Consumer and Producer Surplus Micro: Econ: 13 49 Module Consumer and Producer Surplus KRUGMAN'S MICROECONOMICS for AP* Margaret Ray and David Anderson

What you will learn in this Module: The meaning of consumer surplus and its relationship to the demand curve. The meaning of producer surplus and its relationship to the supply curve. The purpose of this module is to show students how to measure the mutual benefit buyers and sellers enjoy when goods are exchanged. Students will learn how consumer and producer surplus emerges from transactions, how to see this surplus in a graph, and how to compute it.

Consumer Surplus Consumer surplus measures the difference between what a consumer is willing to pay for a good and what he/she actually has to pay. Consumers get all happy and giddy when prices fall. How do we measure this additional happiness? What units would we use to tabulate it? How about a unit of measurement that is easy to observe and compute: money.    Anytime a consumer pays less than his/her willingness to pay, the consumer walks away with that happy feeling that we call consumer surplus.

Willingness to Pay Willingness to pay and the demand curve Willingness to pay and consumer surplus Willingness to pay is found along the demand curve. Basically the WTP numbers can be used as a demand schedule and graphed like a step-wise demand curve. The height of the rectangles represents the WTP. The difference between what the consumer is willing to pay and what the consumer actually pays is the individual’s consumer surplus. It represents the net gain in happiness for the consumer. We measure it in dollars and call it consumer surplus.

Calculating Consumer Surplus If there are many buyers of a good, we can smooth out the demand curve to look like the linear demand curves we typically draw. The total consumer surplus would then be seen as the area below the demand curve (WTP) and above the price. The area of the consumer surplus triangle will be ½ (base) (height).

Calculating Consumer Surplus 1) After doing some market research, Robbie found out that the most sales of laundry service happen around 5$, and that the companies are happy to sell 5 units at that price. If the most any customer is willing to pay is around 10$, what is the consumer surplus? 2) During preparation for the SAT the year 3 students tend to stay in and study, so their clothes don’t get so dirty. 4 loads were done at the normal price. During this week the highest price a student is willing to pay is around 9$. What is the change in consumer surplus from question 1? If there are many buyers of a good, we can smooth out the demand curve to look like the linear demand curves we typically draw. The total consumer surplus would then be seen as the area below the demand curve (WTP) and above the price. The area of the consumer surplus triangle will be ½ (base) (height).

Practice If the price is $10, then what is consumer surplus? What is consumer surplus at a price of $8?   Price FIGURE 1. $30 $10 $8 100 120 Quantity The total producer surplus would then be seen as the area above the supply curve (cost) and below the price. The area of the consumer surplus triangle will be ½ (base) (height).

Producer Surplus Producer surplus measures the difference between the price producers receive for a good and the cost of producing the good. Sellers enjoy higher prices and the benefit they receive is equal to the difference between the price received from the sale and the cost of producing each unit. In fact this cost represents the minimum price the seller must receive to offer that unit to the market. As the price rises higher and higher above this cost, the seller earns more and more benefit: producer surplus.

Cost and Producer Surplus Cost and the supply curve: For each unit of output, producer surplus is the difference between price and the cost of producing that unit. Cost and producer surplus: The total producer surplus would then be seen as the area above the supply curve (cost) and below the price. Producer cost is found along the supply curve. For each unit of output, producer surplus is the difference between price and the cost of producing that unit. The total producer surplus would then be seen as the area above the supply curve (cost) and below the price.

Calculating Producer Surplus The total producer surplus would then be seen as the area above the supply curve (cost) and below the price. The area of the consumer surplus triangle will be ½ (base) (height).

Changes in Price affect Consumer and Producer Surplus If price decreases, Consumer surplus increases (willingness to pay is the same, but the price paid is lower) Producer surplus deceases (costs are the same, but the price received is lower) If price increases, Consumer surplus decreases (willingness to pay is the same, but the price paid is higher) Producer surplus increases (costs are the same, but the price received is higher)

Total Surplus = Consumer Surplus + Producer Surplus Total surplus in the market is equal to consumer surplus plus producer surplus.

Practice Draw a graph representing producer surplus. Draw a graph representing consumer surplus. Draw a graph representing market surplus. The total producer surplus would then be seen as the area above the supply curve (cost) and below the price. The area of the consumer surplus triangle will be ½ (base) (height).

Practice What does consumer surplus measure? How is it calculated? If Bob is willing to pay up to $100 for a ticket to a concert, but actually pays $60, then what is his consumer surplus? The total producer surplus would then be seen as the area above the supply curve (cost) and below the price. The area of the consumer surplus triangle will be ½ (base) (height).

Practice Serena’s company faces the following total cost schedule. Q Total Cost (TC) 0 0 5 $1 7 $3 10 $7 12 $10 17 $15 a. Using the information from the table, derive the supply curve. b. If the price of the good was $7, how units would be produced? What would producer surplus be at this quantity? Show producer surplus on your graph. The total producer surplus would then be seen as the area above the supply curve (cost) and below the price. The area of the consumer surplus triangle will be ½ (base) (height).

The total producer surplus would then be seen as the area above the supply curve (cost) and below the price. The area of the consumer surplus triangle will be ½ (base) (height).

The total producer surplus would then be seen as the area above the supply curve (cost) and below the price. The area of the consumer surplus triangle will be ½ (base) (height).

Reading and Homework Read: 496-499 Homework: Tackle the Test p. 493-494 The total producer surplus would then be seen as the area above the supply curve (cost) and below the price. The area of the consumer surplus triangle will be ½ (base) (height).