CONSUMER SURPLUS AND PRODUCER SURPLUS: MEANING AND ANALYSIS

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The fundamental principles behind the demand curve are somewhat simple to understand. Many of these principles are followed in our day-to-day lives.

For instance, when you hear that a product is on "special offer" such that its price is reduced. As a rational consumer, you will buy more of the product.

However, for any goods and services, they are always some people who are willing to pay well above the given price to acquire them.

This situation introduced the concept of consumer surplus. Consumer surplus arises because some consumers are willing to pay well above the price of a good.

Consumer surplus may be defined as the difference between the amount consumers are willing to pay and the amount they paid.

In other words, consumer surplus is the maximum price a consumer is willing to pay, minus the actual price they paid.

Suppose, the maximum price you're willing to buy a book is €40, but you end up paying €28 for the book, you have received a consumer surplus of €12.

Graphically, consumer surplus is the triangle above the equilibrium point but below the demand curve.

Consumer and producer surplus
Figure A

It is also important that consumer surplus is, partly, determined by the price.

Generally, a price increase will decrease consumer surplus while a price decrease will increase consumer surplus.

Producer surplus 

This is similar to consumer surplus, except that this is the producer perspective of surplus.

Producer surplus is the amount a producer gets for selling a good, minus the amount he is willing to accept for good.

More appropriately, a producer surplus can be defined as the difference between the minimum price that a producer is willing to accept and the amount that was paid.

Suppose the minimum price the seller of a book would have accepted is €30. But, she ends up selling it for €50. Her producer surplus would be €20.

As you saw in figure A, the producer surplus is the triangle below the equilibrium but above the supply curve.

Taken together, consumer surplus and producer surplus will equal economic surplus.

Economic surplus is also called total surplus and social surplus.

It is important to remember that both economic surplus, consumer surplus, and producer surplus will be at a maximum in equilibrium quantity. Any quantity( apart from equilibrium quantity) will provide a decreased economic surplus.

Impact Of Price Control On Economic Surplus

Price control, as I told you before, is a law enacted to regulate prices. It comes in two flavours: price ceiling and price floor.

Economic surplus is the sum of producer and consumer surplus.

But how do price floors affect economic surplus?

An effective price floor is fixed above the equilibrium price. This means consumer surplus will decrease as higher prices would decrease consumer surplus.

What price floor means for the producer?

It means the producer would be able to sell at a price other than the equilibrium price. It might appear that this would increase producer surplus, but this is not exactly true.

As a producer, to achieve a surplus, you have to sell your product which means consumers would have to purchase enough of your product. 

When the price is set above the equilibrium, there would be excess supply as supply would exceed demand. 

This is because producers would find it profitable to produce goods due to high prices (law of supply).

Consumers, on the other hand, would buy a few of the goods because of the high price(law of demand).

This means the increase in producer surplus due to high prices would be offset by the fact that producers are not able to sell all their goods.

This will create a dead-weight loss or a decrease in efficiency as a result of the fact that goods and services are not priced at equilibrium. 

How does the price ceiling affect economic surplus?

An effective price ceiling is fixed below the equilibrium price. This means producer surplus will decrease as lower prices decrease producer surplus

What does the price ceiling mean to consumers?

A price ceiling would mean that the consumer would be able to buy at a price lower than the equilibrium price.

While this might appear that consumer surplus will increase, this is not exactly correct.

As a consumer, you cannot achieve consumer surplus for goods you're not able to buy.

When the price is set below the equilibrium, there would be excess demand as demand would exceed supply.

So, while more consumers would want to purchase the product because of a lower price, they would not be able to do so because they would be a shortage in the market.

Once again, this shortage will lead to dead-weight loss as gains from price reduction will be outweighed by the loss of consumer surplus caused by a shortage in the market.

In essence, both price ceiling and price floor would lead to a reduction in the economic loss as there would be a dead-weight loss in the market.

One advantage of the price floor is that it transfers some surplus from consumer to producer.

An advantage of the price ceiling is that it transfers some surplus from producer to consumer.

However, both price controls are notorious for creating a dead-weight loss.

Is There Producer Surplus When Supply Is Perfect Elastic?

There is no producer surplus when the surplus is perfectly elastic.

The reason is that the amount a producer gets for selling a good is the same as the amount he is willing to accept for a good when the supply is perfectly elastic.

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