Consumer and producer surplus
AIMS
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Explain the meaning of consumer and producer
surplus, as well as social or community surplus
Draw a diagram showing maximum social surplus at
competitive market equilibrium
Explain the conditions for achievement of allocative
efficiency at competitive market equilibrium
• Social surplus is maximum
• Marginal benefits are equal to marginal costs
Calculate consumer and producer surplus from a
diagram
Allocative efficiency in competitive markets
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Allocative efficiency means the market produces desired
goods in the right quantities leading to the maximization
of benefits from consumption among households
Consumer surplus exists when consumers pay less than
they are willing an able to pay for a good
Consumers will increase consumption when price falls
as there will be additional marginal benefits
Producer surplus exists when the price is higher than the
minimum price a firm is willing and able to accept
As firms increase output marginal cost rises, this in part
explains the shape of the supply curve
Allocative efficiency in competitive markets
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At equilibrium in a competitive market, both
consumer and producer surplus are
maximised allowing the market to achieve
allocative efficiency, thus welfare is
maximised
NOTE – allocative efficiency is a positive
statement, it is not a value judgement, nor
does it suggest the goods are distributed fairly
P
Consumer Surplus
S
= MC
Consumer
surplus
P1
Producer
surplus
D
O
Q1
= MB
Q
Consumer surplus
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Consumer surplus is the
difference between the price a 8
consumer is willing to pay and
the price they actually pay,
5
calculated as you would
normally calculate the area of a
triangle: 0.5(base*height)
Alternatively the formula can be
viewed as:
(value of P intercept – price) x quantity
2
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(8-5)x500 = 750
2
= MC
= MB
500
Producer surplus (triangle)
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Producer surplus is the
difference between the price a
firm is willing to accept and the
price they actually receive,
5
calculated as you would
normally calculate the area of a
triangle: 0.5(base*height)
1
Alternatively the formula can be
viewed as:
(price - value of P intercept) x quantity
2
■
(5-1)x500 = 1000
2
= MC
= MB
500
Social surplus
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Social surplus is the sum of producer and
consumer surplus
It shows the value that trade has brought to
society
In the case of the
(8-5)x500 + (5-1)x500
2
2
= 1750
Producer surplus (trapezium)
■
= MC
Producer surplus is calculated
differently when the supply curve
intercepts the X axis
5
= MB
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(Quantity + Q Intercept) x Price
2
(500+100) x 5 = 1500
2
100
500
Reality check
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In reality markets rarely achieve true
allocative efficiency due to human error,
regular shifts in demand and supply and
market failures resulting in welfare loss