Consumer and Producer Surplus
Consumer surplus is the difference between what consumers are willing to pay for a good or service and what they actually pay. It represents the benefit consumers receive from purchasing a product at a price lower than their maximum willingness to pay. Producer surplus, on the other hand, is the difference between the price producers are willing to accept for a good or service and the price they actually receive.
7 Key excerpts on "Consumer and Producer Surplus"
eBook - ePubMicroeconomics
A Global Text
- Judy Whitehead(Author)
- 2014(Publication Date)
- Routledge(Publisher)
...The surplus was measured in monetary units and defined as: ‘the difference between the amount of money that a consumer actually pays to buy a certain quantity of a commodity x, and what he would be willing to pay for this quantity rather than do without it’. The concept of the producer surplus may also be introduced. It may be defined loosely as the difference between what a producer actually receives for the sale of goods and what the producer would have been willing to receive rather than go without selling. The basic concepts of consumer surplus and producer surplus are illustrated graphically in Figure 4.1. Graphically, at price P 1 the consumer buys quantity Q 3. However, the consumer would have been willing to pay P 2 to acquire quantity Q 2 and P 3 to acquire Q 1. This shows that when market price is in equilibrium at P 1, the customer buys Q 3 but would have been willing to pay higher prices for the earlier units of the commodity. This implies that the consumer has gained from acquiring those earlier units at a price below what he/she was willing to pay for them. This difference is the consumer’s surplus represented by the darker shaded area. The consumer surplus may therefore be recognized as the area above the equilibrium price line and below the demand curve. Figure 4.1 Consumer and Producer Surplus On the other hand, the producer surplus is recognized as the area below the equilibrium price and above the supply curve. The producer was willing to supply smaller quantities of the commodity x at lower prices than P 1 as shown by the market supply curve LT. Every unit sold at the equilibrium price P 1 that the producer would have been willing to sell at a lower price, benefits the producer...
eBook - ePubPricing on Purpose
Creating and Capturing Value
- Ronald J. Baker(Author)
- 2010(Publication Date)
- Wiley(Publisher)
...While the consumer surplus is the gain the buyer receives from trade, the producer surplus is sometimes referred to as economic rent —the amount received by sellers of an item over and above what they would have accepted. Michael Jordan and Tiger Woods receive an enormous amount of economic rent above what would be needed to induce them to play their favorite sport. There is also a consumer detriment, representing the customers who are willing to pay more than cost but less than the market price. While consumer surplus makes customers happy, it is economic rent that makes companies—and individuals—rich. In fact, because of this fact, some economists believe Marshall should have called his scissors “sales curves” and “bid curves” rather than supply and demand curves, since what they are really depicting is the highest price an individual would be willing to pay, or the lowest a seller would accept, for a given amount of product. If a business can identify those customers willing and able to pay more, it can capture a portion of this consumer surplus. It is there for any company with a downward sloping demand curve, which is present even for the most elastic demand curves. What if the bookstore owner had known me, and my quest to find the rare Stanley Marcus book? Perhaps with the sophisticated customer relationship management (CRM) software of today he could track the desires of his customers and this would certainly assist him in pricing to capture a larger share of the consumer surplus. Yet, identifying these particular customers is only part of the puzzle, however, since then you have to charge different prices to different customers, and this presents some challenges, although not insurmountable. Charging different prices to different customers is the definition of price discrimination, a term coined in 1920 by Arthur Cecil Pigou in The Economics of Welfare...
eBook - ePub- Bonnie Nguyen, Andrew Wait(Authors)
- 2015(Publication Date)
- Routledge(Publisher)
...The area B represents the increase in consumer surplus that arises from an increase in the net benefit of previously consumed units. The area C represents the increase in consumer surplus arising from the consumption of additional units 9.4.2 Producer surplus On the other side of the market, producer surplus (PS) is the welfare producers (that is, firms) receive from selling units of a good or service in the market. Producer surplus can be measured by considering the net benefit of selling a good or service. That is, producer surplus is given by the price the producer receives, minus the cost of production, for each unit of the good or service bought. Now suppose that Adam is a producer of chocolate bars. As before, the price of chocolate bars is $2, but the marginal cost to Adam of producing the chocolate bar is $0.50. Therefore, if Adam sells the chocolate bar, his net benefit is the $2 received, minus $0.50 in production costs. Therefore, his surplus from selling the chocolate bar is $1.50. However, producer surplus in the market takes into account every unit of the good or service sold. Therefore, if Adam sells multiple chocolate bars, we would need to add up the surplus from each chocolate bar in order to get her total producer surplus. Remembering that a firm’s supply curve is given by its MC curve, a firm’s PS can be found by calculating the area between the price line and the firm’s supply curve. Similarly, we can find the PS of all producers in the market by calculating the area between the price line and the market supply curve. These areas are shown in Figure 9.8. Figure 9.8 The area of producer surplus in this market is denoted by the shaded area Let us again consider what happens when there is a change in price...
eBook - ePubCost-Benefit Analysis
Financial And Economic Appraisal Using Spreadsheets
- Harry F. Campbell, Richard P.C. Brown(Authors)
- 2015(Publication Date)
- Routledge(Publisher)
...For example, suppose that the price of a good or service falls, as in the case of the rental price of unfavourably located apartments in the bridge example discussed above. Buyers of the service (renters) are better off, but suppliers (landlords) are worse off to the same extent. The gain to buyers and the loss to sellers are termed pecuniary effects and they have the characteristic that they net out in an Efficiency Analysis. Because pecuniary effects measure changes in entitlement to an existing flow of goods and services, they are referred to as transfers – they transfer a portion of existing benefits or costs from one group to another. While they are not relevant in the aggregate Efficiency Analysis, they may, as we saw in Chapter 6, need to be accounted for in the Referent Group Analysis which is concerned with the benefits and costs of the project to a subset of agents in the world economy. 7.3 Consumer surplus A surplus is generated when a consumer is able to buy a unit of a good at a price lower than her willingness to pay for that unit, or when a producer is able to sell a unit of a good or factor of production at a price higher than that at which he would willingly part with that unit. The concept of consumer surplus can be explained by means of Figure 7.1, which illustrates an individual consumer’s demand for a recreational service measured by number of trips per annum: according to the diagram, the consumer is willing to pay OE dollars for the first visit she makes, and lower amounts, as measured by the demand curve, for subsequent visits until she is just willing to pay the current price, P 0, and no more, for the last visit she makes. The reason the consumer is not willing to purchase more than Q 0 units (visits) at that price is that additional units are worth less to her, as measured by the height of her demand curve, than the current price, P 0...
eBook - ePub- Lynne Lewis, Thomas Tietenberg(Authors)
- 2019(Publication Date)
- Routledge(Publisher)
...Producer surplus = $800. Consumer surplus plus producer surplus = $1,600 = economic surplus. c The marginal revenue curve has twice the slope of the demand curve, so MR = 80 – 2 q. Setting MR = MC, yields q = 80/3 and P = 160/3. Using Figure 2.8, producer surplus is the area under the price line (FE) and over the marginal-cost line (DH). This can be computed as the sum of a rectangle (formed by FED and a horizontal line drawn from D to the vertical axis) and a triangle (formed by DH and the point created by the intersection of the horizontal line drawn from D with the vertical axis). The area of any rectangle is base ´ height. The base = 80/3 and the Height = P − M C = 160 3 − 80 3 = 80 3. Therefore, the area of the rectangle is 6400/9. The area of the right triangle is 1 2 × 80 3 × 80 3 = 3, 200 9. Producer surplus = 3, 200 9 + 6, 400 9 = $ 9, 600 9 Consumer surplus = 1 2 × 80 3 × 80 3 = $ 3, 200 9 $ 9, 600 9 > $ 800 $ 3, 200 9 < $ 800 $ 12, 800 9 < $ 1, 600 The policy would not be consistent with efficiency. As the firm considers measures to reduce the magnitude of any spill, it would compare the marginal costs of those measures with the expected marginal reduction in its liability from reducing the magnitude of the spill. Yet the expected marginal reduction in liability from a smaller spill would be zero. Firms would pay $X regardless of the size of the spill. Since the amount paid cannot be reduced by controlling the size of the spill, the incentive to take precautions that reduce the size of the spill will be inefficiently low. If “better” means efficient, this common belief is not necessarily true. Damage awards are efficient when they equal the damage caused. Ensuring that the award reflects the actual damage will appropriately internalize the external cost. Larger damage awards are more efficient only to the extent that they more closely approximate the actual damage...
eBook - ePubEconomic Efficiency and Social Welfare (Routledge Revivals)
Selected Essays on Fundamental Aspects of the Economic Theory of Social Welfare
- E. Mishan(Author)
- 2013(Publication Date)
- Routledge(Publisher)
...The division of the welfare gain from free trade into gains (or losses) of consumer’s surpluses offset by losses (or gains) of producer’s surpluses is, therefore, quite arbitrary. Indeed, if producer’s surplus is defined as to be coterminous with pure profit 16 then it is in any case zero for all (long period) equilibrium positions, whether in autarky or free trade, for a perfectly competitive economy. 17 It appears then that the attempt to separate a consumer’s surplus from a producer’s surplus in the construction of Figure (a), or from its derived construction Figure (b), is arbitrary and erroneous. It must be recognized that we have constructed two Pareto-comparable community indifference curves, I 0 I 0 and I 1 I 1 in Figure (a), passing through the consumption batches in the autarkic and free trade situations respectively. And the welfare gain is no more than the difference between them measured here as a single compensating variation at the new international price ratio - as SV along the x -axis or as S’V’ along the y -axis. 18 Either can be interpreted as an exact measure of the gains for the community as a whole, or for a single person, in moving from the consumption possibilities presented by TT’ to the new consumption possibilities presented by VV’. Notes: Chapter 8 I wish to record my indebtedness to D. M. Winch for many valuable comments on a first draft of this paper. 1 With commendable analytic finesse Marshall separates the rising supply curve resulting from differential advantages as between firms, ‘the particular expenses curve’, from the possible external economies which may predominate and act, therefore, to lower the unit cost as the total output of industry is increased. The contribution of external economies are taken as fixed at the equilibrium output, OH, of his figure 39 [11, p. 811]. This procedure is correct inasmuch as the area measures what the total number of firms take to be their rents or producer’s surpluses...
eBook - ePub- Enrico Colombatto(Author)
- 2016(Publication Date)
- Routledge(Publisher)
...In our example, it is the triangle MNP 2. It is easy to observe that the higher is the price of X, the smaller the quantity purchased and the consumer's surplus (and vice versa). Of course, the ideal situation for the consumer is one in which P equals zero. When P=0, his surplus is maximised. This graph helps us appreciate some misconceptions. We shall briefly look at two of them: the mistaken belief that GDP (gross domestic product) is a measure of happiness, and the consequences of price regulation. To begin with, it should by now be apparent that the notion of surplus/welfare differs from the market value of production – say P·X (or GDP, once the market values of all goods and services produced in an economy are added). This claim follows from three observations. First, the value of production is actually the value of consumption, or the subjective value that individuals attribute to the goods and services they consume. For example, one might produce an expensive piece of furniture, which can however be considered worthless by the prospective buyers, perhaps simply because it is ugly. In this case, the value of that piece of furniture is zero, no matter what the price tag says. Second, the value of consumption is always greater than the price at which it is exchanged (its market value), since the satisfaction one obtains from a good/service is always greater than the price one pays for it (except for the marginal unit). Third, welfare (satisfaction) does not amount to the benefits generated by consumption, but to the net benefits, i.e. the satisfaction one enjoys after having deducted the opportunity costs. The upshot is that traditional accounting practices referring to GDP are actually measuring the rectangle P 2 NX 2 O in Figure 2.6, rather than the triangle MNP 2...
