<2.5 CONSUMER & PRODUCER SURPLUS>

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"That's right! Thanks to the forces of demand and supply, the free-market-determined price resulted in both parties receiving a benefit or a monetary 'surplus of benefit' between what they were willing to pay/receive and what they actually paid/received."

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"The difference between what the consumer above was willing to pay (his 'demand curve') and the price they actually paid is referred to as CONSUMER SURPLUS, and if we looked at a demand curve, it would be represented by the area below the demand curve and above the actual price." 

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--TASK--

"Sketch it!" 

"The difference between what the producer above was willing to receive (his 'supply curve') and the price they actually received is referred to as PRODUCER SURPLUS, and if we looked at a supply curve, it would be the area above the supply curve and below the actual price." 

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--TASK--

"Sketch it!"

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"From the diagrams above, we can see that the quantity of CS and PS is linked to the distance between the curve (demand or supply) and the market price, but do they rise or fall in actual $-value?"

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"So what are the most common causes of changes in price?"

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"Below is a table of the most common causes of a change in price and how they impact CS and PS."

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"The reason why some impacts are described as ambiguous is that opposing forces are acting at the same time, so the overall effect is uncertain."

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--TASK 1.--

"Move the 'New price' slider below and find the first 2 scenarios mentioned in the table above and explain the opposing forces that lead to ambiguity."

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“Let’s look at why PS is ambiguous when a minimum price is introduced.”

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“The minimum price raises the price received by producers, increasing PS on the units that are still sold.”

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“However, the higher price causes quantity demanded, and therefore the quantity actually sold, to fall.”

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“Producers therefore lose the PS they previously earned on the units that are no longer sold.”

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“If the gain in PS from the higher price is greater than the loss in PS from fewer sales, total PS rises.”

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“If the loss from fewer sales is greater than the gain from the higher price, total PS falls.”

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“The two diagrams below show these possibilities: one where the gain in PS is larger than the loss, and one where the loss is larger than the gain.”

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"So what is the impact of PED?"

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"Well, PED determines the size of the price rise and the size of the fall in output; hence, if PED is very inelastic, quantity sold barely falls, and producers receive the substantially higher price on almost the same number of units, thus earning higher PS.

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"You can see below that the more inelastic demand curve on the right, means more PS is gained."

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"So what is the impact of PES?"

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PES affects the shape of the supply curve and therefore the size of the PS area lost when output falls after the price increase. We can see below on the right that the more inelastic supply becomes, the greater the PS lost compared to the more elastic supply on the right

--TASK--

"Now do the same for a maximum price and CS."

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"Now let's look at demand shifts!!"

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"We know that when demand increases, the willingness to pay also increases; however, at the same time, the actual price and quantity transacted rise. Intuition tells us that if the supply is very inelastic, this rise in price will be very large relative to the rise in quantity transacted; thus, we would expect the area between the demand curve and the price CS to fall."

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Consumer surplus falls unless the price increase is minimal and the output expansion is substantial—which only happens when supply is highly elastic."

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--TASK--

"Q. Can you think why an increase in demand, which causes a higher price and greater consumption, might not result in greater consumer surplus?

ANSWER

"Because the loss in consumer surplus caused by the higher price paid on existing units may be greater than the gain in consumer surplus from the additional units consumed."

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"Q. Can you think why a decrease in supply, which causes a higher price, lower consumption, and higher production costs, might still result in higher producer surplus?"

ANSWER

"Because the gain in producer surplus from the higher price may be greater than the loss in producer surplus caused by selling fewer units and the increase in production costs."

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"Q. Can you think why an increase in supply, which causes a lower price, greater consumption and lower production costs, might not result in lower producer surplus?"

ANSWER

"Because the gain in producer surplus from selling more units and having lower production costs may be greater than the loss in producer surplus caused by the lower price."

When there is a leftward shift in the supply curve:

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The price rises, which tends to increase PS.

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The quantity sold falls, which tends to decrease PS.

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Production costs increase, which also tends to decrease PS.

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If demand is relatively inelastic, the increase in price may be large enough to more than offset the higher production costs and lower sales, so producer surplus may increase.

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If demand is relatively elastic, the increase in price may not compensate for the higher production costs and lower sales, so producer surplus may decrease.