Micro CHAPTER 2.6:

Market Equilibrium and Producer & Consumer Surplus

CHAPTER SUMMARY

Market equilibrium happens at the point (price & quantity) where the demand curve and the supply curve for a certain good cross. At this point, everything that producers make is bought by consumers, and all the consumers who were willing to pay a certain price for the good are able to buy it. Because of this, we also call the equilibrium price the market-clearing price. Generally, a free market will eventually settle around this price and quantity until there is a change in demand or supply. It looks like this on a chart:

When a market is in equilibrium, there are some consumers who benefit the most. For example, let's say I really love pizza. I would be willing to pay 500k for a good pizza, but the equilibrium price is only 200k. That means that, even though I only have to pay 200k, I get 500k of utility. This leaves me with a marginal net benefit of 300k. All the people who would have been willing to pay more than the equilibrium price receive marginal net benefits, just like me. The total of all this extra utility we receive is called consumer surplus (surplus = extra). The consumer surplus is represented in the green area of the chart below - the area between the demand curve (the prices people would be willing to pay) and the actual price level. To calculate the consumer surplus, we simply need to calculate the area of the triangle.

Similarly, there were some producers who were willing to sell pizza for as cheap as 50k, but because the equilibrium price was 200k, they got an extra 150k more than they needed. This is called producer surplus, and can be seen on the chart below. Just like with consumer surplus, to find out the total producer surplus, we just need to find the area of the triangle.