1. 8 Mutual Gains from Trade
We rely on other people to produce things we want:
We are not forced to rely on others.
Why do we voluntarily rely on others through the market process?
We must answer this question:
What are the gains from mutually beneficial exchange?

2. Mutual gains—Simple Example
You buy food from a grocer because she is willing to sell to you at a price that is:
1) less than the value you place on the good, and/or
2) less than your costs of producing it yourself
Therefore, you gain from shopping at grocer (consumer surplus)
Grocer sells to you. You are willing to pay a price that is:
1) more than the cost of producing the good, and/or
2) more than the seller’s next best alternative
Therefore, grocer gains from selling to you (producer surplus)
We are joined together by mutual gains through market exchange

3. The consumers’ perspective
Look at demand side of market and ask:
What is the total value in use
to consumers of the quality Q*?
It is the total area under demand
curve from 0 to Q* (OABQ*)
People usually do not
have to give up all of this
because suppliers will
deliver at a price of P*
Price A B P*
Demand
O Q* Quantity

4. Consumer surplus The gains from trade going to consumers:
Total use value (ABQ*0)
minus
Total expenditures (P*BQ*0)
equals
Consumer surplus (ABP*)
Price A B P*
Demand
Q* Quantity

5. The producers’ perspective
Look at supply side of market and ask:
What is the total cost to producers
of the quantity Q*?”
Three equal descriptions are:
1. minimum you would accept to
produce Q* rather than Q=0
2. sum of the marginal costs
from 0 to Q*
3. area under the supply curve
Producers usually do not have
to settle for MC, because
demanders will pay a price of P*
Price
Supply = MC P* B
Q* Quantity

6. Producer surplus The gains from trade going to the producer:
Total revenue (P*BQ*0)
Minus
Total costs (0CBQ*) [Costs must be recovered or no production.]
Equals
Producer surplus (P*BC)
Price
S = MC P* B C
Q* Quantity

7. Putting It All Together
Price
Demand
Market
Price
Price
Supply A A S S B B P* P* P* B D D C C
Q* Quantity
Q* Quantity
Q* Quantity
There are gains to suppliers and demanders — room for bargaining.
Who gets producer and consumer surplus? Area ABC is up for grabs!