Market Equilibrium Consumer and Producer Surplus

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TABLE OF CONTENTS

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Suppose you are trying to sell a textbook that you have purchased for a course that you have already completed. Initially, you put the textbook on sale for $130. However, several fellow students make offers on your textbook, all of the offers lying in the $100-$120 price range. Since you would like to receive as much value as possible from your sale, you settle for the highest price offer and sell the textbook for $120. By settling to sell the textbook for $120, the buyer and yourself as the seller find the optimal point of compromise where you're both satisfied enough with the conditions of the transaction to make the sale happen. This is an example of market equilibrium, where buyers and sellers are both happy enough to allow the transaction between the two parties to take place. How can we measure the benefit, if any, that both you as a seller and your friend as a buyer received as a result of this transaction? Read on to find out!

Meaning of market equilibrium, consumer and producer surplus

Market equilibrium is the quantity-price point where supply and demand balance out in such a way that quantity demanded equals quantity supplied. The market stabilizes at the price that corresponds to this quantity.Consumer surplus is the difference that the consumer has to pay for a good or service and the price they would be willing to pay rather than forego that good or service.

Producer surplus is the difference between how much a supplier would be willing to receive for a given quantity of good or service and how much they can actually receive for that quantity based on the market price.

Why is consumer and producer surplus maximized at market equilibrium?

If the price rises, it will diminish the consumer surplus, which reflects on the graph by decreasing the area representing consumer surplus. On the other hand, if the price falls, it will do so at the cost of the producer surplus and reduce the area that denotes producer surplus. Thus, both consumer and producer surplus are maximized at the market equilibrium price.

Market equilibrium definition

Market equilibrium is the point where demand and supply balance out, such that the quantity of a product or service demanded equals the quantity supplied. The price that matches this compromise quantity is the price at which the market can stabilize.

Equilibrium is the point in the market where the quantity of a product or service demanded equals to the quantity supplied, thus determining the market price that corresponds to that quantity.

At equilibrium, the quantity that consumers are seeking equals the quantity that producers are willing to supply, meaning there will be just enough of a good or service to leave no surplus of it and avoid shortages. Equilibrium also reflects the price at which both producers and consumers are willing to settle.

Since the quantity of a good or service demanded equals the quantity supplied, there will be no surplus or shortage of the good at the market price.

A surplus is an event in which the quantity of a product or service supplied exceeds the quantity demanded at the market price, thus leaving an excess quantity of the good that prevents the market from clearing.

A shortage occurs when the quantity of a product or service demanded exceeds the quantity supplied at the market price, meaning there is not enough of the given goods in the market.

Market equilibrium graph

When visualized on a graph, the economic equilibrium is the point of intersection between the demand and supply curves. This point of intersection reflects the compromising quantity that both consumers are willing to seek out and producers are willing to supply at a certain price. Refer to Figure 1 below to see what equilibrium looks like in a basic supply and demand model.

market equilibrium consumer producer surplus supply demand model studysmarter Figure 1. Equilibrium in supply and demand model, StudySmarter Original

Producer and consumer surplus

Identifying the point of equilibrium in a given market does not only reflect the price and quantity at which the market will stabilize, but also helps determine the existing consumer and producer surplus in the market.

Producer surplus graph

Producer surplus is the difference between the price that a producer is willing to supply a product or service for versus the actual market price of that good or service. The resulting gap is the benefit that producers receive by supplying that good or service.

Producer surplus can be found on a supply and demand graph as the area confined by the equilibrium price and the supply curve, as illustrated in Figure 2 below.

market equilibrium consumer producer surplus studysmarter Figure 2. Producer surplus, StudySmarter Original

Consumer surplus graph

Consumer surplus is the difference between the price that consumers would be willing to pay for a product and the price they actually have to pay. This difference is the marginal benefit that consumers receive by purchasing a good or service for its market price.

On a supply and demand graph, consumer surplus is illustrated as the area between the demand curve and the equilibrium price, as demonstrated in Figure 3 below.

market equilibrium consumer producer surplus consumer surplus studysmarter Figure 3: Consumer surplus, StudySmarter Original

Calculating producer and consumer surplus

You can calculate both producer and consumer surplus by either finding the corresponding triangular areas that you can identify on a supply and demand model for any given market, or by using the respective formulas.

The supply and demand model reflects consumer and producer surplus as the inner triangular areas between the equilibrium price and the supply and demand curves respectively.

Thus, both producer and consumer surpluses can also be calculated by using the formula for the area of a right-angled triangle: $A r e a = \frac{B a s e \times H e i g h t}{2}$ $(B a s e \times H e i g h t) / 2$

To determine producer surplus using this method, the base is the equilibrium price, and the height of the producer surplus area is the distance between the equilibrium price - P_E and the y-intercept - P_min of the supply curve. Similarly, consumer surplus can be determined by finding the triangular area where the base is the equilibrium price - P_E and the height is the distance between the equilibrium price and the y-intercept - P_max of the demand curve. Refer to Figure 4 below to see the triangular areas that represent consumer and producer surplus, respectively.

market equilibrium consumer producer surplus studysmarter Figure 4. Consumer and producer surplus, StudySmarter Original

Consumer surplus and producer surplus formula

Producer surplus is found by multiplying the difference between the price that producers are willing to sell at and the market price by the quantity they are able to sell.

As for consumer surplus, it is calculated by multiplying a quantity by the difference between the price consumers would be willing to pay and the market price. See the formulas for producer and consumer surplus provided below.

$P r o d u c e r S u r p l u s = (M a r k e t p r i c e - M i n p r i c e w i l l i n g t o s e l l) \times Q u a n t i t y$

$P r o d u c e r S u r p l u s = \frac{(M a r k e t p r i c e - M i n p r i c e w i l l i n g t o s e l l) \times Q u a n t i t y}{2}$

$C o n s u m e r S u r p l u s = \frac{(M a x p r i c e w i l l i n g t o p a y - M a r k e t p r i c e) \times Q u a n t i t y}{2}$

Change in consumer surplus example

Looking at the graph and the formulas above, imagine if the market price increased from the price corresponding to the equilibrium. How would this shift affect the consumer surplus? Since the lower side of the triangular area of the consumer surplus is denoted by the market price, an increase in price would decrease the consumer surplus.

Refer to Figure 5 below for the following example. Suppose that a popular apparel brand uses imported cotton to produce their cardigans. With the usual volume of imported cotton, the brand is able to supply the cardigans at the quantity Q₁ and price P₁, with the initial market equilibrium marked as Eq_1.

Due to an economic downturn, the country that the brand gets its cotton from has to reduce the quantity of cotton that they are able to supply and export. Now, the market equilibrium Eq₂for this brand's cardigans lies at a lower quantity Q₂ and higher price P₂. This decrease leads to a decrease in consumer surplus. As you can see in Figure 5, the new consumer surplus is represented by a smaller area confined by market price P₂.

market equilibrium consumer producer surplus decrease studysmarter Figure 5. A decrease in consumer surplus. StudySmarter Original

Equally, if you were to use the formula for consumer surplus and the market price was to increase, the remaining difference (the consumer surplus) would be less than it was at a lower price. Thus, an increase in the market price would decrease the perceived benefit that consumers gather from purchasing a certain good or service.

Consumer surplus example problem

Let's dive into an example for consumer surplus calculation!

Imagine that P₁ is $20, P₂ is $25, initial quantity Q₁ is 10, quantity after the change Q₂ is 8, and the y-intercept of the demand curve is $45.

Using the consumer surplus formula, we can calculate the initial consumer surplus before the increase in market price as follows:

$C o n s u m e r s u r p l u s_{1} = \frac{($ 45 - $ 20) \times 10}{2} = $ 125$

Imagine the supply curve shifts to the left, leading to an increased market price. We must use the new market price and new decreased quantity corresponding to the equilibrium to calculate the consumer surplus.

$C o n s u m e r s u r p l u s_{2} = \frac{($ 45 - $ 25) \times 8}{2} = $ 80$

As you can see, the change in the market led to a reduction in consumer surplus from $125 to $80. At a higher price and lower quantity, consumers do not receive as much benefit from the transaction as they did at a lower price and higher quantity, which is reflected by a decrease in consumer surplus.

Producer surplus example problem

Let's dive into an example for producer surplus calculation!

Suppose that due to a significant decrease in income, demand for laptops shifts leftward, decreasing the equilibrium quantity and price from 20 to 15 and $1000 to $700, respectively. The y-intercept of the supply curve is $100.

For suppliers of laptops, this means that the producer surplus is now smaller than it was at a higher quantity and price, as illustrated in Figure 6 by the decrease in size of the area representing producer surplus.

market equilibrium consumer producer surplus decrease surplus studysmarter Figure 6. A decrease in producer surplus, StudySmarter Original

We can also show that the producer surplus decreased by using the formula. First, lets calculate the producer surplus before the change in demand as follows:

id="3060687" role="math" $P r o d u c e r s u r p l u s_{1} = \frac{($ 1000 - $ 100)}{2} \times 20 = $ 9, 000$

Given that the shift in demand led the equilibrium price and quantity to decrease, we need to use the reduced quantity and price to calculate the new producer surplus.

id="3060688" role="math" $P r o d u c e r s u r p l u s_{2} = \frac{($ 700 - $ 100)}{2} \times 15 = $ 4500$

As you can see, the decrease in equilibrium price led producer surplus to decrease from $9000 to $4500. At a lower price, producers do not get as much value out of selling their product on the market, hence the decrease in producer surplus.

Market Equilibrium and Consumer and Producer Surplus - Key takeaways

Market equilibrium is the quantity-price point where supply and demand balance out in such a way that quantity demanded equals quantity supplied. The market stabilizes at the price that corresponds to this quantity.
Consumer surplus is the difference that the consumer has to pay for a good or service and the price they would be willing to pay rather than forego that good or service.
Producer surplus is the difference between how much a supplier would be willing to receive for a given quantity of good or service and how much they can actually receive for that quantity based on the market price.
Producer surplus is the inner triangular area between the equilibrium price and the supply curve.
Consumer surplus is the inner triangular area between the equilibrium price and the demand curve.
Both consumer and producer surplus can be calculated by either using formulas or finding the inner areas between the equilibrium price and their respective curves.

Frequently Asked Questions about Market Equilibrium Consumer and Producer Surplus

Market equilibrium is the quantity-price point where supply and demand balance out in such a way that quantity demanded equals quantity supplied. The market stabilizes at the price that corresponds to this quantity.

Consumer surplus is the difference that the consumer has to pay for a good or service and the price they would be willing to pay rather than forego that good or service.

Producer surplus is the difference between how much a supplier would be willing to receive for a given quantity of good or service and how much they can actually receive for that quantity given based on the market price.

The consumer surplus is the triangular area between the demand curve and the price that corresponds to the equilibrium.

The consumer surplus is the difference between the price that consumers are willing to pay for a certain good or service versus the price they actually have to pay as per the market price, while producer surplus is the difference between the amount that producers can receive for a good or service on the market minus the price they would be willing to sell it for.

On a graph, the difference between consumer and producer surplus is that consumer surplus is the area between the demand curve and the equilibrium price, while producer surplus is the area between the supply curve and the equilibrium price.

Consumer surplus is measured by subtracting the price that consumers actually have to pay for a certain good or product from the price they would be willing to pay for it.

Producer surplus is measured by subtracting how much producers of a certain good or product would be willing to sell it for from how much they can actually receive for it in the market.

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How is consumer surplus measured?

Consumer surplus is measured by subtracting the price that consumers actually have to pay for a certain good or product from the price they would be willing to pay for it. This difference is then multiplied by the quantity purchased.

How is producer surplus measured?

Producer surplus is measured by subtracting how much producers of a certain good or product would be willing to sell it for from how much they can actually receive for it in the market. This difference is then multiplied by the quantity sold.

Where is consumer surplus found on the graph?

On a graph, consumer surplus is the triangular area between the demand curve and the price corresponding to the equilibrium.

Where is producer surplus found on the graph?

On a graph, producer surplus is the triangular area between the supply curve and the price corresponding to the equilibrium.

Consumer surplus is calculated by...

Subtracting the price that consumers have to pay for a product or service from the price they would be willing to pay

Where can the market equilibrium be found on the supply and demand graph?

Equilibrium is the point of intersection between the demand curve and the supply curve.

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Market Equilibrium Consumer and Producer Surplus

Meaning of market equilibrium, consumer and producer surplus