Consumer and producer surplus

Economics AS · The price system and the microeconomy. The idea in plain words, the rules to remember, the mistake to avoid and a worked example, written and checked by Mega Lecture.

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The idea

Consumer surplus is the difference between the price consumers are willing to pay for a good and the price they actually pay. On a diagram it is the area below the demand curve and above the market price.

Producer surplus is the difference between the price producers actually receive and the lowest price at which they are willing to sell. It is the area above the supply curve and below the market price.

Both surpluses change when price and quantity change. A lower price with a larger quantity raises consumer surplus. A higher price with a larger quantity raises producer surplus. How far each one changes depends on the price elasticity of demand and of supply.

Rules to remember

Consumer surplus = what consumers are willing to pay − what they actually pay
Producer surplus = price received − lowest price producers would accept
With straight-line curves each surplus is a triangle: area = ½ × base (quantity) × height (price gap)
Supply increases (demand unchanged): price falls, quantity rises, consumer surplus rises
Demand increases (supply slopes upwards): price and quantity rise, producer surplus rises
A specific tax reduces both consumer surplus and producer surplus
The side of the market that is more price inelastic bears more of the change: inelastic demand means consumers lose most from a tax

Common mistake

Students use the whole price as the height of the triangle. The height is only the gap between the market price and the point where the curve meets the price axis.

Worked example

A straight-line demand curve meets the price axis at $20 and a straight-line supply curve meets it at $2. The equilibrium price is $8 and the equilibrium quantity is 300 units. Find consumer surplus and producer surplus.

Consumer surplus height = $20 − $8 = $12, so area = ½ × 300 × 12 = $1,800.
Producer surplus height = $8 − $2 = $6, so area = ½ × 300 × 6 = $900.

Answer: Consumer surplus is $1,800 and producer surplus is $900.

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