Consumer & Producer Surplus (DP IB Economics)

Consumer & Producer Surplus

• Consumer surplus is the difference between the amount the consumer is willing to pay for a product and the price they have actually paid

  • E.g. If a consumer is willing to pay £18 to watch a movie and the price is £15, their consumer surplus is £3
    

• Producer surplus is the difference between the amount that the producer is willing to sell a product for and the price they actually do

  • E.g. if a producer is willing to sell a laptop for £450 and the price is £595, their producer surplus is £145

A market diagram illustrating consumer and producer surplus

Diagram Analysis

• The area between the equilibrium price and the demand curve represents the consumer surplus in the market (ABP_e)

  • The consumer surplus lies underneath the demand curve

• The area between the equilibrium price and the supply curve represents the producer surplus in the market (CBP_e)

  • Producer surplus lies above the supply curve

• When the market is at equilibrium the producer and consumer surplus are maximised

• Consumer surplus + producer surplus = social/community surplus

  • Any disequilibrium reduces the social surplus

How Market Changes Affect Producer & Consumer Surplus

• Any change to a non-price determinant of supply or demand will cause a shift in the relevant curve

• This shift will change the consumer and producer surplus in the market

1. An increase in supply

A non-price determinant of supply has changed and the diagram on the left shows the resulting change to consumer surplus while the diagram on the right shows the change to producer surplus

 
Diagram Analysis

• Prior to the change in supply

  • Consumer surplus was equivalent to ACE and producer surplus was equivalent to ACF

  • Social surplus was equivalent to ECF

• After the change, supply increased from S₁→S₂

  • Consumer surplus is now equivalent to BED and producer surplus is equivalent to BDG

  • Social surplus is equivalent to DEG

• Both the consumer surplus and producer surplus have increased as a result of the increased supply in the market

2. An increase in demand

A non-price determinant of demand has changed and the diagram on the left shows the resulting change to producer surplus while the diagram on the right shows the change to consumer surplus

 
Diagram Analysis

• Prior to the change in demand

  • Producer surplus was equivalent to ACE and consumer surplus was equivalent to ACF

  • Social surplus was equivalent to ECF

• After the change, demand increased from D₁→D₂

  • Producer surplus is now equivalent to BED and consumer surplus is now equivalent to BDG

  • Social surplus is equivalent to DEG

• Both the producer surplus and consumer surplus have increased as a result of the increased demand in the market

Calculating Consumer & Producer Surplus from a Diagram

• Producer and consumer surplus can be calculated from a diagram using a standard formula for calculating the area of a triangle

• The following steps should be applied to each calculation

  • Identify the current equilibrium price

  • Draw a horizontal line from it to the Y axis

  • Ensure that both the demand and supply curves pass through the Y axis so as to complete the two surplus triangles

  • Using the formula, calculate the producer surplus from the triangle which lies below the equilibrium price (area above the supply curve)

  • Using the formula, calculate the consumer surplus from the triangle which lies above the equilibrium price (area beneath the demand curve)
    

• It is also possible to calculate a change to consumer or producer surplus following a specific event

  • In the diagram below, assume that rice farmers in Vietnam start using a new genetically modified seed which increases yields (output)

Calculating producer or consumer surplus from a diagram after the introduction of new technology increases output
  

Diagram Analysis

1. Consumer surplus in diagram on the left

• The initial equilibrium is found at point C

• The line AC separates the original consumer surplus from the producer surplus

• Consumer surplus before the new seed = ACE

• The application of the seed technology shifts the supply curve to the right, resulting in a new equilibrium at point D

•  The line BD separates the new consumer surplus from the new producer surplus

• Consumer surplus after the new seed = BDE

2. Producer surplus in diagram on the right

• Follow the same process as above

• Producer surplus before the new seed = ACF

• The application of the seed technology shifts the supply curve to the right, resulting in a new equilibrium at point D

•  The line BD separates the new consumer surplus from the new producer surplus

• Producer surplus after the new seed = BDG

Allocative Efficiency

• Efficiency is a key concept in economics

• Economists generally identify two types of efficiency - productive efficiency and allocative efficiency
   

An Explanation of Productive and Allocative Efficiency

• Using the ideas of marginal utility (marginal benefit) and marginal cost, we can label the community surplus diagram slightly differently so as to reflect the benefits received by producers and consumers
   

A diagram that reflects the maximisation of community surplus (allocative efficiency) when the marginal benefit equals the marginal cost

Diagram Analysis

• The demand curve represents the marginal benefit (MB) to the consumer

• The supply curve represents the marginal cost (MC) to the producer

• The market is in equilibrium at P_eQ_e

• Any change to the allocation of resources in this market will make either the consumer or producer worse off (excess demand or excess supply would occur)

• This market is allocatively efficient when MB=MC

• Community surplus is maximised at the point of allocative efficiency