket for £40. In this case, your consumer surplus is £10.

Definition of producer surplus

• This is the difference between the price a firm receives and the price it would be willing to sell it at.
• If a firm would sell a good at £4, but the market price is £7, the producer surplus is £3.

Diagram of Consumer Surplus

How elasticity of demand affects consumer surplus

If demand is price inelastic, then there is a bigger gap between the price consumers are willing to pay and the price they actually pay.

The demand curve shows the maximum price that a consumer would have paid. Consumer surplus is the area between the demand curve and the market price.

If the demand curve is inelastic, consumer surplus is likely to be greater

• Monopolies are able to reduce consumer surplus by setting higher prices
• Price Discrimination is an attempt to extract consumer surplus by setting.

Consumer surplus and marginal utility theory

The demand curve illustrates the marginal utility a consumer gets from consuming a product. At quantity 500 litres, the marginal utility is £0.80 – which indicates the marginal utility is 80p. However, with a price of 50p, the consumer surplus is the difference.

Producer Surplus

• This is the difference between the price a firm receives and the price it would be willing to sell it at.
• Therefore it is the difference between the supply curve and the market price

How free trade affects consumer and producer surplus

Free trade means a reduction in tariffs. It leads to lower prices for consumers and an increase in consumer surplus

• If tariffs are cut, then we can import at S Eu (P1) – a lower price than P2.
• Imports increase from (Q3-Q2) to (Q4-Q1)
• However, domestic producers see a decline in producer surplus.
• WIth tariffs, we used to buy Q2 from domestic producers. But, now we only buy Q1 at price P1.
• So area 1 represents the decline in producer surplus.

Related

• Definition of Consumer Surplus