Microeconomics in Modules and Economics in Modules Third

Microeconomics in Modules and Economics in Modules Third Edition Krugman/Wells Module 11 Consumer and Producer Surplus

What You Will Learn 1 2 The meaning of consumer surplus and its relationship to the demand curve The meaning of producer surplus and its relationship to the supply curve. 2 of 22

Consumer Surplus and the Demand Curve • A consumer’s willingness to pay for a good is the maximum price at which he or she would buy that good. • Individual consumer surplus is the net gain to an individual buyer from the purchase of a good. It is equal to the difference between the buyer’s willingness to pay and the price paid. 3 of 22

The Demand Curve for Used Textbooks Price of book Aleisha $59 Brad 45 Claudia 35 Willingness to pay Aleisha Brad $59 Claudia 35 Darren Edwina 25 45 10 Darren 25 Edwina 10 D 0 Potential buyers 1 2 3 4 5 Quantity of books A consumer’s willingness to pay for a good is the maximum price at which he or she would buy that good. 4 of 22

Willingness to Pay and Consumer Surplus • Total consumer surplus is the sum of the individual consumer surpluses of all the buyers of a good. • The term consumer surplus may refer to either individual or total consumer surplus. 5 of 22

Consumer Surplus in the Used Textbook Market 6 of 22

Consumer Surplus in the Used Textbook Market Price of book Aleisha’s consumer surplus: $59 – $30 = $29 $59 Aleisha 45 Brad’s consumer surplus: $45 – $30 = $15 Brad Claudia’s consumer surplus: $35 – $30 = $5 35 Claudia 30 Price = $30 25 Darren 10 The total consumer surplus given by the entire shaded area—the sum of the individual consumer surpluses of Aleisha, Brad, and Claudia—is equal to $29 + $15 + $5 = $49. Edwina D 0 1 2 3 4 5 Quantity of books 7 of 22

Consumer Surplus Price of i. Pad The total consumer surplus generated by purchases of a good at a given price is equal to the area below the demand curve but above that price. Consumer surplus Price = $500 D 0 1 million Quantity of i. Pads 8 of 22

How Changing Prices Affect Consumer Surplus • A fall in the price of a good increases consumer surplus through two channels: – It provides a gain to consumers who would have bought at the original price. – It provides a gain to consumers who are persuaded to buy by the lower price. 9 of 22

Consumer Surplus and a Fall in the Price of Used Textbooks Price of book $59 Increase in Aleisha’s consumer surplus Aleisha Increase in Brad’s consumer surplus 45 Brad Increase in Claude’s consumer surplus Claudia 35 30 Original price = $30 Darren 25 New price = $20 20 10 Edwina Darren’s consumer surplus D 0 1 2 3 4 5 Quantity of books 10 of 22

A Fall in the Market Price Increases Consumer Surplus Price of i. Pad Increase in consumer surplus to original buyers $2, 000 Consumer surplus gained by new buyers 500 D 0 200, 000 1 million Quantity of i. Pads 11 of 22

Economics in Action A Matter of Life and Death • Each year, about 4, 000 people in the United States die while waiting for a kidney transplant. • The United Network for Organ Sharing is devising a new set of guidelines whereby kidneys would be allocated on the basis of greatest net benefit, where net benefit is measured as the increase in lifespan from the transplant. • This would increase recipients’ extra years by 11, 000. • The “net benefit” concept is like consumer surplus: the individual consumer surplus generated from getting a new kidney. 12 of 22

Producer Surplus and the Supply Curve • A potential seller’s cost is the lowest price at which he or she is willing to sell a good. • Individual producer surplus is the net gain to a seller from a sale. It is equal to the difference between the price received and the seller’s cost. • Total producer surplus in a market is the sum of the individual producer surpluses of all sellers of a good. 13 of 22

The Supply Curve for Used Textbooks Price of book $45 Engelbert 25 Carlos 15 Engelbert Donna Cost $ 5 15 Betty 25 35 Andrew 45 Carlos Donna 35 Betty Andrew 5 0 Potential sellers S 1 2 3 4 5 Quantity of books 14 of 22

Producer Surplus When the Price of a Used Textbook is $30 15 of 22

Producer Surplus in the Used Textbook Market Price of book S $45 Engelbert 35 Donna Price = $30 Carlos’s producer surplus Betty’s producer Andrew’s surplus producer surplus 30 25 Carlos Betty 15 5 0 Andrew 1 2 3 4 5 Quantity of books 16 of 22

Producer Surplus Price of wheat (per bushel) S $5 Price = $5 Producer surplus 0 The total producer surplus from sales of a good at a given price is the area above the supply curve but below that price. 1 million Quantity of wheat (bushels) 17 of 22

How Changing Prices Affect Producer Surplus • When the price of a good rises, producer surplus increases through two channels: – the gains of those who would have supplied the good even at the original lower price – the gains of those who are induced to supply the good by the higher price 18 of 22

A Rise in the Price Increases Producer Surplus Price of wheat (per bushel) Increase in producer surplus to original sellers Producer surplus gained by new sellers S $7 5 0 1 million 1. 5 million Quantity of wheat (bushels) 19 of 22

Summary 1. The willingness to pay of each individual consumer determines the demand curve. 2. The difference between willingness to pay and price is the net gain to the consumer, the individual consumer surplus. 3. Total consumer surplus in a market is the sum of all individual consumer surpluses in that market. 4. A rise in the price of a good reduces consumer surplus; a fall in the price increases consumer surplus. 20 of 22

Summary 5. The cost of each potential producer, the lowest price at which he or she is willing to supply a unit of that good, determines the supply curve. If the price of a good is above a producer’s cost, a sale generates a net gain to the producer, known as the individual producer surplus. 6. Total producer surplus, the sum of the individual producer surpluses in a market, is equal to the area above the market supply curve but below the price. 21 of 22