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Consumer and Producer Surplus

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Economics

Imagine you are ready to buy the new Apple AirPods Max for £800, and when you go to the store, you end up paying £550. What benefit did you get from actually paying less than £800? How much did the seller benefit from being willing to sell the new AirPods Max for less than £250? That’s what consumer and producer surplus is all about. In this article, you’ll learn everything you need to know about consumer and producer surplus.

Consumer and producer surplus definition

What is the difference between consumer surplus and producer surplus?


Consumer surplus refers to the difference between the price a consumer is willing to pay for a particular good and the price they pay. Consumer surplus is an excellent way to measure how much an individual benefits from a transaction in an economy.

For example, if an individual is willing to pay £300 for Apple AirPods Pro and instead pays £180, the total consumer surplus is £120. What would happen if the price of AirPods was £310? The consumer would then not buy the Apple AirPods.

Consumer surplus is an important metric for measuring consumer wealth in society. In general, an increase in consumer welfare follows an increase in consumer surplus. There are many factors that affect consumer wealth. A price increase always leads to a decrease in consumer surplus and thus to a decrease in consumer welfare.

Consumer surplus is the difference between the amount a consumer is willing to pay for a particular good and the amount they pay.

In economics, producer surplus is defined as the difference between the amount a firm producing the goods is willing to pay for a given quantity of goods and the amount it can earn by selling the goods at the market price.

The difference, also called the surplus amount, is the benefit the producer receives from selling the item in the market. A producer surplus occurs when market prices for goods are higher than the lowest price producers would otherwise be willing to accept for their goods.

Producer surplus is the difference between the price at which a firm is willing to sell a good and the price at which it sells it.

Producer surplus is an essential factor in measuring the economic welfare of producers. It helps find the optimal allocation of resources that benefit society as a whole.

Consumer and producer surplus calculations

In this section, we will break down how to calculate the consumer and producer surplus. We will also present this calculation with a consumer and producer surplus graph.

Producer surplus calculation

We can calculate producer surplus.

Consumer and Producer Surplus Graph StudySmarterFigure 1. Producer surplus- StudySmarter

Figure 1 shows the producer surplus, which you can find above the supply curve. The area of the triangle P1-A-Pmin is the area of producer surplus.

Considering the P1-A-Pmin triangle, you can calculate the producer surplus.

The formula to calculate the area of a right-angled triangle is:

In this case, the base of the triangle is the quantity sold at price P1 = Q1, whereas the height of the triangle is equal to the price that the firm sells their good, subtracting the minimum price the firm would accept to sell the good = P1-Pmin

Therefore we have,

Consider, for example, a firm that’s willing to sell ten computers for £1000. The firm’s sales department manages to sell the computers for £1500. What’s the producer surplus of the firm?

The producer surplus= 1/2 x 10 x (£1500 - £1000) = 2500. That means that the total benefit of the producer is equal to £2500.

Consumer surplus calculation

We can calculate consumer surplus.

Consumer and Producer Surplus Graph StudySmarterFigure 2. Consumer surplus- StudySmarter

Figure 2 shows the consumer surplus on a graph. Consumer surplus is the difference between the maximum price a consumer is willing to pay and the price they end up paying.

The triangle P1-Pmax-A represents the consumer surplus is represented. Again, you can use the formula that helps calculate the area of a triangle to calculate the consumer surplus.

The formula to calculate the area of the right-angled triangle is:

In this case, the triangle’s height is the difference between the maximum price a consumer is willing to pay and the price they end up paying = Pmax-P1. The base equals the total quantity the consumer gets from paying P=Q1.

Therefore, consumer surplus is:

Assume that a consumer is willing to pay a maximum price of £30 for five chocolates. The price the consumer pays is £10. What is the consumer surplus? Consumer surplus= ½ x 5 (30-10)= £50. That means that the total benefit received by the consumer, in this case, is equal to £50.

There are many factors that can influence the consumer surplus. Generally, consumer surplus is much higher in a perfectly competitive market, whereas it is lower in an imperfectly competitive market.

Consumer and producer surplus in monopoly

We can analyse the effects that monopoly has on producer and consumer surplus.

Consumer and Producer Surplus Graph Consumer and producer surplus in monopoly and perfect competition StudySmarterFigure 3. Consumer and producer surplus in monopoly and perfect competition- StudySmarter

Figure 3 shows the impact monopoly has on producer and consumer surplus. It first assumes that the market was initially in perfect competition at point 1, diagram 2. At this point, there is a Q1 amount of goods exchanged for P1. However, when the firm receives market power and turns into a monopoly, it charges higher prices, as seen in diagram 2. When higher prices are charged, not everyone can afford the new price. Therefore, the quantity demanded drops to Q2.

Remember that in a monopoly, the MC curve is equal to what would be the supply curve of the firm if the market was in perfect competition. Assume that to maximise the profit, the firm chooses to price where MC=MR. As shown in the diagram above, this increases the price to P2.

How does this impact the consumer surplus? The total amount that a consumer was willing to pay is at point Pmax. Under perfect competition, a consumer would pay P1, and the total benefit would be Pmax-P1.

On the other hand, in a monopoly, where the price has increased to P2, the consumer surplus has shrunk, as Pmax-P2 is smaller than Pmax-P1. You can see from the figure that the consumer surplus was initially the triangle P1-Pmax-1, and after monopoly, it became P2-Pmax-2.

On the other hand, the producer surplus of monopoly has increased at the expense of the consumer. The minimum amount a firm will choose to exchange for their product can be found where the MC curve intersects the y-axis. That’s because a firm will not supply when the price is below the MC as it would make losses.

In equilibrium, the producer surplus was the difference between the price they are selling their goods for and the minimum price they are willing to accept. When the price was P1, the producer surplus was P1-Pmin-1. After the price had increased, the producer surplus became P2-Pmin-3-2, where P2 is greater than P1. The gain in producer surplus at the expense of consumer surplus is represented by the rectangular area P1-P2-2-4.

However, there is a loss for both consumer and producer surplus in a monopoly. That is due to the drop in quantity from Q1 to Q2. This is known as deadweight loss and represents the economic loss of welfare. In other words, it illustrates how much the society losses from a monopoly, as resource allocation doesn’t occur at optimal levels. The deadweight loss is shown by the triangle 1-2-3 in diagram 1 of Figure 3.

Keep in mind that there will be a loss in overall economic welfare whenever there is an imperfectly competitive market. Additionally, there will be an increase in producer surplus in such a market structure at the expense of consumer surplus.

Price elasticity of demand and consumer surplus

Price elasticity of demand measures how sensitive the quantity demanded is towards a price change. A demand curve is inelastic when the change in quantity demanded is proportionally lower than the price change. A demand curve is elastic when the change in quantity demanded is proportionally greater than the price change.

Therefore, the elasticity of demand will determine the size of the consumer surplus.

Consumer and Producer Surplus Graph Consumer surplus and elasticity of demand StudySmarterFigure 4. Consumer surplus and elasticity of demand- StudySmarter

Figure 4 shows the consumer surplus when you have price elastic and inelastic demand.

As seen in diagram one, the consumer surplus is higher when the demand is inelastic. That’s because the consumers are willing to pay a higher price for the good. Therefore there is a larger gap between Pmax and Pe.

On the other hand, when the demand is elastic, consumers will be willing to pay a lower price for the good. There is a smaller gap between Pmax and Pe, as seen in diagram 2. This makes the consumer surplus smaller.

To learn more about demand’s price elasticity, check our explanation Price Elasticity of Demand.

Consumer and Producer Surplus - Key takeaways

  • Consumer surplus refers to the difference between how much a consumer is willing to pay for a particular good and how much they end up paying.
  • Producer surplus is the difference between how much a firm is willing to sell a good for and how much it actually sells it for.
  • In an imperfectly competitive market, there is an increase in producer surplus at the expense of consumer surplus.
  • The consumer surplus is higher when the demand is price inelastic.

Consumer and Producer Surplus

Producer surplus=1/2 x Q1 x(P1-Pmin)
Consumer surplus=1/2 x Q1x (Pmax-P1)

Consumer surplus refers to the difference between the price a consumer is willing to pay for a particular good and the price they pay. 

Producer surplus is the difference between the price at which a firm is willing to sell a good and the price at which it sells it.

Consumer surplus is the total benefit a consumer gains when purchasing a good or service.
Producer surplus is the total benefit a producer receives from selling a good or service.

Final Consumer and Producer Surplus Quiz

Question

What is consumer surplus?

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Answer

Consumer surplus refers to the difference between how much a consumer is willing to pay for a particular good and how much they actually end up paying.

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Question

What does consumer surplus measure?

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Answer

Consumer surplus is a great way to measure how much an individual benefits from a transaction in an economy.

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Question

What is producer surplus?

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Answer

In economics, producer surplus is defined as the difference between how much a firm that produces goods is prepared to take for a given amount of goods and how much they can earn by selling the good at market price.

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Question

When is a producer surplus created?

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Answer

A producer surplus occurs when market prices for items are higher than the lowest price at which producers would otherwise be ready to accept their goods for sale.

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Question

What does producer surplus measure?

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Answer

Producer surplus is an important factor in measuring the economic welfare of producers. 

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Question

Why are consumer and producer surplus important when measuring the welfare in society?

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Answer

They help find the optimal allocation of resources for which society benefits.

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Question

How does perfect and imperfect competition influence consumer surplus?

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Answer

Generally, consumer surplus is much higher in a perfectly competitive market, whereas it is lower in an imperfectly competitive market.

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Question

How does monopoly impact consumer surplus?

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Answer

Consumer surplus shrinks under monopoly.

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Question

How does a monopoly affect producer surplus?

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Answer

In monopoly, producer surplus increases at the expense of consumer surplus.

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Question

What is deadweight loss?

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Answer

The economic loss in welfare as a result of monopoly or any imperfectly competitive market.

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Question

How does elasticity of demand influence consumer surplus?

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Answer

The consumer surplus is higher when the demand is inelastic.

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Question

If you were willing to buy an iPhone for £700 and you end up paying £600, what would your consumer surplus be?

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Answer

Consumer surplus = £700-£600=£100.

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Question

If you were willing to sell your car for at least £5000 and you end up selling it for £5500, what would your producer surplus be?

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Answer

Producer surplus= 5500-5000=£500

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