part iv: consumer surplus producer surplus
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Part IV:Part IV:•Consumer SurplusConsumer Surplus•Producer SurplusProducer Surplus
ECONOMICSECONOMICSWhat does it mean to me?
READ Krugman Section 9, Modules 49, 50, 51Mankiw Ch 7, 8. 9
VOCABULARY
Willingness to PayWillingness to Pay: the maximum price at which he/she would pay for a good.
Individual Consumer SurplusIndividual 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:Total Consumer Surplus: the sum of all the consumer surpluses of all the buyers of a good.
INDIVIDUAL CONSUMER SURPLUS
60
40
20
10
0
Price =$28
Buyer Willingness to pay Price paid Individual Consumer Surplus
David $62 $28 $34
Maggie 55 28 27
Henry 38 28 10
Jamie 18 ---- 0
Anna 11 ---- 0
Maggie’s CS is $55 - 28 = $27
David’s CS is $62 - 28 = $34
Henry’s CS is $38 - 28 = $10
Jamie
Anna
Total Consumer Surplus equals
34 + 27 + 10 = $71$71
60
40
20
10
0
Price =$28
Now, lets suppose a sale drops the price to $14. How has Consumer Surplus changed?
Maggie’s CS is $55 - 14 = $41
Now David’s CS is $62 - 14 = $48
Henry’s CS is $38 - 14 = $24
Now, Jamie has CS, $18 - 14 = $4
Anna
…..Total Consumer Surplus now equals
48 + 41 + 24+ 4 = $117$117
Price = $14
INDIVIDUAL PRODUCER SURPLUS
45
35
25
15
0
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
Chelsea’s
Jerusha’s
Brandon’s
Chris
Hannah
PotentialSeller’s
Sellers Cost
Chris $5
Brandon 15
Chelsea 25
Jerusha 35
Hannah 45
45
35
25
15
0
At a price of $30, Chris, Brandon and Chelsea sell their books.
Chelsea
Jerusha
Brandon
Chris
Hannah
PotentialSeller’s
Sellers Cost
Chris $5
Brandon 15
Chelsea 25
Jerusha 35
Hannah 45
Price = $30
45
35
25
15
0
At a price of $30.
Chelsea’s PS, $25 -30 = $5
Jerusha
Brandon’s PS, $15 - 30 = $15
Chris’s PS, $5 - 30 = $25
Hannah
Total Producer Surplus is
25 + 15 + 5 = $45
Price = $30
CONSUMER SURPLUSCONSUMER SURPLUS
andand
PRODUCER SURPLUSPRODUCER SURPLUS
(when there are many (when there are many potential buyers/sellers)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.
6
5
4
3
2
1
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
P
Q
This results in CONSUMER
SURPLUS, which is the
difference between D
and P
D
P
$2.50
$4.00
- 1.50
$2.50
x 10
$25.00
Price
So, Consumer SurplusConsumer Surplus is the TOTAL BENEFIT consumers receive from
having a market in the good.
6
5
4
3
2
1
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
P
Q
D
P
$2.50
$4.00
- 1.50
$2.50
x 10
$25.00
Price
Rise 2.50Run 10
= .25=
Now, let’s graph this problem using an economist’s demand curve.
6
5
4
3
2
1
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
P
Q
The equation for this line would be:
P = 4 - .25Q
If P=0, then Q=__
If Q=0, then P=__P = 4 - .25 (0)
P = 4 - 0P = 4
0 = 4 - .25Q+ .25Q.25Q = 4 .25 .25
Q = 16
The area between the demand ($4.00) and the price ($1.50) is the CONSUMER SURPLUS.
6
5
4
3
2
1
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
P
Q
Mathematically, P < 4 - .25Q, P > 1.50, Q > 0
Area of a triangle = 1/2bh
Consumer Surplus = 1/2 (10 x 2.50)
= $12.50
So….how much do producers benefit
from this transaction?
6
5
4
3
2
1
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
P
Q
Suppose that a firm is willing to sell the good for $.50 but the price is $1.50 for
10 widgets.
PriceSupply (willing
to sell cost)
PRODUCER SURPLUS is the
difference between supply
curve and the price.
$1.00
Rise 1.50Run 10
= .15=
Let’s graph the supply curve on the old graph.
6
5
4
3
2
1
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
P
Q
P = .15Q
If the price is set at 1.50, then 1.50 = .15Q
.15 .15
10 = Q
S
DPrice
Remember the area of a triangle = 1/2bh, so…..
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5
4
3
2
1
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
P
Q
1/2 (10 x 1.50) = $7.50 =
PRODUCER SURPLUS
S
DPrice
In this case, both consumers and producers gain:
6
5
4
3
2
1
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
P
Q
CS + PS = 12.50 + 7.50 = $20.00
TOTAL BENEFIT TO SOCIETY
S
DPrice
Now, let’s suppose a tax of $.80 is added to the price of gasoline. This adds to the cost of producing the widgets.
6
5
4
3
2
1
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
P
Q
If 0 widgets, then P = 0 + .80 = .80
S
DPrice
If 10 widgets, then P = 1.50 + .80 = 2.30
S1
This changes our point of equilibrium.
6
5
4
3
2
1
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
P
Q
S
D
Price
S1
What happens to consumer surplus?
What happens to producer surplus?What happens to producer surplus?
What does the pink rectangle represent?What does the pink rectangle represent?
TAX REVENUE
The green triangle represents DEADWEIGHT loss, or the amount of sales
you give up with the higher price.
What is the new Quantity?
6
5
4
3
2
1
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
P
Q
S
DPrice
S1
Demand P = 4 - .25Q
Supply P = .15Q
Supply w/tax P = .15Q + .80
4-.25Q+.25Q = .15Q+.25Q+.80
4 - .80 = .40Q +.80 - .80
3.20 = .40Q
4-.25Q =
P = .15(8)
P = 2.00
(8, 2)
.15Q +.80
.40 .40
8 = Q
6
5
4
3
2
1
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
P
Q
S
DPrice
S1
(8, 2)
Consumers pay: $2 per unit, including the tax…..
Producers receive after they pay the tax: $2 - .80 = $1.20
What is the height for the new Consumer Surplus triangle?
6
5
4
3
2
1
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
P
Q
S
DPrice
S1
4 - 2.00 = 2.00* 8 * 1/2 = $8.00 new CS
(compared to $12.50 old CS)
What is the height for the new Producer Surplus triangle?
6
5
4
3
2
1
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
P
Q
S
DPrice
S1
1.20 = h 8 = b
1.820 * 8 * 1/2 = $4.80$4.80 new PSnew PS
(compared to $7.50 old PS)
So…..using the equation 1/2bh (area of a triangle)
6
5
4
3
2
1
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
P
Q
S
DPrice
S1
1/2 * 8 * 1.70 = $8.00 = New CS
1/2 * 8 * .80 = $4.80 = New PS
.80 * 8 = $6.40 = Tax Amount
8.00 + 4.80 + 6.40 = $19.20 Total Benefit
(compared to $20.00 old TB)
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 Consumers avoid paying the whole of the tax by buying less of the product at a lower tax by buying less of the product at a lower
quantity.quantity.
GAINS FROM TRADE:
6
5
4
3
2
1
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
P
Q
S
DPrice
S1
Consumer Surplus = 1/2 * 8 * (4 - 2) = $8.00
Producer Surplus = 1/2 * 8 * (1.20 - 0) = $4.80
Tax Revenue = $. 80 * 8 = $6.40
GAINS FROM TRADE = 8 + 4.80 + 6.40 = $19.20
Deadweight Loss = 20.00 - 19.20 = $ .80
Project by:Project by:
Virginia H. MeachumVirginia H. Meachum
Coral Springs High SchoolCoral Springs High School
Sources:Sources:
Principles, Problems, and PoliciesPrinciples, Problems, and Policies, by Campbell McConnell & , by Campbell McConnell & Stanley BrueStanley Brue
Principles of EconomicsPrinciples of Economics, by N. Gregory Mankiw, 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 Notes by Florida Council on Economic Education and FAU Center for Economic Education (Prof Bill Boshardt)Center for Economic Education (Prof Bill Boshardt)
Notes by Foundation for Teaching EconomicsNotes by Foundation for Teaching Economics
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