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.

1. How Markets Work – Consumer &
Producer Surplus

2. Economic Welfare
Consumer and
Producer Surplus

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. 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. 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. 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. 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. 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)

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