Consumer & Producer Surplus (HL IB Economics)

Revision Note

Author

Steve Vorster

Expertise

Economics & Business Subject Lead

Consumer & Producer Surplus

Consumer surplus is the difference between the amount the consumer is willing to pay for a product and the price they have actually paid
- E.g. If a consumer is willing to pay £18 to watch a movie and the price is £15, their consumer surplus is £3
Producer surplus is the difference between the amount that the producer is willing to sell a product for and the price they actually do
- E.g. if a producer is willing to sell a laptop for £450 and the price is £595, their producer surplus is £145

A market diagram illustrating consumer and producer surplus

Diagram Analysis

The area between the equilibrium price and the demand curve represents the consumer surplus in the market (ABP_e)
- The consumer surplus lies underneath the demand curve
The area between the equilibrium price and the supply curve represents the producer surplus in the market (CBP_e)
- Producer surplus lies above the supply curve
When the market is at equilibrium the producer and consumer surplus are maximised
Consumer surplus + producer surplus = social/community surplus
- Any disequilibrium reduces the social surplus

How Market Changes Affect Producer & Consumer Surplus

Any change to a non-price determinant of supply or demand will cause a shift in the relevant curve
This shift will change the consumer and producer surplus in the market

1. An increase in supply

1-2-8-changes-to-consumer-_-producer-surplus---supply-increases_edexcel-al-economics

A non-price determinant of supply has changed and the diagram on the left shows the resulting change to consumer surplus while the diagram on the right shows the change to producer surplus

Diagram Analysis

Prior to the change in supply
- Consumer surplus was equivalent to ACE and producer surplus was equivalent to ACF
- Social surplus was equivalent to ECF
After the change, supply increased from S₁→S₂
- Consumer surplus is now equivalent to BED and producer surplus is equivalent to BDG
- Social surplus is equivalent to DEG
Both the consumer surplus and producer surplus have increased as a result of the increased supply in the market

2. An increase in demand

1-2-8-changes-to-consumer-_-producer-surplus---demand-increases_edexcel-al-economics

A non-price determinant of demand has changed and the diagram on the left shows the resulting change to producer surplus while the diagram on the right shows the change to consumer surplus

Diagram Analysis

Prior to the change in demand
- Producer surplus was equivalent to ACE and consumer surplus was equivalent to ACF
- Social surplus was equivalent to ECF
After the change, demand increased from D₁→D₂
- Producer surplus is now equivalent to BED and consumer surplus is now equivalent to BDG
- Social surplus is equivalent to DEG
Both the producer surplus and consumer surplus have increased as a result of the increased demand in the market

Exam Tip

Understanding changes to consumer and producer surplus is useful when analysing the impact of government intervention such as indirect taxes, subsidies and price controls.

In essay responses, even if it is not explicitly mentioned, you can refer to these concepts when evaluating dynamic (changing) markets and the impacts on different stakeholders. It demonstrates excellent economic knowledge and analysis.

Calculating Consumer & Producer Surplus from a Diagram

Producer and consumer surplus can be calculated from a diagram using a standard formula for calculating the area of a triangle

$Producer or consumer surplus = \frac{b x h}{2}$

The following steps should be applied to each calculation
- Identify the current equilibrium price
- Draw a horizontal line from it to the Y axis
- Ensure that both the demand and supply curves pass through the Y axis so as to complete the two surplus triangles
- Using the formula, calculate the producer surplus from the triangle which lies below the equilibrium price (area above the supply curve)
- Using the formula, calculate the consumer surplus from the triangle which lies above the equilibrium price (area beneath the demand curve)
It is also possible to calculate a change to consumer or producer surplus following a specific event
- In the diagram below, assume that rice farmers in Vietnam start using a new genetically modified seed which increases yields (output)

Calculating producer or consumer surplus from a diagram after the introduction of new technology increases output

Diagram Analysis

1. Consumer surplus in diagram on the left

The initial equilibrium is found at point C
The line AC separates the original consumer surplus from the producer surplus
Consumer surplus before the new seed = ACE

$Consumer surplus before the new seed = \frac{b x h}{2} Consumer surplus before the new seed = \frac{(AC) x (AE)}{2}$

The application of the seed technology shifts the supply curve to the right, resulting in a new equilibrium at point D
The line BD separates the new consumer surplus from the new producer surplus
Consumer surplus after the new seed = BDE

$Consumer surplus after the new seed = \frac{b x h}{2} Consumer surplus after the new seed = \frac{(BD) x (BE)}{2}$

2. Producer surplus in diagram on the right

Follow the same process as above
Producer surplus before the new seed = ACF

$Producer surplus before the new seed = \frac{b x h}{2} Producer surplus before the new seed = \frac{(AC) x (AF)}{2}$

The application of the seed technology shifts the supply curve to the right, resulting in a new equilibrium at point D
The line BD separates the new consumer surplus from the new producer surplus
Producer surplus after the new seed = BDG

$Producer surplus after the new seed = \frac{b x h}{2} Producer surplus after the new seed = \frac{(BD) x (BG)}{2}$

Worked Example

Australia has the highest taxes on cigarettes in the world. At the current market equilibrium, the price of a pack of 30's is AU$50 and is comprised of the components shown in the table below

Table 1

Components	Amount AU$ /30s pack
Selling price	50
Cost for suppliers	12
Profit for suppliers	3
Indirect tax	35

Figure 1 illustrates the market for cigarettes in Australia. D represents the demand for cigarettes in thousands of 30s packs a day. S + t represents the supply (incorporating the effects of the indirect tax) of thousands of 30s packs a day.

Figure 1

ibdp-economics---calculating-consumer-surplus

a) On figure 1, draw the market supply curve without the indirect tax having been added [2]

Answer:

Step 1: Identify the indirect tax from the table

AUD$ 35 per box of 30s

Step 2: Choose 2 quantity points and use them to draw in the original supply curve

Quantity points identified at AUD$ 35 less - 150, 000 and 550,000 - and draw the supply curve [2 marks]

ibdp-economics---figure-2-calculating-consumer-surplus

b) Using figure 1 and your answer to a), calculate the loss in consumer surplus as a result of the imposition of the indirect tax [2]

Answer:

Step 1: Identify the area on the diagram which represents the loss of consumer surplus and draw gridlines to mark it out

Draw gridlines to identify the two equilibrium points - price and quantity

Area A and B represent what has been lost from the overall original consumer surplus

ibdp-economics-figure-3---calculating-consumer-surplus

Step 2: Calculate the area of A and B

$Loss of consumer surplus = (L x W of A) + \frac{b x h of B}{2} Loss of consumer surplus = 400, 000 x (50 - 20) + \frac{150, 000 x (50 - 20)}{2} [1 mark] Loss of consumer surplus = 12, 000, 000 + 2, 250, 000 Loss of consumer surplus = AUD $ 14, 250, 000 [2 marks for the correct answer]$

Remember to read the units from the bottom of the graph and include them in your calculations. In this case they are presented in '000s. Also remember to include the correct unit for surplus calculations - it is always a monetary unit and in this case its is AUD$

Allocative Efficiency

Efficiency is a key concept in economics
Economists generally identify two types of efficiency - productive efficiency and allocative efficiency

An Explanation of Productive and Allocative Efficiency

Allocative Efficiency	Occurs at the level of output where the marginal utility (marginal benefit) = marginal cost (MB = MC) At this point, resources are allocated in such a way that consumers and producers get the maximum possible benefit No one can be made better off without making someone else worse off There is no excess demand or supply
Productive Efficiency	Occurs at the level of output where average costs are minimised There is no wastage of scarce resources and a high level of factor productivity

Using the ideas of marginal utility (marginal benefit) and marginal cost, we can label the community surplus diagram slightly differently so as to reflect the benefits received by producers and consumers

A diagram that reflects the maximisation of community surplus (allocative efficiency) when the marginal benefit equals the marginal cost

Diagram Analysis

The demand curve represents the marginal benefit (MB) to the consumer
The supply curve represents the marginal cost (MC) to the producer
The market is in equilibrium at P_eQ_e
Any change to the allocation of resources in this market will make either the consumer or producer worse off (excess demand or excess supply would occur)
This market is allocatively efficient when MB=MC
Community surplus is maximised at the point of allocative efficiency

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Consumer & Producer Surplus (HL IB Economics)

Revision Note

Consumer & Producer Surplus

Diagram Analysis

How Market Changes Affect Producer & Consumer Surplus

1. An increase in supply

Diagram Analysis

2. An increase in demand

Diagram Analysis

Exam Tip

Calculating Consumer & Producer Surplus from a Diagram

Diagram Analysis

1. Consumer surplus in diagram on the left

2. Producer surplus in diagram on the right

Worked Example

Allocative Efficiency

Diagram Analysis

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Author: Steve Vorster