Consumer Surplus and the Demand CurveProducer Surplus and the Supply CurveTotal Surplus and the Gains from TradeEcon 101: Principles of MicroeconomicsChapter 4: Consumer and Producer SurplusFall 2010Herriges (ISU) Ch. 4: Consumer and Pro d ucer Surplus Fall 2010 1 / 32Outline1Consumer Surplus and the Demand Curve2Producer Surplus and the Supply Curve3Total Surplus and the Gains from TradeHerriges (ISU) Ch. 4: Consumer and Pro d ucer Surplus Fall 2010 2 / 32Consumer and Producer SurplusWe’ve already talked about the notion of efficiency, noting that themarket usually lead to efficient outcomes (Principle #8).We’ve also noted that that there are gains from trade throughspecialization (Principle #5).Some natural questions we might ask are:1Is there a way to measure (i.e., quantify) the gains from trade?2Similarly, when there are inefficiencies in the market (either intentional,as a means of achieving equity, or unintentional, due to market failureor intervention in the market), can we measure the corresponding loss?In this chapter, we introduce the notions of consumer surplus andproducer surplus to answer these questions.Herriges (ISU) Ch. 4: Consumer and Pro ducer Surplus Fall 2010 3 / 32Consumer Surplus and the Demand CurveMarginal Willingness-to-PayThe demand curve provides a graphical depiction of the quantitydemanded of a good at various price levels.Another useful way of looking at the demand curve is as measuringthe consumer’s marginal willingness-to-pay (or MWTP) for a good.The MWTP is the maximum price the individual would be willing topay for the next unit of the good or service.Herriges (ISU) Ch. 4: Consumer and Pro ducer Surplus Fall 2010 4 / 32Consumer Surplus and the Demand CurveAn Example: Joseph’s MWTP for ShoesSuppose we know that Joseph has the following MWTP for shoesQuantity Joseph’s MWTP1 $1202 $1003 $804 $60Notice that the MWTP declines as the quantity goes up.Herriges (ISU) Ch. 4: Consumer and Pro d ucer Surplus Fall 2010 5 / 32Consumer Surplus and the Demand CurveJoseph’s MWTP GraphicallyThe MWTP generates Joseph’s demand curve.Herriges (ISU) Ch. 4: Consumer and Pro d ucer Surplus Fall 2010 6 / 32Consumer Surplus and the Demand CurveConsumer Surplus for the IndividualSo, what is the net gain to Joseph if he buys 2 pairs of shoes at $90per pair?Well, he would have been willing to pay $120 for the first pair, butonly paid $90, for a net gain (or surplus) of $120 - $90 = $30.For the second pair, his surplus is smaller, since he is only WTP $100for the second pair of shoes.In this case, the surplus is $100 - $90 = $10.Joseph’s total consumer surplus is $30 + $10 = $40Graphically, this total surplus is the area above the market price andbelow the individual’s demand curve.Herriges (ISU) Ch. 4: Consumer and Pro d ucer Surplus Fall 2010 7 / 32Consumer Surplus and the Demand CurveJoseph’s Consumer Surplus GraphicallyHerriges (ISU) Ch. 4: Consumer and Pro d ucer Surplus Fall 2010 8 / 32Consumer Surplus and the Demand CurveMore than One ConsumerSuppose we now have several consumers in the market for shoes, withMWTP’sPrice Joseph Michael John Mary1 120 110 90 852 100 70 65 753 80 30 40 654 60 0 15 25Herriges (ISU) Ch. 4: Consumer and Pro d ucer Surplus Fall 2010 9 / 32Consumer Surplus and the Demand CurveIndividual MWTP GraphsHerriges (ISU) Ch. 4: Consumer and Pro d ucer Surplus Fall 2010 10 / 32Consumer Surplus and the Demand CurveThe Market Demand for ShoesThe market will naturally organize itself from highest to lowest MWTPHerriges (ISU) Ch. 4: Consumer and Pro d ucer Surplus Fall 2010 11 / 32Consumer Surplus and the Demand CurveWhat would be the Consumer Surplus with P=70?Herriges (ISU) Ch. 4: Consumer and Pro d ucer Surplus Fall 2010 12 / 32Consumer Surplus and the Demand CurveConsumer SurplusIn a large market, or in a market where quantities need not beintegers, the demand curve is typically drawn as smoothConsumer surplus is still the area above the price and below thedemand curveHerriges (ISU) Ch. 4: Consumer and Pro d ucer Surplus Fall 2010 13 / 32Consumer Surplus and the Demand CurveWhat Happens to CS if Price Falls?Herriges (ISU) Ch. 4: Consumer and Pro d ucer Surplus Fall 2010 14 / 32Pro ducer Surplus and the Supply CurveThe Producer SideNow let’s look at that producer’s side of the problem.The supply curve tells us the quantity supplied at each pricelevel,. . . but it also can be interpreted as indicating the marginal costof producing one more unit.The marginal cost will be the lowest price at which the producerwould be willing to sell the next unit of the good or service.Don’t forget that when we talk about costs, we are referring to theopportunity cost.Herriges (ISU) Ch. 4: Consumer and Pro d ucer Surplus Fall 2010 15 / 32Pro ducer Surplus and the Supply CurveConsider a Single Producer of Shoes - SamQuantity Sam’s MC1 $202 $403 $804 $100Herriges (ISU) Ch. 4: Consumer and Pro d ucer Surplus Fall 2010 16 / 32Pro ducer Surplus and the Supply CurveSam’s Marginal Cost CurveThe MC generates Sam’s supply curve.Herriges (ISU) Ch. 4: Consumer and Pro d ucer Surplus Fall 2010 17 / 32Pro ducer Surplus and the Supply CurveProducer Surplus for the IndividualSo, what is the net gain to Sam if he sells 2 pairs of shoes at $70 perpair?Well, the first pair of shoes cost him $20 to produce, but he soldthem for $70, for a net gain (or surplus) of $70 - $20 = $50.For the second pair, his surplus is smaller, since they cost him $40 toproduce.In this case, the surplus is $70 - $40 = $30.Sam’s total producer surplus is $40 + $30 = $70Graphically, this total surplus is the area above the producer’s supplycurve and below the price.Herriges (ISU) Ch. 4: Consumer and Pro d ucer Surplus Fall 2010 18 / 32Pro ducer Surplus and the Supply CurveSam’s Producer Surplus GraphicallyHerriges (ISU) Ch. 4: Consumer and Pro d ucer Surplus Fall 2010 19 / 32Pro ducer Surplus and the Supply CurveMore than One ProducerSuppose we now have several producers in our shoe market, with MC’sPrice Sam Annie Mark Cathy1 20 40 25 502 40 80 50 603 80 120 75 704 100 160 100 80Herriges (ISU) Ch. 4: Consumer and Pro d ucer Surplus Fall 2010 20 / 32Pro ducer Surplus and the Supply CurveIndividual MC GraphsHerriges (ISU) Ch. 4: Consumer and Pro d ucer Surplus Fall 2010 21 / 32Pro ducer Surplus and the Supply CurveThe Market Supply for ShoesThe market will naturally organize itself from lowest to highest MCHerriges (ISU) Ch. 4: Consumer and Pro d ucer Surplus Fall 2010 22
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