Consumer Surplus

In the graph below, the supply and demand curves intersect at an equilibrium price of $5 and an equilibrium quantity of 120 products. If the price had been $6, buyers would have purchased 110 products. If the price had been $7, buyers would have purchased 100 products. If the price had been $8, buyers would have purchased 90 products, and so forth. This means that quite a few buyers would have been willing and able to pay more for the product than they are actually paying at the equilibrium price of $5. At the equilibrium price of $5 everyone pays that price, including the buyers who would have been willing to pay a higher price. The difference between how much consumers value a product and how much they actually pay for it at the equilibrium price is called consumer surplus. The consumer surplus in the graph below is illustrated by the shaded triangle.

 

For a video explanation of consumer surplus, please watch:

Producer Surplus

Producer surplus is similar to consumer surplus, but it measures the benefits of a trade for producers. Producer surplus is the difference between the minimum price at which producers would have been willing to produce the product and how much they are actually receiving at the equilibrium price. The producer surplus in the graph below is illustrated by the shaded triangle.  

The total additional benefit to society of trading this product is the sum of consumer surplus and producer surplus. Can you figure out what happens to consumer surplus and producer surplus if both demand and supply increase (both curves shift to the right)?

Because the terms are so similar, it is easy to be confused about the difference between a regular (product) surplus, and a consumer or producer surplus.

A regular surplus (of a product) happens when businesses are charging a price that is higher than the equilibrium price. This happens when the price charged is above the equilibrium price (above the intersection of the supply and demand curves). For example, if a product’s equilibrium price is $5 but a business is charging $6 (perhaps because of a government mandate), then there will be a surplus of products (businesses are producing more than what consumers are buying).

When we discuss consumer surplus, the price charged by businesses is the equilibrium price (it is not higher than the equilibrium). Consumer surplus is the concept that consumers benefit and gain value from buying a product at the equilibrium price. So let’s say that the equilibrium price of a product is $5. If 80 people would have been willing to pay $6 for the product (because they value the product a lot) then the consumer surplus of these 80 people is $1 each (or $80 total). They are valuing the product at $6, but they are paying the equilibrium price of $5 per product.

The concept of producer surplus is the same as consumer surplus, except that it applies to producers who sell the product instead of consumers.

For a video explanation of producer surplus, please watch: