Consumer and Producter
Surplus
Microeconomics
Consumer Surplus
 Consumer Surplus is ….
when a consumer pays of price LESS than their
maximum willingness to pay.
 Willingness to pay is …..
Maximum price a consumer would pay for a
particular good or service.
Consumer Surplus
 Consumer Surplus is ….
Amount would have paid – amount did pay
The area below the D curve and above P
CS = ½ BH (area of a triangle)
CS = ½ P*Qd
Calculate Consumer Surplus
Consumer
Willingness to Pay
(WPT)
P = $40
CS = WTP - P
A
$100
$40
$60
B
$80
$40
$40
C
$60
$40
$20
D
$40
$40
$0
E
$20
$40
Will not buy
TOTAL CS = $120
Consumer Surplus Calculations
Problem: The D curve for a product is P = 40 -2Qd. The current price is
$20.
Compute Total Consumer Surplus.
Draw the D curve with P and Qd.
Shade CS.
CS = ½((20)(10) = $100
∆P Affects CS
Consumer
Willingness to Pay
(WPT)
P = $60
CS = WTP - P
A
$100
$60
$40
B
$80
$60
$20
C
$60
$60
$0
D
$40
$60
Will not buy
E
$20
$60
Will not buy
TOTAL CS = $60
Graph the new CS.
∆P Affects CS
CS  when P .
CS  when P .
Producer Surplus
 Producer Surplus is ….
when a producer receives a price HIGHER than their
cost.
Cost is the minimum price the seller must receive to offer
the product on the market.
Producer Surplus
 Producer Surplus is ….
Price received - cost
The area above the S curve (cost) and below P
CS = ½ BH (area of a triangle)
CS = ½ P*Qs
Producer Surplus
Units Supplied
Cost
P = $40. Will it be
supplied?
$30. Will it be
supplied?
1
$10
yes
yes
2
$20
yes
yes
3
$30
yes
yes
4
$40
yes
no
5
$50
no
no
Graph Producer Surplus with values.
Producer Surplus Calculations
Units Supplied
P = $40
Cost
PS = P - Cost
1
$40
$10
$30
2
$40
$20
$20
3
$40
$30
$10
4
$40
$40
$0
5
$40
$50
Will not be
supplied
TOTAL PS = $60
Producer Surplus Calculations
Problem: The S curve for a product is P = 2Qs. The current price is
$60.
Compute Total Producer Surplus.
Draw the S curve with P and Qs.
Shade PS.
PS = ½((60)(30) = $900
∆P Affects PS
Units Supplied
P = $30
Cost
PS = P- Cost
1
$30
$10
$20
2
$30
$20
$10
3
$30
$30
$0
4
$30
$40
Will not be
supplied
5
$30
$50
Will not be
supplied
TOTAL CS = $30
Graph the new CS.
∆P Affects CS
PS  when P .
PS  when P .
CS, PS and TS Measure what?
 CS = (value to buyers) – (amount paid by buyers)
Buyers’ benefit from participating in the market
 PS = (amount received by sellers) – (cost to sellers)
Sellers’ benefit from participating in the market
 Total Surplus = CS + PS
Total gains (loss) from trade in a market
Consumer Surplus, Producer Surplus
and Efficiency
A trade had been made anytime a consumer makes a purchase from a producer.
Widget Buyers
WTP
Widget Sellers
Cost
1
$10
A
$2
2
9
B
3
3
8
C
4
4
7
D
5
5
6
E
6
6
5
F
7
7
4
G
8
Consumer Surplus, Producer Surplus
and Efficiency
Gains From Trade
Widget
Buyers
WTP
Price
CS
Widget
Sellers
Price
Cost
PS
1
$10
$6
$4
A
$6
$2
$4
2
9
6
3
B
6
3
3
3
8
6
2
C
6
4
2
4
7
6
1
D
6
5
1
5
6
6
0
E
6
6
0
6
5
6
NT
F
6
7
NT
7
4
6
NT
G
6
8
NT
What is CS, PS and TS?
CS, PS and Efficiency
 An Efficient Market is…..
Equitable gains from trade.
No way to make some better of without making
others worse off.
CS, PS and Efficiency
 An Efficient Market performs four important functions.
 Allocates good consumption to buyers who value it most
Demonstrated by WTP
 Allocates sales to sellers who value the right to sell the good most
Demonstrated by cost
 Ensures every consumer values the good more than every seller who makes
sale
Trade is mutually beneficial
 Ensures every consumer who DOES NOT make a purchase values the good
less than every seller who DOES NOT make a sale
NO mutually beneficial trades are missed
CS, PS and Efficiency
 NOT ALL MARKETS ARE EFFICIENT (EXTERNALITIES) AND/OR EQUITABLE
 Widget price of $6 fair for some but not for those whose WTP < $6.
 TPS – List two goods/service you think are unfairly priced.
 State one thing you would do to correct the price issue?
 (minimum wage is a price floor since the wage for unskilled labor is considered unfairly
low – abolish minimum wage to increase efficiency?)
CS, PS and Efficiency
TAXES
Equity and efficiency are at the root of the debate surrounding taxes.
 TPS – What is the purpose of taxes?
 Redistribute some income from wealthy to the poor
CS, PS and Efficiency
TAXES
A Progressive tax …
 rises MORE in proportion to INCOME
Higher-income pays a higher % than low-income in taxes
A Regressive tax …
Rises LESS in proportion to INCOME
Higher – income pays a smaller % than low-income in taxes
A Proportional tax …
Rises IN Proportion to INCOME
All tax payers pay the same % of their income
The Effects of Taxes on Total Surplus
 The Excise Tax is …
 Levied on each unit of a good sold
Ex: Gasoline, tobacco, alcohol, hotel rooms
The Effects of Taxes on Total Surplus
EXAMPLE:
Smog City is free of any taxes. P = $2/gallon, and 1 million gallons are
sold/day.
P
$5
S1
2
D1
1
Q (millions)
The Effects of Taxes on Total Surplus
EXAMPLE:
Smog City decide to impose a $1 tax on gasoline sellers on every gallon of gas sold. Sellers must receive
$3/gallon so they can send $1 to the Smog City government.
What is causing the S curve to shift? Which direction will the S curve shift? What amount will the S curve shift by?
S2
P
$5
S1
2.60
2
1.60
1
D1
.8
1
Q (millions)
The Effects of Taxes on Total Surplus
Price Elasticities and Tax Incidence
 A Tax Incidence is …
 the distribution of the tax burden
 Depends on the elasticity of the D and S curves.
 Buyers pay more when
 D curve = Inelastic and S curve = Elastic
 Sellers pay more when
 D curve = Elastic and S curve = Inelastic
Benefits and Costs of Taxation
Revenue from an Excise Tax
Tax revenue = (# gallons sold)*(per gallon tax) =
800,000 * $1/gallon = $800,000
P
$5
Revenue
S2
S1
2.60
2.00
1.60
D1
.8
1
Q (millions)
Benefits and Costs of Taxation
Costs of Taxation
 The Tax Revenue collected by the government is …
 A redistribution of CS and PS to the government.
 The True Cost of the Tax is Deadweight loss.
 Deadweight Loss is the inefficiency created by the tax.
Benefits and Costs of Taxation
Cost of Taxation
Deadweight Loss = Before Tax TS – (After Tax TS + Gov. Revenue)
$2,500,000 – (1,680,000 + 800,000) = $20,000
P
$5
Revenue
S2
S1
Deadweight Loss
2.60
2.00
1.60
D1
.8
1
Q (millions)
Utility Maximization
Utility is a measure of satisfaction the consumer derives from consuming
good and services.
Total Utility is the total happiness (utility) received from the
consumption of a number of units of a good.
Marginal Utility is the change in happiness (utility) between the
initial consumption of a good and each subsequent consumption of the
good.
Diminishing Marginal Utility is the principle describes
what happens when each successive unit of a good consumer adds less to
total utility than the previous utility.
Utility Maximation
Number of Slurpees
(in a week)
Total Utility (TU) Received
(happy points)
0
0
1
40
2
70
3
90
4
100
5
105
6
90
Marginal Utility (MU)
from each
Utility Maximization
MU = ∆TU/∆X
MU >= 0 the consumer will choose to consume it.
When does the consumer no longer consume
Slurpees that week?
Assumption: consumer can afford to buy 5
Slurpees in a week.
Budgets and Optimal Consumption
Consumers want to maximize utility BUT must do so
within a budget.
Consumers need to …
Find the bundle of goods which are affordable
Choose the bundle that provides the highest utility
Bruno’s Budget and Optimal
Consumption
 Bruno’s income is $50.
 Notebooks cost $5.
 CDs cost $10.
1. Write the linear equation for Bruno’s data.
$50 = $5N + $10CD
He CANNOT afford a bundle >$50.
2. Create a table of Bruno’s consumption options.
Bruno’s Consumption Options
Q of Notebooks
Q of CDs
0
5
2
4
4
3
6
2
8
1
10
0