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ECONOMICS
What does it mean to me?
Part IV:
•Consumer Surplus
•Producer Surplus
READ Krugman Section 9, Modules 49, 50, 51
Mankiw Ch 7, 8. 9
VOCABULARY
Willingness to Pay: the maximum price at which he/she
would pay for a good.
Individual Consumer Surplus: the net gain in the purchase
of a good. It is the difference between the actual price and a
person’s willingness to pay.
Total Consumer Surplus: the sum of all the consumer
surpluses of all the buyers of a good.
INDIVIDUAL
CONSUMER
SURPLUS
Buyer
Willingness to pay Price paid
David
Individual Consumer Surplus
$62
$28
$34
Maggie
55
28
27
Henry
38
28
10
Jamie
18
----
Anna
11
----
David’s CS is
$62 - 28 = $34
60
40
20
10
0
0
0
Total Consumer
Surplus equals
Maggie’s CS is
$55 - 28 = $27
34 + 27 + 10 = $71
Henry’s CS is
$38 - 28 = $10
Price =$28
Jamie
Anna
Now, lets suppose a sale drops the price to $14. How has Consumer Surplus
changed?
…..Total Consumer
Surplus now equals
48 + 41 + 24+ 4 = $117
Now David’s CS is
$62 - 14 = $48
60
40
20
10
0
Maggie’s CS is
$55 - 14 = $41
Henry’s CS is
$38 - 14 = $24
Price =$28
Now, Jamie has CS, $18 - 14 = $4
Anna
Price = $14
INDIVIDUAL
PRODUCER
SURPLUS
Just as buyers of a good would have been willing to pay more for their purchase
than the price they actually pay, sellers of a good would have been wiling to sell
it for less than the price they actually receive
Potential Seller’s
Hannah
45
Jerusha’s
35
Chelsea’s
25
Brandon’s
15
Chris
0
Sellers
Cost
Chris
$5
Brandon
15
Chelsea
25
Jerusha
35
Hannah
45
At a price of $30, Chris, Brandon and
Potential Seller’s
Chelsea sell their books.
Hannah
45
Sellers
Cost
Chris
$5
Brandon
15
Chelsea
25
Jerusha
35
Hannah
45
Jerusha
35
Price = $30
25
15
Chelsea
Brandon
Chris
0
At a price of $30.
Total Producer
Surplus is
25 + 15 + 5 = $45
Hannah
45
35
Jerusha
Price = $30
25
15
Chelsea’s PS, $25 -30 = $5
Brandon’s PS, $15 - 30 = $15
Chris’s PS, $5 - 30 = $25
0
CONSUMER SURPLUS
and
PRODUCER SURPLUS
(when there are many
potential buyers/sellers)
Whenever a transaction
occurs in the marketplace,
both consumers and
producers benefit.
But how
much do
they
benefit?
Suppose I am willing to pay $4 for 10 widgets.
However, the price is $1.50.
P
6
5
4
D
$2.50
3
This results in
CONSUMER
SURPLUS, which
is the difference
between D and P
$4.00
- 1.50
$2.50
x 10
2
1
P
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
Price
$25.00
Q
P
So, Consumer Surplus is the TOTAL
BENEFIT consumers receive from having a
market in the good.
$4.00
6
- 1.50
5
$2.50
4
D
$2.50
3
2
x 10
$25.00
1
P
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
Price
Q
Rise
Run
2.50
= .25
=
10
Now, let’s graph this problem using an economist’s
demand curve.
The equation for this line would be:
P = 4 - .25Q
If Q=0, then P=__
P
P = 4 - .25 (0)
6
P=4-0
5
P=4
4
If P=0, then Q=__
3
0 = 4 - .25Q+ .25Q
.25Q = 4
2
.25 .25
1
Q = 16
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
Q
The area between the demand ($4.00) and the price
($1.50) is the CONSUMER SURPLUS.
P
Mathematically, P < 4 - .25Q, P > 1.50, Q > 0
6
Area of a triangle = 1/2bh
5
Consumer Surplus = 1/2 (10 x 2.50) =
4
$12.50
3
2
1
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
Q
So….how much do
producers benefit from this
transaction?
Suppose that a firm is willing to sell the good for
$.50 but the price is $1.50 for 10 widgets.
PRODUCER
SURPLUS is the
difference between
supply curve and the
price.
P
6
5
4
3
2
1
0
Price
$1.00
Supply (willing to
sell cost)
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
Q
Rise
Run
1.50
= .15
=
10
Let’s graph the supply curve on the old graph.
P = .15Q
P
If the price is set at 1.50, then
1.50 = .15Q
.15
6
5
10 = Q
4
S
3
2
Price
1
0
.15
D
1 2 3 4 5 6
7 8 9 10 11 12 13 14 15 16
Q
Remember the area of a triangle = 1/2bh, so…..
1/2 (10 x 1.50) = $7.50
P
6
PRODUCER SURPLUS
5
4
S
3
2
Price
1
0
=
D
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
Q
In this case, both consumers and producers gain:
CS + PS = 12.50 + 7.50 =
P
6
5
$20.00
TOTAL BENEFIT TO
SOCIETY
4
S
3
2
Price
1
0
D
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
Q
Now, let’s suppose a tax of $.80 is added to the
price of gasoline. This adds to the cost of
producing the widgets.
P
6
If 0 widgets, then P = 0 + .80 = .80
If 10 widgets, then P = 1.50 + .80 = 2.30
5
4
S1
S
3
2
Price
1
0
D
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
Q
This changes our point of equilibrium.
What happens to consumer surplus?
P
6
5
4
3
2
1
0
What happens to producer surplus?
What does the pink rectangle represent?
The green triangle represents
DEADWEIGHT loss, or the amount of sales
you give up with the higher price.
S1
S
TAX REVENUE
Price
D
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
Q
What is the new Quantity?
P
Demand
P = 4 - .25Q
Supply
P = .15Q
Supply w/tax
P = .15Q + .80
4-.25Q = .15Q +.80
4-.25Q+.25Q = .15Q+.25Q+.80
4 - .80 = .40Q +.80 - .80
3.20 = .40Q
6
.40
.40
5
4
3
S1
(8, 2)
8=Q
S
P = .15(8)
Price
P = 2.00
2
1
0
D
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
Q
Consumers pay: $2 per unit, including the
tax…..
P
6
Producers receive after they pay the tax:
$2 - .80 = $1.20
5
S1
4
3
(8, 2)
S
2
1
0
Price
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
D
Q
What is the height for the new Consumer Surplus
triangle?
P
6
4 - 2.00 = 2.00 * 8 * 1/2 = $8.00 new CS
(compared to $12.50 old CS)
5
4
3
2
1
0
S1
S
Price
D
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
Q
What is the height for the new Producer Surplus
triangle?
1.20 = h
P
6
5
4
3
2
1
0
8=b
1.820 * 8 * 1/2 =
$4.80 new PS
(compared to $7.50 old PS)
S1
S
Price
D
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
Q
So…..using the equation 1/2bh (area of a
triangle)
1/2 * 8 * 1.70 = $8.00 = New CS
1/2 * 8 * .80 = $4.80 = New PS
P
6
5
4
3
2
1
0
.80 * 8 = $6.40 = Tax Amount
8.00 + 4.80 + 6.40 = $19.20 Total Benefit
(compared to $20.00 old TB)
S1
S
Price
D
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
Q
Compare the New Total Benefit
of $19.20 to the Old Total
Benefit of $20.00.
Do excise taxes benefit society?
Economists do not support taxes
which do not benefit society, such
as excise taxes.
Good taxes include: property
taxes, income taxes, and estate
taxes.
So….who pays the $.80 ?
Consumers pay: $ .50
Producers pay:
$ .30
In this case, consumers pay most (BUT NOT ALL) of the
tax. Tax incidence depends on the elasticity of demand and
the elasticity of supply. In short, whomever is less flexible
in adjusting to changes in price will pay more of the tax.
Consumers avoid paying the whole of the tax by buying
less of the product at a lower quantity.
GAINS FROM TRADE:
Consumer Surplus = 1/2 * 8 * (4 - 2) = $8.00
Producer Surplus = 1/2 * 8 * (1.20 - 0) = $4.80
P
6
5
4
3
2
Tax Revenue = $. 80 * 8 = $6.40
GAINS FROM TRADE = 8 + 4.80 + 6.40 = $19.20
Deadweight Loss = 20.00 - 19.20 = $ .80
S1
S
1
Price
D
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
Q
Project by:
Virginia H. Meachum
Coral Springs High School
Sources:
Principles, Problems, and Policies, by Campbell McConnell &
Stanley Brue
Principles of Economics, by N. Gregory Mankiw
Economics For AP, by Paul Krugman, Robin Wells, David
Anderson, Margaret Ray
Notes by Florida Council on Economic Education and FAU
Center for Economic Education (Prof Bill Boshardt)
Notes by Foundation for Teaching Economics