Consumer and Producer Surplus PDF

Consumer and Producer Surplus
• What is consumer surplus? How is it related to

the demand curve?
• What is producer surplus? How is it related to
the supply curve?
• Do markets produce a desirable allocation of
resources? Or could the market outcome be
improved upon?
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Willingness to Pay (WTP)
A buyer’s willingness to pay for a good is the
maximum amount the buyer will pay for that good.
WTP measures how much the buyer values the good.
name WTP Example:

4 buyers’ WTP
Anthony $250
for an iPod
Chad 175
Flea 300
John 125
1
WTP and the Demand Curve
Q: If price of iPod is $200, who will buy an iPod, and
what is quantity demanded?
A: Anthony & Flea will buy an iPod,

Chad & John will not.
name WTP
Hence, Qd = 2
Anthony $250 when P = $200.
Chad 175
Flea 300
John 125
2
Derive the
P (price
demand who buys Qd
of iPod)
schedule:
$301 & up nobody 0
name WTP 251 – 300 Flea 1
Anthony $250 176 – 250 Anthony, Flea 2

Chad 175 Chad, Anthony,
126 – 175 3
Flea 300 Flea
John, Chad,
John 125 0 – 125 4
Anthony, Flea
3
P
$350
P Qd
$300
$250 $301 & up 0
$200 251 – 300 1

$150 176 – 250 2
$100
126 – 175 3
$50
0 – 125 4
$0 Q
0 1 2 3 4
4
About the Staircase Shape…
P This D curve looks like a staircase
$350 with 4 steps – one per buyer.
$300 If there were a huge # of buyers,
as in a competitive market,
$250
there would be a huge #
$200
of very tiny steps,
$150 and it would look
$100 more like a smooth
curve.
$50
$0 Q
0 1 2 3 4
5
P At any Q,
Flea’s WTP
$350 the height of
$300 Anthony’s WTP the D curve is
the WTP of the
$250 Chad’s WTP marginal buyer,
John’s
$200 the buyer who
WTP
$150 would leave the
market if P were
$100 any higher.
$50
$0 Q
0 1 2 3 4
6
Consumer Surplus (CS)
Consumer surplus is the amount a buyer is willing
to pay minus the amount the buyer actually pays:
CS = WTP – P
name WTP Suppose P = $260.
Anthony $250 Flea’s CS = $300 – 260 = $40.
Chad 175 The others get no CS because

they do not buy an iPod at this
Flea 300 price.
John 125 Total CS = $40.
7
CS and the Demand Curve
P
Flea’s WTP P = $260
$350
Flea’s CS =
$300 $300 – 260 = $40
$250 Total CS = $40
$200
$150
$100
$50
$0 Q
0 1 2 3 4
8
P
Flea’s WTP Instead, suppose
$350 P = $220
$300 Anthony’s WTP
Flea’s CS =
$250 $300 – 220 = $80
$200 Anthony’s CS =
$250 – 220 = $30
$150
Total CS = $110
$100
$50
$0 Q
0 1 2 3 4
9
P
$350 The lesson:
Total CS equals
$300
the area under
$250 the demand curve
$200 above the price,
from 0 to Q.
$150
$100
$50
$0 Q
0 1 2 3 4
10
CS with Lots of Buyers & a Smooth D Curve
At Q = 5(thousand),
Price The demand for shoes
P
the marginal buyer
per pair
$ 60
is willing to pay $50
for pair of shoes. 50
Suppose P = $30. 40
Then his consumer 30
surplus = $20. 1000s of pairs
20 of shoes
10
D
0 Q
0 5 10 15 20 25 30
11
CS with Lots of Buyers & a Smooth D Curve
CS is the area b/w The demand for shoes
P and the D curve, P
from 0 to Q. $ 60
Recall: area of 50
h
a triangle equals 40
½ x base x height
30
Height =
$60 – 30 = $30. 20
So, 10
D
CS = ½ x 15 x $30 0 Q
= $225. 0 5 10 15 20 25 30
12
How a Higher Price Reduces CS
If P rises to $40,
P
CS = ½ x 10 x $20 1. Fall in CS
60
= $100. due to buyers
50 leaving market
Two reasons for the
fall in CS. 40
30
2. Fall in CS due to 20
remaining buyers 10
paying higher P D
0 Q
0 5 10 15 20 25 30
13
ACTIVE LEARNING 1
Consumer surplus demand curve
P
50
A. Find marginal
buyer’s WTP at $ 45
Q = 10. 40
B. Find CS for 35
P = $30. 30
Suppose P falls to $20. 25
How much will CS 20
increase due to… 15
C. buyers entering 10
the market 5
D. existing buyers 0
paying lower price 0 5 10 15 20 Q
25
ACTIVE LEARNING 1
Answers demand curve
P
50
A. At Q = 10, marginal
$ 45
buyer’s WTP is $30.
40
B. CS = ½ x 10 x $10 35
= $50
30
P falls to $20. 25
C. CS for the 20
additional buyers 15
= ½ x 10 x $10 = $50 10
D. Increase in CS 5
on initial 10 units 0
= 10 x $10 = $100 0 5 10 15 20 Q
25
Cost and the Supply Curve
 Cost is the value of everything a seller must give
up to produce a good (i.e., opportunity cost).
 Includes cost of all resources used to produce
good, including value of the seller’s time.
 Example: Costs of 3 sellers in the lawn-cutting
business.
name cost A seller will produce and sell
the good/service only if the
Jack $10 price exceeds his or her cost.
Janet 20
Hence, cost is a measure of
Chrissy 35 willingness to sell.
16
P Qs
Derive the supply schedule
from the cost data: $0 – 9 0
10 – 19 1
20 – 34 2
name cost
35 & up 3
Jack $10
Janet 20
Chrissy 35
17
P
$40 P Qs
$0 – 9 0
$30
10 – 19 1
$20
20 – 34 2
$10 35 & up 3
$0 Q
0 1 2 3
18
P
At each Q,
$40 the height of
Chrissy’s
cost the S curve
$30 is the cost of the
Janet’s marginal seller,
$20 cost the seller who
would leave
$10 Jack’s cost the market if
the price were
$0 Q any lower.
0 1 2 3
19
Producer Surplus
P PS = P – cost
$40 Producer surplus (PS):
the amount a seller
$30 is paid for a good
minus the seller’s cost
$20
$10
$0 Q
0 1 2 3
20
Producer Surplus and the S Curve
P PS = P – cost
$40 Suppose P = $25.
Chrissy’s
cost Jack’s PS = $15
$30
Janet’s Janet’s PS = $5
$20 cost Chrissy’s PS = $0
$10 Jack’s cost Total PS = $20
Total PS equals the

$0 Q area above the supply
0 1 2 3 curve under the price,
from 0 to Q.
21
PS with Lots of Sellers & a Smooth S Curve
Suppose P = $40.
Price The supply of shoes
P
per pair
At Q = 15(thousand), 60
the marginal seller’s
50 S
cost is $30,
and her producer 40
surplus is $10. 30
1000s of pairs
20 of shoes
10
0 Q
0 5 10 15 20 25 30
22
PS with Lots of Sellers & a Smooth S Curve
PS is the area b/w The supply of shoes
P
P and the S curve,
from 0 to Q. 60
50 S
The height of this
triangle is 40
$40 – 15 = $25.
30
So, h
20
PS = ½ x b x h
= ½ x 25 x $25 10
= $312.50 0 Q
0 5 10 15 20 25 30
23
How a Lower Price Reduces PS
If P falls to $30, P 1. Fall in PS
PS = ½ x 15 x $15 60 due to sellers
= $112.50 50
leaving market S
Two reasons for 40
the fall in PS.
30
2. Fall in PS due to 20
remaining sellers 10
getting lower P
0 Q
0 5 10 15 20 25 30
24
ACTIVE LEARNING 2
Producer surplus supply curve
P
50
A. Find marginal
45
seller’s cost
at Q = 10. 40
35
B. Find total PS for
P = $20. 30
25
Suppose P rises to $30.
Find the increase 20
in PS due to: 15
C. selling 5 10
additional units 5
D. getting a higher price 0
on the initial 10 units 0 5 10 15 20 Q
25
ACTIVE LEARNING 2
Answers supply curve
P
50
A. At Q = 10, 45
marginal cost = $20
40
B. PS = ½ x 10 x $20 35
= $100 30
P rises to $30. 25
C. PS on 20
additional units 15
= ½ x 5 x $10 = $25 10
D. Increase in PS 5
on initial 10 units 0
= 10 x $10 = $100 0 5 10 15 20 Q
25
CS, PS, and Total Surplus
CS = (value to buyers) – (amount paid by buyers)
= buyers’ gains from participating in the market
PS = (amount received by sellers) – (cost to sellers)

= sellers’ gains from participating in the market
Total surplus = CS + PS
= total gains from trade in a market
= (value to buyers) – (cost to sellers)
27

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Consumer and Producer Surplus

• What is consumer surplus? How is it related to

name WTP Example:

A: Anthony & Flea will buy an iPod,

name WTP 251 – 300 Flea 1

Anthony $250 176 – 250 Anthony, Flea 2

$200 251 – 300 1

name WTP Suppose P = $260.

Anthony $250 Flea’s CS = $300 – 260 = $40.

Chad 175 The others get no CS because

$10 Jack’s cost Total PS = $20

Total PS equals the

PS = (amount received by sellers) – (cost to sellers)

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