Lecture 5
CONSUMER SURPLUS AND PRODUCER SURPLUS

1. Consumer surplus (CS)

  • Link between negative slope of DD curve and Law of diminishing marginal utility

  • Difference between: The price the consumer is willing to pay for a unit of the good and the market price of the good

Measuring CS

  • Area bounded by the demand curve above and market price below

  • Area of a triangle (if demand is linear)

Effect of market price on CS

  • Higher the price, lower the consumer surplus (why?)


2. Producer surplus (PS)

  • The supply curve is the same as the firm's marginal cost curve

  • Difference between price recd by the seller and the price at which seller is willing to sell a unit of the good

Measuring PS

  • Area bounded by the market price above and supply curve below

  • Area of a triangle (assuming linear supply)

Effect of market price on PS

  • Higher the price, greater the producer surplus (why?)


3. Welfare

  • Welfare is the sum of consumer surplus, producer surplus and govt. revenue (in the case of tariffs):

      W = CS + PS + R

  • In the case of govt. subsidies, R is negative
 Example
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