51 Consumer & Producer Surplus
Learning Objectives
- Explain, calculate, and illustrate consumer surplus
- Explain, calculate, and illustrate producer surplus
- Explain, calculate, and illustrate social surplus
Demand, Supply and Efficiency
The familiar demand and supply diagram holds within it the concept of allocative efficiency. One typical way that economists define efficiency is when it is impossible to improve the situation of one party without imposing a cost on another. Conversely, if a situation is inefficient, it becomes possible to benefit at least one party without imposing costs on others.
Efficiency in the demand and supply model has the same basic meaning: the economy is getting as much benefit as possible from its scarce resources and all the possible gains from trade have been achieved. In other words, the optimal amount of each good and service is being produced and consumed.
Consumer Surplus, Producer Surplus, Social Surplus
Consider a market for tablet computers, as shown in Figure 1. We usually think of demand curves as showing what quantity of some product consumers will buy at any price, but a demand curve can also be read the other way. If we choose a quantity of output, the demand curve shows the maximum price consumers would be willing to pay for that quantity. According to the demand curve in Figure 1, if producers wanted to sell a quantity of 20 million tablets, some customers are willing to pay $90 each (see point J.) In other words, a tablet is worth $90 to those customers.
However, that doesn’t mean that those customers will end up paying $90. Figure 1 shows that the equilibrium price is $80 and the equilibrium quantity is 28 million tablets. At that price, each customer who would have been willing to pay $90 for a tablet is getting a good deal. We all know what a good deal is—it’s when you get something for less than you think it’s worth. We don’t have to stop there. If suppliers chose to produce only 14 tables (as shown in point K), we can look at Figure 1 and up to the demand curve to see that some customers would have been willing to pay about $115 for a tablet at this quantity produced. What that means is that this subset of customers got an even better deal at the equilibrium price.
The demand curve shows what consumers are willing to pay for any given quantity of tablets. In other words, the height of the demand curve at any quantity shows what some consumers think those tablets are worth. We can formalize this idea of how good a deal consumers get on a transaction using the concept of consumer surplus.
Since a demand curve traces consumers’ willingness to pay for different quantities, we can define the gain to consumers as the difference between what they would have been willing to pay and the price that they actually paid. At point J, consumers were willing to pay $90, but they were able to purchase tablets at the equilibrium price of $80, so they gained $10 of extra value on each tablet. This is exactly an