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Tutor2u - Consumer and Producer Surplus

This section focuses on consumer and producer surplus – both are measures of economic welfare. Top answers often make frequent reference to these concepts in their answers. Please ensure you can show consumer surplus on a demand and supply diagram and explain how changes in demand or supply might affect consumer surplus. Likewise with producer surplus, be able to show the area of producer surplus on a diagram and analyse the effects of shifts in supply and demand on the revenues / returns to producers in markets.

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Tutor2u - Consumer and Producer Surplus

  1. 1. How Markets Work – Consumer & Producer Surplus
  2. 2. Economic Welfare Consumer and Producer Surplus
  3. 3. What is Consumer Surplus? • Consumer surplus is the difference between the total amount that consumers are willing and able to pay for a good or service (shown by the demand curve) and the total amount they actually do pay (i.e. the market price). • Consumer surplus is indicated by the area under the demand curve and above the market price. Consumer surplus is a measure of the welfare that people gain from consuming goods and services Price Quantity A Q1 Demand Consumer surplus = area ABC B C
  4. 4. Consumer Surplus and Changes in Market Prices The level of consumer surplus changes as the market price for a good or service changes – here are two examples: Price Quantity A Q1 Demand Higher supply costs leads to a rise in market price and a fall in consumer surplus from ABC to DBE B C Price Quantity A Q1 Demand B CS1 S2 Q2 D E D2 S1 Q2 G H I An increase in market demand causes consumer surplus to rise from area ABC to area GHI
  5. 5. Consumer Surplus and Price Elasticity of Demand When demand is inelastic, there is a greater consumer surplus because there are some buyers willing to pay a very high price to continue consuming the product Price Quantity Quantity A A B C Demand Supply Supply Demand Price Low Ped means a high level of consumer surplus Elastic demand means relatively low consumer surplus (ABC)
  6. 6. What is Producer Surplus? • Producer surplus is the difference between what producers are willing and able to supply a good for and the price they actually receive • Producer surplus shown by area above the supply curve and below the market price • Higher prices provide an incentive to supply more to the market (profit motive) Producer surplus is a measure of producer welfare Price Quantity A Q1 Supply B C Producer surplus = area ABC
  7. 7. Producer Surplus and Changes in Market Prices The level of producer surplus changes as the market price for a good or service changes – here are two examples Price QuantityQ2 D1 Lower supply costs cause the market price to fall. Producer surplus rises from area ADB to area FEC B Price QuantityQ1 D1 Q1 S1 Q2 An increase in market demand leads to a higher price and a rise in producer surplus from area ABC to DEC D2 S1 S2 A C D E F A B C D E
  8. 8. Consumer and Producer Surplus in one diagram At the equilibrium, consumer surplus is RSP, producer surplus is QRS Price Quantity Demand Supply P Q R S T O Producer surplus Consumer surplus Consumer and producer surplus are important concepts to use when discussing the effects of different government interventions in markets. Changes in conditions of market supply and demand will bring about changes in the level of consumer and producer surplus (welfare)
  9. 9. Get help from fellow students, teachers and tutor2u on Twitter: @tutor2u_econ
  10. 10. Tutor2u Keep up-to-date with economics, resources, quizzes and worksheets for your economics course.

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