Consumer and producer surplus

Consumer surplus refers to the monetary profit acquired by consumers on purchasing a product for a price which is lower than the highest price that they would be willing to give. On the other hand, producer surplus is the value of the benefits acquired by producers while selling a product at a market price which is higher than the least that they would be willing to sell for. Together, these two create an economic surplus which plays a major role in Economics.

Definition Of Consumer Surplus

Consumer surplus is defined as the difference between the total amount that consumers are willing and able to pay for a good or service (indicated by the demand curve) and the total amount that they actually do pay (i.e. the market price). 

For instance, if you would pay $30 for a meal, but can buy it for $20, your consumer surplus is $10.

How Does The Elasticity Of Demand Affect Consumer Surplus?

What exactly does elasticity of demand mean?

In the simplest words, the effect of a change of price on the quantity demanded is called the elasticity of demand. Consumer surplus is affected by the elasticity of demand as follows:

1. When the demand for a good or service is perfectly elastic:

In this case, the price that people are willing to pay is exactly equal to the market price of a product. Hence, the consumer surplus is zero.

2. When the demand is perfectly inelastic:

When the demand is perfectly inelastic, the consumer surplus becomes infinite. In this situation, the quantity demanded remains the same irrespective of the price. This happens in the case of certain products that have no obvious substitutes like any life-saving product where a consumers' willingness to pay will be extremely high.

As a matter of fact, most of the demand curves in markets are assumed to be downward sloping. When demand is inelastic, there are a lot of consumers who are ready to buy goods or services at a price higher than what they expected to pay, and that’s what the businesses tend to make the most of this opportunity. They often raise prices when demand is inelastic and eventually turn consumer surplus into producer surplus!

Consumer Surplus And Marginal Utility Theory

Economists all around the globe utilize marginal utility theory to determine what quantity of additional products are the customers willing to buy. Marginal utility helps quantify the additional satisfaction that a consumer may experience on acquiring an additional good or service. Consumer surplus is based on the economic theory of marginal utility. Generally, the higher the amount of a good or service the consumers have, the less they tend to spend for its additional amount. In other words, the marginal utility of a consumer who acquires more and more of a good or service eventually declines.

What Is Producer Surplus?

Now that we have known what consumer surplus is let's switch to another, similar concept - producer surplus. In economics, producer surplus defines the difference between the amount that a producer receives from the sale of a good and the lowest amount that a producer finds acceptable for that product. The higher the difference between the two prices, the greater the benefit to the producer.

Consumer surplus can be considered as a gain for the consumers while producer surplus is a benefit for the producer. The two together create an economic surplus.

How To Calculate Consumer And Producer Surplus?

Here’s how you calculate consumer and producer surplus easily.

Consumer Surplus:

The area under the demand curve that represents the difference between what a consumer is willing and able to pay for a product and what the consumer actually ends up paying, is consumer surplus. The formula used for calculating it is:

      1/2 base x height

If the price that a consumer is willing to pay is more than the market price, consumer surplus is positive.

Producer Surplus:

This is the area under the supply curve that represents the difference between the expected selling price of a product and what the producer sells that particular product for it for. The formula for calculating producer surplus is:

     1/2 base x height

How Free Trade Affects Consumer And Producer Surplus?

Free trade means a reduction in tariffs. It leads to lower prices for consumers and an increase in consumer surplus. Reduced tariffs further mean decreased or reduced import charges which lower the dependency on domestic producers. Now that importing goods and services is not a problem due to minimal import charges, people would prefer importing products rather than depending on domestic producers. So, these producers would slow down the production of their goods. This indicates a decline in producer surplus for domestic producers.

Example Of Consumer And Producer Surplus

One of the best examples of consumer and producer surplus can be that of airline tickets. For instance, you are planning a vacation to your dream destination, say, Rome, during your upcoming vacations. Suppose, you buy an airline ticket for a flight to Rome for $150. However, you were expecting the tickets to cost around $310. You were even willing to pay the same. In this case, the difference between the expected price and the one that you paid i.e. $160 represents your consumer surplus.

So, that was an example of consumer surplus. Now, let’s take the same example for producer surplus. The airlines know that the demand for flight tickets to Rome will increase during the upcoming vacation and that people will be willing to pay higher prices. As a result,  they raise their ticket prices to $380 each as your vacation approaches near. That's how consumer surplus will eventually be turned into producer surplus.

So by raising the ticket prices, the airlines are taking consumer surplus and turning into producer surplus or additional profits.

What happens to consumer and producer surplus when there is a price ceiling?

Price ceiling limits the maximum price that can be charged for a product or service. An effective price ceiling will lower the price of a good, eventually decreasing producer surplus. Though a lowered price means a decreased cost price for the consumers, it would mean a decreased available supply for sale from producers. This decrease further causes a decline in any benefits gained by the consumers. This eventually translates into a net decrease in total economic surplus.

That’s what consumer surplus is all about. Quite complicated, isn’t it? Well, the students pursuing a higher degree in Economics know this better. Are you too one of those students who is losing sleep juggling with academic writing tasks on topics like & ldquo;Consumer surplus ” and “Producer surplus”, exam stress, and hectic academic schedule at the same time? Stress no more! You can simply refer to these books from the top experts:

• Book 1

Fundamentals of Managerial Economics By Mark Hirschey (published by Cengage Learning, 2008)

• Book 2

Price Theory and Applications: Decisions, Markets, and Information By Jack Hirshleifer, Amihai Glazer, David Hirshleifer (published by Cambridge University Press, 2005)

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