Consumer and Producer Surplus

11 Key excerpts on "Consumer and Producer Surplus"

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  eBook - ePub

  Microeconomic Foundations I

  Choice and Competitive Markets

  • David M. Kreps(Author)
  • 2012(Publication Date)
  • Princeton University Press

    (Publisher)

  Chapter Twelve

  Producer and Consumer Surplus

  Most courses in microeconomics at some point engage in policy evaluation: What happens if the government taxes or subsidizes the sale of some good? What happens if a price ceiling or a price floor is established? What if imports into a particular domestic market are capped at some level?

  The discussion of “what happens?” can begin and end with an analysis of changes in prices and quantities. But when it comes to evaluation, one typically seeks dollar-denominated measures of the impact such policies have on firms inside the industry and on consumers of the specific product. The concepts of producer and consumer surplus appear at this point; the former is advanced as a dollar-denominated measure of the impact the policy has on producers; the latter is asserted to be a dollar-denominated measure of its impact on consumers. These concepts are defined graphically, by pictures such as Figures 12.1a and b . In this chapter, we explore the foundations of these two concepts.

  Figure 12.1. Producer and consumer surplus. Intermediate-level textbooks in microeconomics often have the pictures shown here, accompanied by text such as “The shaded region in panel a is producer surplus, a dollar-denominated measure of the value producers obtain from this market. The shaded region in panel b is consumer surplus, a dollar-denominated measure of the value obtained by consumers.” The objective of this chapter is to make these notions as precise as we can.

  12.1.   Producer Surplus

  Producer surplus has a relatively simple story, although one with a hidden trap. The story concerns the market for a particular good supplied by a number F of firms. We assume that the firms are all competitive, engaged in profit maximization in the sense and style of Chapter 9 ; Zf will denote the production-possibility set of firm f. We let p ∈ be the vector of all prices, and we will suppose that coordinate indices have been chosen so that i

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  Intermediate Microeconomics

  • John H Hoag(Author)
  • 2012(Publication Date)
  • WSPC

    (Publisher)

  P* – P2. If we continue up to the equilibrium output, we obtain a surplus.

  Definition 7.5:  Producer surplus is the price the producer receives for the good minus the value the firm places on the good for all units sold.

  You can predict that the producer surplus is the area above the supply and below the price line. This is shown in Figure 7.4 .

  Figure 7.4  The producer surplus is the area above the supply and below the market price, as shown in the shaded area.

  Exercise 4.  Suppose that we have a market and the firm is forced to produce more than X* at the price P*. What will the producer surplus be then?

  Exercise 5.  Suppose that we have a market and the producer produces X*, but receives a price higher than P*. What will the producer surplus be then?

  As is true in the case of the consumer, there are externalities to consider. The cost to the firm is not necessarily the cost to society of that extra unit. What if there is an externality in production? Suppose that a steel mill produces both steel and air pollution. Now the cost to society of a ton of steel is both the cost of the resources needed to produce the steel as well as the cost to society of the air pollution, the increased cost of health care and the like. Obviously, we need a concept of marginal social cost.

  Definition 7.6:  Marginal social cost (MSC) is the cost to society of producing an added unit of output.

  Section Summary:

  In this section, we have developed the ideas of Consumer and Producer Surplus as well as the idea that price is a measure of the value of a good to the consumer and that marginal cost measures the value of the resources that go into the production of the good. Based on these definitions, we will develop a criterion for how resources should be allocated. That is the next task.

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  Economics For Dummies

  Book + Chapter Quizzes Online

  • Sean Masaki Flynn(Author)
  • 2023(Publication Date)
  • For Dummies

    (Publisher)

  less than the $5 per gallon market price. You can see this by the fact that the supply curve lies below the horizontal price line up to the very last drop of the 1,000th gallon. The fact that they receive $5 per gallon for all of it despite being willing to produce it for less is the source of the producer surplus, which is represented by the area of the shaded triangle.

  Using the formula for the area of a triangle ( ), you can compute that the producer surplus in this example is $2,000. Producers are $2,000 better off after selling the 1,000 gallons of oil because the total cash they get from selling the 1,000 gallons is $2,000 greater than the minimum amount that they’d have been willing to accept to produce those units.

  Computing total surplus

  The total surplus that society receives from producing the socially optimal level of output of a certain good or service is simply the sum of the consumer surplus and producer surplus generated by that output level.

  Figure 7-6 illustrates total surplus for a market in which the equilibrium price and quantity are, respectively, and . (If this graph looks familiar, that’s because it’s just like Figure 7-1 .)

  © John Wiley & Sons, Inc.

  FIGURE 7-6: Total surplus is the sum of consumer surplus and producer surplus.

  I’ve drawn the total surplus area so you can clearly see that it’s made up of consumer surplus (the vertically striped area) plus producer surplus (the diagonally striped area). The two are separated by the horizontal line extending from the market equilibrium price ($5).

  By again using the formula for the area of a triangle, you multiply to figure out that for this graph the total surplus is $16. The total gain to society of producing at this output level is $16.

  Contemplating total surplus

  Total surplus is important because it puts a number on the gains that come from production and trade. Firms make things to generate a profit. People spend money on products because consuming those products makes them happy. And total surplus tells you just how much better off both consumers and producers are after interacting with each other.

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  Economics of Tourism and Hospitality

  A Micro Approach

  • Yong Chen(Author)
  • 2021(Publication Date)
  • Routledge

    (Publisher)

  Aggregating the producer surplus of all firms in the market we obtain total producer surplus, denoted by the area beneath the equilibrium price P 0 and above the supply curve S bounded also by zero and the equilibrium quantity Q 0 (Figure 2.4). Different from consumer surplus, producer surplus is the economic profit that firms obtain by selling at a price higher than their marginal costs. Figure 2.4 Consumer surplus, producer surplus, and social surplus The sum of consumer surplus and producer surplus is social surplus, which is the total welfare obtained by both consumers and firms as a whole in the market. Social surplus is denoted by the area between the demand curve and the supply curve bounded by zero and the equilibrium quantity (Figure 2.4). Social surplus can be seen as the economic pie produced both by consumers and firms in voluntary transactions with each other in the free market. In market equilibrium the economic pie is the largest because any single consumer or firm who is willing and able to trade with each other can fulfil their transaction precisely at equilibrium price. On the one hand, market equilibrium is the outcome from voluntary transactions between consumers and firms in the free market based on their willingness to pay and sell. On the other hand, equilibrium price reflects that the last voluntary transaction is fulfilled in the market when a consumer’s willingness to pay is equal to a firm’s willingness to sell. Therefore, equilibrium quantity is the largest amount of transactions that the free market can accomplish. Hence only in market equilibrium can social surplus be maximized. 2.3.2   Price controls and deadweight loss Given the demand and supply curves in Figure 2.4, consumer surplus and producer surplus that are determined in market equilibrium cannot be changed without changing price. In other words, if the market price deviates from equilibrium price, consumer surplus, producer surplus, and social surplus will be affected

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  Environmental Economics and Policy

  • 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

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  Economics for Investment Decision Makers

  Micro, Macro, and International Economics

  • Christopher D. Piros, Jerald E. Pinto(Authors)
  • 2013(Publication Date)
  • Wiley

    (Publisher)

  Exhibit 1-15 , the gain in value experienced by Warren is depicted by the crosshatched trapezoid. Note that the increase in Warren’s value is necessarily less than the loss in Smith’s. Recall that consumer surplus is value minus expenditure. Total consumer surplus is reduced when individuals consume quantities that do not yield equal marginal value to each one. Conversely, when all consumers face the identical price, they will purchase quantities that equate their marginal values across all consumers. Importantly, that behavior maximizes total consumer surplus.

  A precisely analogous argument can be made to show that when all producers produce quantities such that their marginal costs are equated across all firms, total producer surplus is maximized. The result of this analysis is that when all consumers face the same market equilibrium price and are allowed to buy all they desire at that price, and when all firms face that same price and are allowed to sell as much as they want at that price, the total of Consumer and Producer Surplus (total surplus) is maximized from that market. This result is the beauty of free markets: They maximize society’s net benefit from production and consumption of goods and services.

  3.13. Market Interference: The Negative Impact on Total Surplus

  Sometimes, lawmakers determine that the market price is too high for consumers to pay, so they use their power to impose a ceiling on price below the market equilibrium price. Some examples of ceilings include rent controls (limits on increases in the rent paid for apartments), limits on the prices of medicines, and laws against price gouging after a hurricane (i.e., charging opportunistically high prices for goods such as bottled water or plywood). Certainly, price limits benefit anyone who had been paying the old higher price and can still buy all they want but at the lower ceiling price. However, the story is more complicated than that. Exhibit 1-16 shows a market in which a ceiling price,

  Pc

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  Political Econ of Growth

  • Paul A. Baran(Author)
  • 2019(Publication Date)
  • Monthly Review Press

    (Publisher)

  TWO

  The Concept of the Economic Surplus

  THE concept of economic surplus is undoubtedly somewhat tricky, and in clarifying and employing it for the understanding of the process of economic development neither simple definitions nor refined measurements can be substituted for analytical effort and rational judgment. Yet it would certainly seem desirable to break with the time-honored tradition of academic economics of sacrificing the relevance of subject matter to the elegance of analytical method; it is better to deal imperfectly with what is important than to attain virtuoso skill in the treatment of what does not matter.

  In order to facilitate the discussion as much as possible, I shall be speaking now in terms of “comparative statics”: that is, I shall ignore the paths of transition from one economic situation to another, and shall consider these situations, as it were, ex post. Proceeding in this way, we can distinguish three variants of the concept of economic surplus.

  Actual economic surplus, i.e. the difference between society’s actual current output and its actual current consumption.1 It is thus identical with current saving or accumulation, and finds its embodiment in assets of various kinds added to society’s wealth during the period in question: productive facilities and equipment, inventories, foreign balances, and gold hoards. It would seem to be merely a matter of definition whether durable consumer goods (residential dwellings, automobiles, etc.) should be treated as representing saving rather than consumption, and it is undoubtedly quite arbitrary to treat houses as investment while treating, say, grand pianos as consumption. If the length of useful life be the criterion, where should one place the benchmark? In actual fact, it is essential for the comprehension of the economic process to make the distinction not on the basis of the physical properties of the assets involved, but in the light of their economic function, i.e. depending on whether they enter consumption as “final goods” or serve as means of production contributing thus to an increase of output in the subsequent period. Hence an automobile purchased for pleasure is an object of consumption, while an identical car added to a taxi-fleet is an investment good.2

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  Introduction to Political Economy (Routledge Revivals)

  • E. Mishan(Author)
  • 2013(Publication Date)
  • Routledge

    (Publisher)

  market demand curves only. It is practically impossible to estimate demand curves, and therefore the relevant consumer surpluses, of single individuals.

  Fortunately, it is the consumer surplus for the market, for society in effect, that the normative economist is trying to capture. Therefore estimates of the market demand curves for particular goods will admirably serve his purpose – which is not to say that there are not statistical difficulties in estimating many such demand curves owing to the paucity of data.

  After this somewhat leisurely exposition, we can begin to romp along at a brisker pace. Figure 8 shows a market demand curve DD in which the price has fallen from P2 , say $10 per unit x, at which price the amount OQ2 was bought, to Pl , say $8 per unit, at which price the amount OQ1 is bought. A fall in the price of x by $2 implies an increase in the welfare of buyers of x; at least, it does so if no other goods prices rise, which we may assume in a partial context. The measure of the gain in social welfare from this fall in price is the consumer surplus as measured by the shaded area between the two horizontal price-lines from P2 and P1 respectively.

  If this is not evident at first, look at it thus: if the price P2 were first established where previously the good x had been unobtainable, the improvement would have been measured as a consumer surplus equal to the triangular area DP2 E. If, instead, the lower price P1 had first been established, the improvement would have been a larger consumer surplus, one equal to the larger triangular area DP1 G. It follows that the difference to consumers of x from having the lower market price P1 rather than P2 is the difference between the two triangular areas, a difference that is measured by the shaded horizontal strip P2 P1 GE. This latter area then is the consumer surplus for a fall in price from P2 to P1 .

  Figure 8

  Perhaps you would like to look at it another way, more intuitively obvious to some. The rectangular part of the shaded area P2 P1 FE is the price difference on the original amount of x, OQ2 , bought when the price was P2 . Were consumers restricted to buying this same amount OQ2 of x (even though the price had fallen to P1 ) they would have saved just that much money. For this shaded rectangle P2 P1 FE is equal to the price difference (P2 – P1 ) times OQ2 of x. Thus this area measures the most consumers would pay for this fall in price provided they were allowed to buy no more than OQ2 , this being the amount of x they bought at the old price P2

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  Cost-Benefit Analysis

  Financial and Economic Appraisal Using Spreadsheets

  • Harry F. Campbell, Richard P.C. Brown(Authors)
  • 2022(Publication Date)
  • Routledge

    (Publisher)

  with-and-without comparison conducted in the Efficiency Analysis. In both cases a positive value indicates a more productive use of inputs.

  We now turn to Consumer and Producer Surplus changes associated with the quantity of the output or input traded in the world without the project. As noted above, a fall in output price will benefit the consumers of the original quantity of the good traded, but it will also be to the detriment of the firms supplying the good. Similarly, a rise in input price, such as an increase in the wage, will benefit the suppliers of the original quantity of the input, but will similarly be to the detriment of the firms employing the input and may result in consumers paying higher prices for output These effects are pecuniary effects, as discussed in Section 7.2, and they net out of the Efficiency Analysis. If they are included in the Referent Group Analysis, it is likely to be in the category described by Area C in Table 6.1 (net Referent Group benefits not measured by market prices), given the localised nature of the project’s effects as discussed above. Whether they are relevant to the decision about the project is a matter for the decision-maker, who may not be interested in changes in the distribution of surplus among consumers, labour and firms, especially given that most households represent more than one of these categories of economic agents, but if they are included, and these agents are all members of the Referent Group, they are entered twice in the Referent Group Analysis, once as a benefit and once as a cost, so that they cancel out in the measure of overall project effects, thereby preserving the adding-up property of the cost-benefit model.

  Suppose now that the output of a project, such as an improvement to a public road leading to a national park, is not marketed. As we saw from Figure 7.1 , the project benefit takes the form of an increase in consumer surplus accruing to users of the park. As in the case of changes in Consumer and Producer Surplus induced by changes in market prices and associated with project output or inputs, this form of net benefit is not measured by the Market Analysis. In the case of improved access to the national park, the change in surplus is included in area C or D in Table 6.1 , depending on whether or not the consumers are members of the Referent Group. In contrast to the case of a marketed output, surplus accruing to consumers of the without quantity of the service (Area P0 ABP1 in Figure 7.1

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  The Limits to Capital

  • David Harvey(Author)
  • 2018(Publication Date)
  • Verso

    (Publisher)

  CHAPTER 3

  Production and Consumption,Demand and Supply and theRealization of Surplus Value

  The notion that there must be some sort of balance or equilibrium between production and consumption, between demand and supply appears innocuous enough. The primary role of the market in a general system of commodity exchange appears to be to equilibrate demand and supply and thereby achieve the necessary relation between production and consumption. Yet the whole relation between demand and supply, between production and consumption, has been the focus of an immense and occasionally awesome battle in the history of political economy. The intensity of the debate is understandable, since the stakes are high. Not only do we here confront, head-on, the interpretation of business cycles and the short- or long-run stability of capitalism, but we enter into the heart of the controversy over the ultimate viability of the capitalist mode of production itself.

  In Marx’s time the central point of controversy was over the proposition that supply necessarily created its own demand. There was a variety of nuanced versions of Say’s Law, as it is usually called.1 The simplest states that the incomes paid to the suppliers of factors of production (land, labour and capital) in the form of wages, profits and rents must equal the total price of the goods produced with these factors. This means that ‘the income generated during the production of a given output is equal to the value of that output’, and that any increase in the ‘supply of output means an increase in the income necessary to create a demand for that output’ with the general consequence that ‘supply creates its own demand’. A corollary of the law is that there can be no general overproduction or ‘general glut’ and that crises are the result either of ‘exogenous shocks’ (wars, revolutions, widespread harvest failures, etc.) or of temporary disproportionalities in production. There could be overproduction within an industry or geographical region, but this meant underproduction somewhere else. Transfers of capital and labour could equilibrate the system. What Say’s Law precluded was a general

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  Microeconomics in Context

  • Neva Goodwin, Jonathan M. Harris, Julie A. Nelson, Pratistha Joshi Rajkarnikar, Brian Roach, Mariano Torras(Authors)
  • 2022(Publication Date)
  • Routledge

    (Publisher)

  The difference between these two curves at any point represents the gap between the maximum WTP of consumers and the production costs of suppliers. Some of this difference is “captured” by producers as profits, and the rest is consumer surplus. As long as the demand curve is above the supply curve, society receives net benefits by producing that unit of a product. However, if the supply curve is above the demand curve, then marginal costs exceed marginal benefits, and society would actually be worse off if that unit were produced and sold. Thus, as long as the demand curve is higher than the supply curve, it makes sense (from the perspective of social welfare) for society to produce each unit, to the point where marginal benefits equal marginal costs. Note in Figure 5.9 that this is true up to the equilibrium quantity of 700 cups of coffee. However, when the supply curve is higher than the demand curve, marginal costs exceed marginal benefits and society should not produce these units. Any production above 700 cups of coffee would decrease social welfare. In other words, the market equilibrium is the outcome that maximizes social welfare. We now test this result by considering what happens when the market is not allowed to reach equilibrium—when a regulation is enacted that sets a price different from the equilibrium price. 4.2 Price Ceilings Sometimes, governments intervene in markets to set price limits, either above or below the market equilibrium price. Somewhat confusingly, a price set below the market price is called a price ceiling (it is a “ceiling” because it establishes a maximum allowable price). price ceiling: a regulation that specifies a maximum price for a particular product Price ceilings are usually set with the goal of helping certain groups of consumers by keeping prices low. A classic example is rent control, which specifies maximum prices for rental units

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