Economic surplus

1
Economic surplus

• Gains and losses with international trade
  Economic Welfare

2
Consumer surplus

• Consumer surplus is the net gain to consumers
  being able to buy a product through a market
• Consumer surplus is the difference between the
  highest price someone is willing to pay for a
  product and the actual market price that is paid,
  then summed over all units that are demanded and
  consumed

3

• The highest price that someone is willing to pay
  for a unit of a product indicates the value that
  the buyer attaches to that unit
• In order to measure consumer surplus, one has to
  have
• Market price, quantity demanded, and slope or
  shape of the demand curve

4
Consumer surplus can then be measured as the area
below the demand curve and above the market-price
line
CONSUMER SURPLUS IS THE AREA GIVEN BY THE
TRIANGE, C
PRICE
a
a the intercept of the inverse demand function,
while P market price, and Q the quantity
consumed at the price P
C
C
Price in the market
P
DEMAND
Q
QUANTITY
5
AS DEMAND SHIFTS OUTWARD TO THE RIGHT, GIVEN THE
SAME MARKET PRICE, THEN CONSUMER SURPLUS INCREASES
CONSUMER SURPLUS IS THE AREA GIVEN BY THE
TRIANGE, C
a
PRICE
C
ALSO RECALL THAT THE AREA OF A TRAINGLE IS ½
TIMES BASE TIMES HEIGHT
DEMAND
C
Price in the market
P
Q
QUANTITY
SO CONSUMER SURPLUS IS THEREFORE, ½(a p)Q
6
Now we impose an actual supply function and
derive the price as the equilibrium price from
the condition that demand supply in the market
A PERFECTLY COMPETITIVE MARKET IS ASSUMED HERE
CONSUMER SURPLUS TRIANGLE
PRICE
NOW, WE HAVE ANOTHER SURPLUS CALLED PRODUCERS
SURPLUS --- THE DIFFERENCE BETWEEN MARKET PRICE
AND THE SUPPLY CURVE
a
SUPPLY
E
P
DEMAND
g
Q
QUANTITY
g IS THE INTERCEPT OF THE INVERSE SUPPLY FUNCTION
7
LETS USE AN ACTUAL DEMAND FUNCTION AND AN ACTUAL
SUPPLY FUNCTION, BUT WITHOUT ANY INCOME EFFECT
(IN DEMAND) AND WITHOUT ANY PRICE OF INPUTS (IN
SUPPLY)

• SUPPOSE THE DEMAND FUNCTION IS THEN GIVEN AS
• QD 18 1.2P, FOR QD QUANTITY AND P PRICE
• LET THE SUPPLY FUNCTION BE GIVEN BY
• QS -2 0.6P, FOR QS QUANTITY AND P PRICE
• WE NOW NEED THE EQUILIBRIUM PRICE AND QUANTITY IN
  THE MARKET
• SET QD QS, OR 18 1.2P -2 0.6P
• SOLVE FOR P BY REARRANGING AS 1.8P 16, OR
• P 16/1.8 8.89
• THEN SUBSTITUTE P8.89 INTO THE DEMAND FUNCTION
  TO GET Q 18 1.2(8.89) 7.33

8
SO EQUILIBRIUM PRICE IS 8.89 AND EQUILIBRIUM
QUANTITY IN THE MARKET IS 7.33

• WE NOW WANT TO CALCULATE THE CONSUMER AND
  PRODUCER SURPLUS VALUES
• INVERSE DEMAND FROM THE DEMAND FUNCTION Q 18
  1.2P IS GIVEN BY P 18/1.2 Q/1.2
• WHICH IS EQUAL TO P 15 0.83Q
• SO OUR INTERCEPT, a, IS NOW a 15
• INVERSE SUPPLY FROM THE SUPPLY FUNCTION Q -2
  0.6P IS GIVEN BY P 2/0.6 Q/0.6
• WHICH IS EQUAL TO P 3.33 1.67Q
• SO OUR INVERSE SUPPLY INTERCEPT, g, IS NOW g
  3.33

9
NOW ON TO CONSUMER SURPLUS AND PRODUCER SURPLUS
GIVEN EQUILIBRIUM PRICE IS P 8.89 EQUILIBRIUM
QUANTITY IS Q 7.33 a 15, AND g 3.33

• CONSUMER SURPLUS ½(15 8.89)(7.33)
• WHICH IS APPROXIMATELY EQUAL TO 22.39
• PRODUCER SURPLUS ½(8.89 3.33)(7.33)
• WHICH IS APPROXIMATELY 20.38

CONSUMER SURPLUS 22.39
PRICE, P
a
Actually Inverse supply
Equilibrium price, P
Actually inverse demand
PRODUCER SURPLUS 20.38
g
Equilibrium quantity Q
QUANTITY, Q
10
THE AREA UNDER THE SUPPLY CURVE AND UP TO A
QUANTITY SUPPLIED OF Q IS THE PAYMENT TO VARIABLE
INPUTS (VARIABLE COSTS) --- SO THE PRODUCER
RECEIVES A SURPLUS OVER VARIABLE COSTS ---
PRODUCERS SURPLUS
CONSUMER SURPLUS AREA aEP
PRICE
a
SUPPLY
P IS EQUILIBRIUM PRICE
E
P
SUPPLY DEMAND AT POINT E
DEMAND
g
PRODUCERS SURPLUS AREA gPE
QUANTITY
Q
Q IS EQUILIBRIUM QUANTITY