Consumer’s surplus and producer’s surplus
Consumer's surplus. Consumer's surplus is the difference between what the consumer is willing to pay and what she actually pays. For a market demand curve, consumer surplus is a monetary indicator of the gap between the total utility that society derives from a good and the good's actual market value. Graphically, it is the area below the demand curve and above the equilibrium price.
Consider an individual's demand curve for good X as shown in Figure 2.15, and suppose that the prevailing market price is 8 shillings. The figure indicates that the individual will buy 6 units of the good per month, paying out a total of 48 shillings (8x6 = 48J.
Consumer's surplus.
Consumer's surplus.
The first unit of good X that the individual buys yields much utility that one would be prepared to pay as much as 18 shillings for it. Similarly, one would have been prepared to pay as much as 16 shillings for the second unit, 14 shillings for the third unit, 12 for the fourth unit, 10 shillings for the fifth unit, and 8 shillings for the sixth unit.
Since a single price of 8 shillings prevails in the market, one has to pay 48 shillings for the six units (area Oabc), instead of shillings [18 + 16 -te1 14 + 12 + 10 + 8) - 78 which one would have been prepared to pay.
The 30 shilling (78 - 48) difference can be thought of as the consumer's surplus and is indicated by the area cbd.
It should be noted that the higher the market price, the smaller the consumer's surplus and vice versa.
Producer surplus.
This is a difference between what the producer is willing to charge and what is actually charged. Consider the market supply curve S in Figure 2.16.
Figure 2.16 Producer Surplus.
Recall that the supply curve shows the quantity of good X that producers are willing and able to supply over a given time period of different prices. Suppose the prevailing market price is OP0, so that quantity OQ0 is being supplied. The firm is receiving total revenue of OP0 X OQ0, represented by the total area OP0bQ0.
It can be seen from the figure that the firm would have been prepared to supply the first unit (Q^) at a much lower price of OP^ The second unit (Q2) at price OP2, the third unit (Q3) at OP3, and so on. Since the firm is receiving the same price (OP0) for each unit sold, the area above the supply curve and below the price line, (AP0B ) is referred to as producer's surplus. It is determined by the market price. The higher the market prices the bigger the producer's surplus and vice versa.
Assume that the producer was willing to charge price 10 for the first unit, price 20 for the second unit, price 30 for the third unit and price 40 for the fourth unit. The producer would be getting revenue equal to 100 [obtained as 10 + 20 + 30 + 40) instead of 160 (obtained as 4 x 40) when a uniform price is charged. Since a uniform price is charged, the producer gets a surplus of 60 [obtained as 160 - 100).