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

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

effect-of-cutting-tariffs-on-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.

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3 thoughts on “Consumer surplus and producer surplus

  1. Please help me with this question :
    The uk government are attempting to increase consumer and producer supply
    Para 1 supply + demand curve
    Para 2 fiscal / monetry policy
    Para 3 Positive / negative of increased demand
    Para 3 negative increase supply
    Thank you

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